INTERNATIONAL ECONOMIC & ENERGY WEEKLY

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP97-00771R000706940001-6
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 38
• Document Creation Date: December 22, 2016
• Document Release Date: October 19, 2010
• Sequence Number: 1
• Publication Date: April 13, 1984
• Content Type: REPORT

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Directorate of
Intelligence
~~6 6~;Pc~
International
Economic & Energy
Weekly
DI !EEW 84-015
13 April 1984
Copy 6 8 4
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Secret
International
Economic & Energy
Weekly
13 April 1984 25X1
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Synopsis
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Persnective-US Involvement in China's Energy Sector
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OEA
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Energy
International Finance 25X1
Global and Regional Developments
National Developments 25X1
11 ~ummit Issues: Big Six Interest Rates
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17
/ E is Mili
tary: Im
pact of E
conomic Difficultie
s
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NESA
33 Nigeria: Running Short of Time
37
China: Energy and Economic Growth
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Comments and queries regarding this publication are welcome. They may be 25X1
directed t Directorate of Intelligence,
Secret
13 April 1984
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Secret
Weekly
International
Economic & Energy
Synopsis
Perspective-US Involvement in China's Energy Sector
Summit Issues: Big Six Interest Rates
recovery
We believe that the present high level of real interest rates is holding back the
economic recovery in Western Europe and retarding economic growth in Japan
and Canada. Both nominal and real interest rates in the Bix Six countries
presently are higher than the rates that existed at the start of the 1976
17 Egypt's Military: Impact of Economic Difficulties
Egypt's tight foreign financial situation has led to a guns-versus-butter debate
within the Cabinet, and President Mubarak already has requested bilateral
debt relief on military loans from the United States. A debt crisis could
threaten Egypt's longer term military modernization progra
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33 ! Nigeria: Running Short of Time
increased coup plotting are inevitable.
Unless the Buhari government soon puts together a politically and economical-
ly viable austerity program, which we believe is unlikely, domestic unrest and
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37 China: Energy and Economic Growth
Weakness in China's supply of energy has already forced Beijing to make
major changes in .the country's. long-term political and economic policies.
China's need for new technology, both to explore and develop new energy
resources and to improve the efficiency of energy use, is one of the most
important motivations for Beijing to strengthen commercial links with the
Western world, particularly the United States
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13 April 1984
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Secret
International
Economic & Energy
Weekly
13 April 1984
Perspective
US Involvement in China's Energy Sector
President Reagan's visit to Beijing comes at a time when the energy sector is
developing into one of the best. venues for mutual cooperation between China
and the United States.
China has good reasons for wanting to increase the flow of Western technology
and capital into its energy sector. We anticipate, and this is reflected in many
Chinese policy statements, that, even with this new technology, pressures on
China's energy supplies will increase through the rest of the 1980s:
Offshore oil production may not be available soon enough to offset an
expected decline in production from the country's large but mature onshore
oilfields.
Coal production, because it is being counted on to substitute for oil wherever
possible, will be hard pressed to provide the energy needed to fuel economic
growth.
e Electricity shortages, caused by insufficient investment in recent years and
surging demand, may become the most critical short-term constraint to 25X1
Beijing must resolve these and other potentially divisive problems if satisfac-
tory economic growth is to be attained. Since 1978, China has made
exceptional progress in improving the efficiency with which its economy uses
energy. This has allowed fairly rapid economic growth and a large increase in
energy exports despite slow and erratic increases in the production of energy.
Unlike most countries, China has done this without sharp increases in energy
pricesF___~ 25X1
Two important decisions now being debated are whether to reduce or even
eventually eliminate petroleum exports-20 percent of the country's foreign
exchange earnings-and how to build the political consensus that is needed to
increase domestic energy prices sharply. 25X1
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The government's ability to channel energy supplies toward industry should
allow the economy to increase at a modest 4- or 5-percent rate through the
1980s-slower than in the past but faster than that initially planned by
Beijing. We doubt, however, that the much faster growth presently expected
by Beijing for the 1990s can be achieved without putting undue strain on the
energy sector.
The Chinese appear anxious to promote still closer linkages with US energy
firms and will continue to pressure the US Government for maximum latitude
in technology transfer issues. Many Chinese leaders, however, still hope only to
borrow this technology from the West in order to learn it quickly and regain
energy self-reliance in the decade ahead. This is particularly true within
China's very large and politically powerful energy industries
The depth of cooperation with the West-and China's long-term ability to
meet its energy requirements-is critically dependent on large oil discoveries
being made in China's offshore regions. Should the Western firms that are
scheduled to drill dozens of wells this year not find the oil deposits they expect,
China may have to decide between importing oil in the 1990s-at great
expense to the country's international financial position-or returning to the
more self-reliant and isolationist policies of the past.
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13 April 1984
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Briefs
Energy
Oil /Market Trends Despite tension in the Middle East, sluggish oil consumption has kept oil prices
soft in recent weeks. Spot prices for most Middle East crudes are $0.10 to
$0.50 per barrel below official prices, while North Sea and Light African
crudes are at or near official prices. Oil sales in the United States rose during 25X1
the first quarter, reflecting increased industrial activity and colder-than-
normal weather. In contrast, February oil sales in Italy and France dropped by
about 3 percent and 7 percent, respectively, following sharp gains registered in
January. Data from the International Energy Agency indicate inventories fell
by only about 1 million b/d during the first quarter-considerably less than oil
companies had anticipated. If companies attempt to pare high inventories, oil
prices could face renewed downward pressure during the coming months. 25X1
egotiate Oil Contracts prices and terms to renew oil contracts that expired last month. As an added
Ir and Japan Iran is prepared to offer Japanese traders favorable ZDA-I
incentive, Tehran may be willing to increase imports from Japan at the
expense of West Germany and other countries, which are not buying as much 25X1
oil as Tehran expected. Iran's overtures may win over the Japanese, who have
been holding out for price concessions and, to a lesser extent, for opportunities
to increase exports to Iran.F 25X1
Japan should not experience serious problems arranging for the delivery of
Iranian oil, barring an.Iragi attack on Khark Island or Iraqi airstrikes on
shipping in the Persian Gulf. Press reports indicate Tehran has deposited $100
million into a London bank to insure all tankers loading oil at Khark Island.
Iranian insurance coverage and an oversupply in the world oil tanker market
will encourage shippers to continue loading oil at Khark Island. The press
reports that the Japanese are chartering foreign flag vessels to transport
Iranian oil, however, because the Japanese Seamen's Union has refused to load
tankers stopping at Khark Island, following recent Iraqi attacks on shipping.
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OPEC Barter Trade OPEC members are making increased use of barter trade, primarily because
Arrangements ! they fear further oil price cuts could get out of control, and the slump in the oil
i l Arrangements
market has left them short of hard currency.
Libya is marketing 30 percent of its current oil production through barter 25X1
deals.
Iran is trading oil for a wide variety of military and civilian goods.
Nigeria and Great Britain reportedly are negotiating an exchange of 22
million barrels of oil for construction work. 25X1
Iraq has used oil to pay for French weapons.
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OPEC countries also are offering nonpetroleum products in barter agreements.
Ecuador is swapping foodstuffs for industrial and consumer goods. Indonesia
reportedly has exported nonoil products worth $765 million in the past two
years through barter deals. Venezuela is trading finished aluminum for
Jamaican bauxite. The role of barter is likely to expand until the global
economy improves.
United Kingdom Steps In a move to accelerate the pace of onshore oil and gas exploration, the UK
Up Onshore Petroleum Department of Energy has announced a new onshore licensing system that is
Exploration parallel to the licensing procedure for offshore areas. London apparently wants
to explore options that could help offset projected declines in British North Sea
oil production. The government will begin.to offer onshore areas in regular
licensing rounds, possibly beginning this June, rather than on an ad hoc basis.
Moreover, the government will authorize six-year exploration licenses and five-
year appraisal permits. Although the United Kingdom currently produces only
5,000 b/d of oil onshore, prospects of increasing production from areas such as
Wytch Farm-where production is projected to reach 40,000 b/d by 1987-
and lower drilling costs have renewed industry interest in onshore areas.
Canadian Petroleum At the request of Canada's National Energy Board, the Canadian Petroleum
ation Updates Association (CPA}-an independent industry group including most of the
As,Xi
Fo ecast major oil companies operating in Canada-has updated its forecast of
indigenous oil and natural gas supplies through 1995. The CPA estimates that,
under present economic and operating conditions, Canada's oil production
capacity will decline from about 1.5 million b/d in 1984 to 1.2 million b/d in
1995. Conventional crude oil production is expected to decline rapidly over this
period, and, by the mid-1990s, oil sands projects and production from future
tertiary recovery projects probably will account for about one-half of total oil
production. CPA's projection excludes any oil from Canada's "frontier" areas
because of technical, jurisdictional, and fiscal constraints. In addition, the
association forecasts Canadian natural gas supplies to be ample to meet
projected domestic requirements and existing export commitments.
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13 April 1984
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the cruzeiro, continuing fiscal and credit incentives, and major export
promotion campaigns-coupled with rising foreign demand-enabled Brazil to
Brazil's Export-Driven Brazil's vigorous drive to expand exports has begun to yield results, which, if
Gro th Strategy sustained, will help support an economic recovery. Repeated devaluations of
increase its first-quarter 1984 export earnings to $5.6 billion, 21 percent
greater than the same period last year. Manufactured and semimanufactured
goods accounted for the major share of the increase. The Brazilian Govern-
ment hopes that a continued rise in export revenues, helped by large sales of
soybeans and other agricultural products, will soon permit the easing of import
restraints on raw materials and capital goods and spur an industrial recovery
in the second half of 1984.
Peruvian IMF Program
Threatened
We believe Brasilia may use its improved export performance to attempt to ex-
act more generous terms from foreign bankers. in debt talks and thus help
sustain a recovery. Because of the $2.4 billion first-quarter trade surplus, the
government's economic team is more confident that Brazil will achieve the $9
billion trade surplus target under its IMF program and substantially increase
its precariously low foreign exchange reserves
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Mounting political and social pressures -prompted Peruvian President Belaunde
to dismiss Finance Minister Rodriguez Pastor last month and to ease the
government's strict austerity measures. A continuation of'restrictive govern-
ment policies in the wake of last year's poor economic performance-a 12- 25X1
percent decline in GDP and 125-percent inflation-produced a nationwide
general strike and a strong public outcry against the IMF in March. In
response to rising popular opposition to austerity policies, President Belaunde
last week appropriated an additional $120 million in public funds to be used
with foreign development financing for public-sector infrastructure projects.
Moreover, he again reshuffled his Cabinet on 10 April and, we believe, will al- 25X1
international creditors. Lima has received half of the $200 million in new bank
loans arranged last year as a result of its February IMF letter of intent, 25X1
The new initiatives are likely to strain Peru's relations with the IMF and
The remaining $100 million scheduled for
disbursement before the end of May will be in jeopardy if the Peruvians fail to
stick to their IMF program. Despite Lima's assurances, we are skeptical it will
meet its IMF policy targets because the recent budget appropriations probably
will cause the deficit to exceed the IMF ceiling. 25X1
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Global and Regional Developments
EC To Limit Imports of The EC Commission notified the GATT last Friday of its intention to curb im-
US Farm Products ports of US-produced feed grain substitutes that now enter the Community
duty tree. The Commission plans to impose tariffs on corn gluten imports
exceeding 3 million tons and distillers dregs and germ cake imports exceeding
1.5 million tons. Last year the United States exported 3.4 million tons of corn
gluten to the EC, and the American feed substitute sales to the Ten totaled
$500 million. The Commission argues that these cheap imported feeds
aggravate the EC agricultural glut by displacing domestic grain and encourag-
ed for over $3 billion in US exports to the EC in 1983.
The Commission has invoked GATT Article XXVIII, which provides for
consultations with the injured party. As compensation to the United States,
the Community may offer to eliminate the variable levy it now charges on corn
imported for the manufacture of starch. If the United States and the
Community do not reach a compensation agreement within 90 days of GATT
notification and the Community presses ahead and imposes new duties, the
United States will be free to retaliate. Should the EC succeed in raising tariffs
on feed grain substitutes, the move could encourage the Community to lift zero
bindings on other agricultural goods such as soybean products, which account-
Australia Looking To Prime Minister Hawke announced last week that Canberra intends to lower
Cut Auto Protectionism the automobile industry's high protection level to boost the industry's sagging
competitiveness and hold down consumer prices. The Australian auto industry
presently enjoys a 57.5-percent tariff, quotas which restrict imports to 20
percent of the market, and an 85-percent local content requirement for
domestically manufactured passenger vehicles. Hawke's move will trim quotas
and reduce tariffs by two-thirds, down to the average rate of protection for
manufacturing. We believe Hawke will face considerable opposition to the new
policy from the auto industry, organized labor, and even some members of his
Cabinet. He probably will be forced to settle for smaller reductions as he
advances the legislation in the months ahead
stack Government
Policies
Secret
13 April 1984
National Developments
Developed Countries
The Greek business community is in an uproar over a proposed trade law that
would regulate prices and profit margins based on a complex formula involving
interest rates, tax indexes, inflation, and the general state of the economy. The 25X1
law also introduces new distribution and marketing regulations, and establish-
es a state import-export agency. This latest strain in relations between the
government and the business community comes on the heels of a strong
condemnation of government policy by Greek industrialists, who claim the
government is ideologically hostile to private enterprise. The industrialists have
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been careful to avoid directly criticizing Prime Minister Papandreou or
National Economy Minister Arsenis, apparently because they still hope to
influence policy:
Greek private investment has been declining since 1980, and, as the economy
deteriorates, a growing number of private firms are experiencing serious
financial difficulties. With unemployment currently about 8 percent and
rising, the government has responded by taking over several "ailing enter-
prises" to prevent bankruptcies and save jobs. The interventionist policies of
Papandreou, however, have many businessmen convinced that Athens intends
to nationalize nearly all private industry, and the proposed trade bill reinforces
this perception. Without a reverse. in policies, private investment will remain
depressed and economic growth stagnant.
Less Developed Countries
Chilean Economic
Moves
Although Chile's new economic team is publicly calling for only cautious
reflation to avoid a confrontation with international lenders, more expansionist
economic measures are likely to be taken. The Economy Minister has promised
publicly to reduce unemployment without jeopardizing IMF targets by helping
construction and agriculture and providing domestic firms with debt relief.
the Finance
Minister-a political' ally of Interior Minister Jarpa, who favors a quicker
recovery-has privately stated that inflation could be allowed to double to
reduce unemployment.
The reactivation measures publicly announced thus far will decrease unem-
ployment gradually but are unlikely to produce the public perception of a
strong recovery that is necessary to reduce political discontent. More aggres-
sive economic policies, however, could upset negotiations for a $780 million
loan from foreign bankers. Nonetheless, in view of President Pinochet's
strategy to undercut support for the protest movement, we believe the new
economic team is likely to opt for a more rapid recovery and will seek
increased official borrowing to support its efforts
01
nds
A compromise wage agreement initialed 10 April has ended a 26-day
dockworkers' strike, the longest and most costly in Indian history. Roughly
half of India's foreign trade-including exports of perishable cargo and
imports of fertilizer and capital goods-were halted, although military
personnel facilitated unloading of crucial petroleum and edible oil products.
Port congestion resulting from the strike will hinder economic activity fdr
several months.
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Soviet Foreign Trade Recently published Soviet data indicate that the USSR's foreign trade surplus
S rplus.Increases increased last year. Moscow reduced its assistance to the East European
nations by cutting its trade surplus with them. Nonetheless, the Soviets' trade
surplus with Communist countries as a group increased slightly.
A decline in imports from the developed Western countries allowed Moscow to
increase its trade surplus with non-Communist countries, despite the slow
growth of Soviet exports. Soviet purchases of grain and other agricultural
products fell as a result of improved harvests in 1982 and 1983. Most of the re-
duction was in imports from the United States. The USSR was able to
increase export earnings from non-Communist countries for the second year in-
a row, despite a drop in world oil prices. The Soviets raised oil exports to the
West by 150,000 barrels a day to about 1.7 million barrels, primarily by
reexporting oil they obtained from OPEC nations. Arms sales are second only
to oil as a hard currency earner but may have declined for the year because of
a drop in sales during the last quarter.
Soviet Foreign Trade
Exports
Imports
Balance
Exports
Imports
Balance
Total
87.2
77.8
9.4
91.6
80.4
11.2
Communist
47.1
42.5
4.6
50.9
45.5
5.4
Eastern Europe
36.3
33.6
2.7
39.4
37.2
2.2
Other
10.8
8.9
1.9
11.5
8.3
3.2
Non-Communist
40.0
35.3
4.7
40.7
35.0
5.7
Developed West
26.0
26.1
-0.1
26.5
25.3
1.2
Less Developed
Countries
14.0
9.2
4.8
14.2
9.7
4.5
ungarian Economic Hungarian officials have told the US Embassy that some of the new economic
reforms, which are likely to be presented for approval at a party plenum in
mid-April, already have been watered down. Nonetheless, central planners
close to the proposals say that the reforms will give workers more voice in the
selection of managers'and managers 'more freedom to determine prices, wages,
and investment. The proposals are complex, and some party leaders are
concerned about popular reaction to possible higher prices and job losses.
Budapest also sees a need to persuade its allies that its search for greater
Secret
13 April 1984
economic efficiency will not undermine the party's authority.
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Gold To Pay Debts and efforts to restore trade financing from West European sources. Since
North Korea May Sell Recent large gold shipments by P'yongyang may be tied to debt repayment
Chinese Plans To
Transfer S&T
Personnel
defaulting on its debt to the West in the mid-1970s, P'yongyang has used gold
exports to help fund imports from Western countries. In the first quarter of 25X1
1984, North Korea shipped at least 5.8 metric tons of gold worth about $70
million at current market prices to West Germany; this is the largest quarterly
gold shipment by P'yongyang during the past decade.F___1 25X1
North Korea almost certainly will have to resume debt payments to secure
future import financing, and we believe recent gold shipments may be used to
service debts. In the last year, P'yongyang has approached several West
European countries about expanding trade and obtaining economic assistance.
In February, Austria agreed to extend new credits for purchases of power 25X1
plant and steel mill equipment-contingent on P'yongyang's repaying its
outstanding $200 million debt, North Korea
also is reported to have begun making monthly payments on its debt to 25X1
The State Council on 27 March authorized a new plan for transferring
scientists and engineers from government departments to key construction
projects in order to more effectively use skilled personnel. The plan calls for as- 25X1
signing personnel from various ministries, the Chinese Academy of Sciences,
and Liaoning and Jiangsu Provinces to energy, communications, and other
major projects. Most of the first group of 363 scientists, to be transferred this
summer, will be assigned to coal projects. 25X1
The new plan reflects China's need to use scientific and technical personnel to
support economic development. Shortages of skilled technicians have ham-
pered progress on projects, particularly in the more remote minority regions
where China claims that over 60 percent of key construction projects under the
Sixth Five-Year Plan are located. Until now, government departments in
urban areas have refused to transfer scientists even when their talents were un-
derutilized. In implementing the plan, Beijing will face resistance from
scientists reluctant to leave urban areas. Beijing has adopted a number of
incentives to encourage scientific personnel to work in rural and remote areas,
including special salary allowances and the establishment of new schools in 25X1
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Summit Issues:
Big Six Interest Rates
This is the first of several articles that in the
coming weeks will examine economic issues affect-
ing the countries participating in the London Sum-
'
mit on 7-9 June.
We believe that the present high level of real
interest rates is (holding back the economic recovery
in Western Europe and retarding economic growth
in Japan and Canada. Both nominal and real
interest rates in the Big Six countries presently are
higher than the, rates that existed at the start of the
1976 recovery. While nominal rates in the Big Six
are now up an average of about one-half a percent-
age point, real rates are about 4 percentage points
higher on average than they were in 1976. The high
level of real interest rates is related, in part, to large
government budget deficits. If Big Six governments
attempt to reduce budget deficits, real interest
rates might fall but in the short run these countries
probably would suffer lower output and employ-
Interest Rate Trends
Nominal interest rates in the Big Six have been
declining for more than two years, although the
trend in West Germany and Canada appears to
have flattened out over the past few quarters.
Despite the general downward movement, nominal
interest rates remain high by historical standards-
at least 1 percentage point higher than the 1965-83
average
Real interest rates-the more important determi-
nant of investment-are also higher than usual in
the Big Six. In all of the major countries these rates
are several percentage points higher than the aver-
age since 1965. (They are even higher relative to the
rates that existed at the start of the 1976 cyclical
upturn in Western Europe.
? West German real interest rates are presently
about 3 percentage points higher than when the
economy began to recover from the 1974/75
recession. Although the real rate is much less
than it was two years ago, it is still high relative
to the average rate over the 1965-83 period.
? French real interest rates were above 5 percent in
early 1983, but by the fourth quarter had
dropped down to 4 percent. This rate is well
above the - 1.3 percent recorded in the first
quarter of 1976-the beginning of France's mid-
1970s recovery. The current rate is about twice
the average rate experienced in the 1965-83
period.
? The British real interest rate was nearly 6 percent
in early 1983 but has since dropped to 4.4
percent. This is still more than 4 points higher
than at the beginning of the UK recovery in the
third, quarter of 1976. The UK rate is down
substantially from the 7.1-percent peak (fourth-
quarter 1981), but it is roughly 2 to 3 percentage
points higher than the 1965-83 average.
? Italian real interest rates are currently 4.5 per-
cent, far higher than the 1965-83 average and 5.5
percentage points higher than the rate existing in
the beginning quarter of the 1976 recovery.
? Japanese real interest rates at present are the
highest among the Big Six, but the 4-percentage-
point spread between the current rate and the
1976 rate is the second lowest in the group. The
present rate is far above the 1965-83 average.
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Measuring Real Interest Rates
The real interest rate on a loan is usually defined
as the nominal interest rate minus the expected
rate of inflation over the period of the loan.
Unfortunately, price expectations are not measured
directly and must be inferred from other data-
usually the actual inflation rate experienced in the
recent past. There is no general agreement on how
to do this, however, and the results can vary.
depending on the procedure used and on the price
? Measure 3: Expected changes in the inflation rate
are assumed to be reflected in the difference be-
tween the nominal levels of short- and long-term
interest rates. Theory suggests that other factors-
such as a risk premium-also affect the difference
between these two rates, but these other factors are
assumed to equal a constant 1-percentage-point
differential. The real interest rate is calculated by
subtracting the current inflation rate, expected
changes in the inflation rate, and a constant 1
percentage point from the nominal long-term inter-
For this study we assumed that the.GDP deflator
is the best index of inflation. We then considered
three different measures of price expectations and
thus developed three different measures of real
interest rates:
? Measure 1: The expected inflation rate is as-
sumed to equal the actual inflation rate over the
last year. This is the easiest measure to use, but
its concept of price expectations is naive. It
currently tends to give higher estimates of the
real rate than the other measures.
Although we believe Measure 3 best identifies the
perceived level of real interest rates-and have used
it throughout our analysis-we found that all three
measures led to similar conclusions:
? Real interest rates are now considerably higher
than at the beginning of the 1976 recovery.
? Real interest rates are much higher than the aver-
age rate during the 1965-83 period.
? Measure 2: The expected inflation rate is as-
sumed to equal the average inflation rate over
the last four years.
? Canadian real interest rates of almost 6 percent
are down sharply from their peak but remain far
above either the near-zero rate of 1976 or the
long-run average.
Impact on Growth
We believe the present level of real interest rates is
an important factor holding back. economic growth
Secret
13 April 1984
25X1,
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Secret
Big Six: Real Interest Rates, 1965-838 Big Six: Recent Trends in Nominal
Interest Rates, 1980-848
Percentage points
West Germany
-4 -6
10
I.... I.... I .... I''
5 11
I
I 1 1 1 I I I 1 1 1 1 1 1 I I I I I I 1111111111111111
-6 V
- 1U 1965 70 75 80 -y 1965 70 75 80
83 84 8 1980 81 82 83 84
25X1
25X1
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1983 -
Beginnin
of
g
Economic
Recovery in 1976
West Germany 2.2
1.8
8.9
(1981 III)
3.7
1.0
France 1.7
2.0
7.4
(1981 III)
4.0
-1.3
United Kingdom 0.1
1.8
7.1
(1981 IV)
4.4
0.1
Italy 2.6
2.9
7.4
(1981 III)
4.5
-1.0
Japan 2.6
2.5
10.9
(1980 II)
6.8
2.8
Canada 1.6
1.8
10.9
(1981 III)
5.6
0
United States 2.2
2.3
6.9(19821)
5.7
0.1
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Secret
Big Six: Impact of a 3-Percentage-Point Decline Percentage-point change
in Real Interest Rates from baseline
Change in Real GNP
Growth Rate
Change in Real Private
Consumption Growth Rate
Change in Real Fixed
Investment Growth Rate
Change in Unemployment
Rate
1984 1985
1984
1985
1984
1985
1984
1985
Big Six
113 1.1
1.3
0.8
3.4
2.1
-0.4
-0.8
West Germany
113 1.6
1.5
1.0
4.2
4.1
-0.6
-1.5
France
110 1.2
0.8
1.0
3.1
2.0
-0.4
-0.9
United Kingdom
111 0.3
1.7
0.3
3.3
-0.3
-0.3
-0.5
Italy
111 1.4
0.6
1.3
3.0
4.4
-0.1
-0.4
Japan
1~5 0.7
1.3
0.6
2.2
1.1
-0.3
-0.4
Canada
0 1.0
1.5
1.0
7.7
1.5
-0.3
-0.7
15 Secret
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Secret
Egypt's Military: Impact of
Economic Difficulties
Egypt's tight foreign financial situation has led to a
guns-versus-butter debate within the Cabinet, and
President Mubarak already has requested bilateral
debt relief on military loans from the United
States. Foreign payments difficulties and a debt
crisis could threaten Egypt's longer term military
modernization program and restrict benefits for
armed forces personnel. Should Egypt ultimately
be forced to take austerity measures-perhaps un-
der IMF auspices and as part of a debt reschedul-
ing exercise-the government would risk urban
unrest that might test the military's loyalty to
Mubarak. Cairo is trying to avoid these difficulties
by deferring hard decisions, but its options are
becoming increasingly limited.
The Military's Role
The Egyptian military remains the most important
political force in Egypt. Its direct, involvement in
decisionmaking, however, has declined since the
late 1960s, when military officers constituted over
half the Cabinet. Now the officer corps exerts
influence mainly as a powerful silent partner whose
opinion limits the extent to which any President can
redirect Egyptian policy. Mubarak-an Air Force
officer before becoming Sadat's Vice President-
seems inclined to follow the policies that have the
broadest support within the military: a nonradical
approach to domestic problems, a generally pro-
Western albeit still nonaligned foreign policy, and
adherence to the Egyptian-Israeli peace treaty.
Peace with Israel and an emphasis on economic
development have altered the status and objectives
of the armed forces. We believe the military's
present goals include:
? Replacing worn-out and obsolete Soviet equip-
ment with new Western weapons.
I
Importance of the Military
? The military is the ultimate guarantor ofpoliti-
cal order and the source of most of the country's
top leadership. The military also backs up the
police and Ministry of lnteriorforces in the event
of serious domestic unrest.
? By Middle Eastern standards, the Egyptian offi-
cer corps is a stable and professional force. Its
middle-class composition contributes to this sta-
bility by imparting a degree of uniformity to its
social, economic, and political goals. 25X1
? The military is the most disciplined institution in
E t and has a strong sense of corporate identi-
ty. 25X1
? Restructuring the armed forces into smaller,
more mobile units.
Restoring the prestige enjoyed by the armed
forces following the 1973 war. Many Egyptians
now question the need for a large army in the
absence of a direct military threat from Israel.
? Regaining economic and social status for military
personnel. Under Sadat's "Open Door" economic
policies, goods available for top military officers
and only a few others in society-good housing,
cars, and television sets-are now more widely
available.
The Military and the Economy
The Military Budget. Official budget data for
Egyptian FY 1983-84 (July-June) show military
expenditures of $2.5 billion-about 13 percent of
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government expenditures and nearly 9 percent of
GDP. These percentages are well below the peak in
1972, when military spending was 33 percent of
government outlays and 15 percent of GDP. As in
most Third World countries, however, military
spending data are incomplete. The available data
are not broken down into specific categories, and
they appear to omit purchases of foreign equip-
Cairo's attention in recent years has swung away
from the military toward domestic economic con-
cerns. The military's share of the budget has been
shrinking because of the importance placed on
public-sector investment and provision of consumer
subsidies. Nonetheless, the government's budgetary
decisions have not affected imports of weapons, and
the military appears to have considerable freedom
to set its own spending levels.
a select group of Cabinet mem-
bers each year "examines" the military budget; by
implication, these ministers have little power to
influence military spending directly.
Foreign Military Purchases. The Egyptian armed
forces have depended on foreign credits or grants to
finance major arms purchases. In the 1960s and
early 1970s, the USSR provided about $4 billion in
low-interest loans for weapons purchases. As rela-
tions with the Soviets deteriorated, Egypt began to
receive assistance from oil-rich Arab states to fund
procurement of weapons from Western countries.
Starting in 1979, the United States provided long-
term credits or grants under the FMS program.
Most purchases from other Western countries,
particularly France, appear to be financed by
medium-term credits.
Defense Industries and Sales. Military factories
produce small arms, ammunition, spare parts, vehi-
cles, and other equipment for the Egyptian armed
forces and for export. The factories receive operat-
ing subsidies from the government. Cairo is pursu-
ing coproduction arrangements with foreign firms
to produce fighter aircraft and tanks, but the lack
of funding is a major problem.
Egypt exports both armaments produced in its
factories and rehabilitated Soviet equipment from
Secret
13 April 1984
its stockpiles.-We suspect Egypt has sold at least $1
billion, and perhaps considerably more, in arma-
ments since early 1981, primarily to Iraq. These
sales are funded by Saudi and other Arab aid to
Baghdad. Egyptian officials refuse to discuss the
financing of sales, although a senior Central Bank
official implied to a US Embassy officer last year
that the Central Bank does not receive the pro- 25X1
ceeds. We suspect that the military has used a large
share of these earnings for non-US weapons pur-
chases and retains most of the rest, turning funds
over to the Central Bank only when there is
insufficient foreign exchange to service the military 25X1
Civilian Projects. Since the mid-1970s, the Egyp-
tian military has become involved in a wide range
of economic endeavors in an effort to increase its
self-sufficiency and to justify its continued large
size during peacetime. In 1979 the Ministry of
Defense created the National Service Projects Or-
ganization (NASPO) to organize, administer, and
implement these civilian projects. Official Egyptian
reports and press accounts claim, for example, that
NASPO has done significant work on sewer lines
and the telephone system. The military reportedly
now supplies 65 percent of its own food, prints
school textbooks, treats civilians at.military hospi-
tals, operates a pharmaceutical factory, and is
building apartments for military personnel. Presi-
dent Mubarak's frequent visits to projects have
assured wide publicity.
Although military conscripts and noncareer officers
appreciate the opportunities to gain skills and earn.
pay bonuses, senior officers believe that military
participation in agriculture and construction less-
ens the prestige of the armed forces, lowers the
morale of professional soldiers, and diverts atten-
tion from the primary mission of defense. These
activities probably will retain popular support, how-
ever, as long as they remain free of corruption, are
perceived as benefiting the public, and continue to
be viewed as more efficient than the public sector.
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The government has tried to use enhanced perqui-
sites to maintain military morale in the face of
reduced peacetime promotion prospects, the scarci-
ty of housing, the failure of pay to keep pace with
inflation, and the decline in the economic status of
the military relative to other Egyptians. These
perquisites include:
? New apartments for officers on favorable finan-
cial terms.
? A subsidized vehicle purchase program offering
officers new Mazdas or Fiats with no downpay-
ment, no import taxes, and 1-percent interest on
loans.
? Half fare on commercial transportation, and a
proposed shuttle bus system to provide military
personnel free transportation throughout Cairo.
Despite these benefits, we believe most officers and
enlisted men consider themselves undercompensat-
ed in comparison with their civilian colleagues.
According to US Embassy reporting, the armed
forces have had difficulty recruiting and retaining
highly, skilled personnel because much more money
can be made in the private sector or abroad. Many
servicemen have great difficulty supporting their
families on military pay alone.
80 percent of
Army officers with the rank of major or above
pursue some form of outside commercial activity.
Many enlisted men hold second jobs despite formal
prohibitions against this practice, and absenteeism
is a major problem. Many officers seek hardship or
overseas postings to receive the associated bonuses.
Civilian resentment of military perquisites is grow-
ing.
the provision of auto-
mobiles and low- ---cost housing is particularly irritat-
in .
some members of the People's Assembly would
like to discontinue such perquisites, which'they
view as Defense Minister Abu Ghazala's way of
enhancing his popularity in the military at public
Current account balance
-2.4
-2.2
-2.5
Trade balance
-5.0
-5.5
-5.8
Exports, f.o.b.
3.6
3.5
3.6
Oil
2.3
2.2
2.3
Imports, c.i.f.
8.6
9.0
9.4
Net Services
2.6
3.2
3.2
Receipts
5.4
6.3
6.5
Remittances
2.1
2.8
3.0
Suez Canal
0.9
1.0
1.0
Tourism
0.6
0.7
0.7
Other
1.8
1.8
1.8
Payments
2.9
3.1
3.3
0.1
0.1
b Preliminary.
c Estimated.
expense. We believe, nonetheless, that the govern-
ment will try to maintain, and perhaps expand, the
special benefits as long as economic circumstances
permit.
Economic Prospects
Egypt's foreign finances are tight. Official nongold
reserves of about $800 million would cover. barely
one month of imports, but Cairo so far has been
able to avoid debt rescheduling and recourse to the
IMF. The government has limited imports, adjust-
ed exchange rates to attract more worker remit-
tances, and increased both oil production and the
volume of oil exports to offset the impact of lower
prices. Moreover, Egypt has benefited from lower
import prices, particularly for food, and from US
economic and military aid. We project Egypt's
current account deficit in 1984 will be about $2.5
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13 April 1984
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billion-close to the level of the past two years.
With limited foreign exchange reserves and a debt
service ratio already exceeding 30 percent of for-
eign earnings, Cairo will have difficulty putting off
an economic adjustment program much longer.
Imports, particularly of food, will continue to rise,
while slower growth is expected in earnings from
remittances, the Suez Canal, and tourism. An
adjustment program would entail reductions in
government spending and probable hikes in prices
of subsidized energy and food. The Mubarak gov-
ernment fears-with good reason-that these steps
would produce negative political repercussions; ,
memories remain fresh of the 1977 riots in Cairo
sparked by bread price hikes.
An end to the Iran-Iraq war probably would hurt
Cairo's immediate economic interests. Cairo could
lose profitable arms sales to Iraq. Moreover, peace
between Iran and Iraq would enable these countries
to boost oil exports, further depressing world oil
prices. Conversely, Egypt would benefit from
sharply higher oil prices should the fighting s read
and reduce oil exports from the Persian Gulf.
Military assistance from the United States has
enabled Egypt to modernize its armed forces with-
out placing an immediate foreign payments burden
on the economy. In addition, the amount and
quality of US military equipment provided are seen
by Egyptians as a measure of the regime's wisdom
in shifting from reliance on the Soviets to the West.
Since US FY 1979, the United States has provided
nearly $4.6 billion in FMS credits and slightly
more than $1 billion in grants for military pur-
chases. For US FY 1985, the administration has
proposed a military aid program of $1.175 billion,
all of it in grants.
The US assistance program has supplied a wide
range of sophisticated weapons. US equipment
delivered or on order include F-16 and F-4 fighter
Secret
13 April 1984
Egypt: US Foreign Military Million US $
Sales Financing
Total 4,575 2,225
1979-81 1,500 0
1981 supplement 550 0
1982 700 200
1983 900 425
1984 925 425
0 1,175
aircraft, C-130 transport aircraft, CH-47 helicop-
ters, M-60A3 tanks, I-HAWK surface-to-air mis-
sile batteries, air defense radars, and E-2C airborne
warning and control aircraft. Planned purchases
and deliveries of US weapons extend through the
end of the decade and will require continued high
levels of US FMS financing or funds from some
other source.
The FMS loans, however, are generating a new set
of problems. Since March 1983, Egypt has repeat-
edly been in arrears on its interest payments,
although never by more than 60 days. Although
there is a 10-year grace period on principal repay-
ment on these 30-year loans, interest due has risen
to about $380 million in Egypt's current fiscal year.
Although this only accounts for one-tenth of the
total debt servicing burden, the FMS payments
have become the focus of Egyptian debt relief
efforts and a major issue in US-Egyptian relations.
During Mubarak's Washington visit in February,
he requested a moratorium on FMS payments or
rescheduling at lower interest rates. Although he
did not repeat earlier threats to stop FMS pay-
ments in July, he argued that Egypt cannot afford
to repay these loans and still pursue an ambitious
economic development program.
25X1
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Similar requests for military debt relief have been
made of China I which reportedly has resched-
uled-and France-which has not. In addition,
Egypt has not been servicing its roughly $4.0 billion
Soviet military debt since President Sadat unilater-
ally declared a moratorium in September 1977.
Some paymentsI on obligations to Islamic countries
have been frozen since formal ties were severed
following the peace treaty with Israel in 1979.
Domestic Implications
We believe economic problems will make it increas-
ingly difficult for Cairo to simultaneously modern-
ize the military; maintain benefits for military
personnel, pursue an ambitious economic develop-
ment plan, and retain generous consumer subsidies.
There is already an intense debate on military
versus economic priorities within the Cabinet be-
tween Prime Minister Muhi al-Din and Defense
Minister Abu Ghazala. Mubarak's sympathies
probably lie with the military, but we believe he
will expect the military to accept spending cutbacks
more readily than urban consumers. Mubarak
tends to rely on! Muhi al-Din on economic issues,
and the Prime Minister's. opposition to rapid and
extensive economic reforms reinforces the natural
caution of Mubarak, who has no chief economic
adviser and who approaches economic decisions
principally in terms of the short-term political risks
involved. Moreover, civilian economic austerity
measures would risk disturbances that the military
might be reluctant to quell and could test the
Implications for the United States
Egypt's heavy dependence on US military, econom-
ic, and diplomatic support has provided the United
form.
Israel and the need for more rapid economic re- 25X1
States with significant influence over Egyptian
policies. Cairo's ability to be responsive to US
wishes, however, is constrained on subjects that
involve strong counterpressures from domestic and
moderate Arab opinion including relations with
Should economic difficulties generate discontent
within the military or the general population, we
believe Mubarak will have even greater incentive to
resist Washington's recommendations on economic
reforms. In such circumstances, strong pressure for
reform is apt to be counterproductive; Mubarak
will seek to avoid charges that he is subservient to a
foreign power. At the same time, Egypt still will
seek sophisticated US weapons as well as bilateral
relief on FMS interest payments and a continuation
of generous aid. Cairo probably will also expect the
United States to help Egypt by influencing the
IMF, commercial banks, Saudi Arabia, and other
donors to assist Egypt. In the event of a major
economic crisis, there will be a strong temptation-
on the part of the government as well as its 25X1
opponents-to blame the United States for failing
to support Egypt adequately.F___1 25X1
military's loyalty to Mubarak.
Mubarak and the Egyptian' leadership have a con-
siderable stake in keeping the guns-versus-butter
debate confined within the government., Egypt is
expanding political participation-.parliamentary
elections are scheduled for next month-and oppo-
sition politicians will exploit any opportunities to
cite economic mismanagement. A public debate
could raise disturbing questions over the military's
role in the economy and politics.
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Secret
Nigeria: Running Short of Time
Nigeria's three-month-old military regime has done
little to deal with underlying economic problems,
and the deteriorating economy threatens to erode
domestic support for the Buhari government even
before Lagos can begin economic rescue measures.
Creditors remain reluctant to implement any re-
scheduling until !Nigeria reaches agreement with
the International Monetary Fund. The regime has
renewed negotiations with the Fund for a $2.4
billion Extended Fund Facility, but Lagos's unwill-
ingness to devalue remains the major stumbling-
block. While Lagos is lobbying hard among OPEC
members to win Ian increase in its official oil
production quota, it continues to exceed its 1.3
million b/d OPEC quota by about 300,000 b/d.
Unless the Buhari government soon puts together a
politically and economically viable austerity pro-
gram, which we believe is unlikely, domestic unrest
Foreign Financial Picture
Lagos favors an informal rescheduling of its offi-
cially guaranteed short-term arrears, which proba-
bly range between $2 billion and $3 billion. Lagos
is pushing official credit agencies in Paris, London,
Bonn, and Washington for a six-year loan with
two-and-a-half years' grace at 1 percentage point
above LIBOR; credit agencies favor less generous
terms. Lagos also adamantly opposes payment of
Nigeria is attempting to reschedule its $3-5 billion
in unguaranteed trade arrearages as well. Lagos
recently reversed its position and now appears
willing to hold discussions with some 350 uninsured
creditors represented by Morgan Grenfell, a Brit-
ish-based bank, but significant differences over
terms remain. Uninsured creditors want Nigeria to:
? Treat their claims like other medium-term debts.
? Accept a coordinating agent bank to act on their
Nigeria: Foreign Financial Billion US $
Projections, 1984
Without
IMF
Agreement
With IMF
Agreement
and Debt
Rescheduling
Trade balance
5.1
5.1
Exports
15.7
15.7
Oil a
15.2
15.2
Imports b
10.6
10.6
Net services
-3.3
-3.7
-1.4 -1.4
0.1 0.1
Gross interest on external debt
1.6
2.0
Other services
-0.4
-0.4
Current account balance
1.7
1.4
Debt repayments (principal)
2.7
2.7
Short-term arrears
7.5
0
IMF disbursements
0
0.5
Financial gap
8.5
0.8
a Assume oil production of 1.4 million barrels per day in January
and 1.6 million b/d thereafter with oil prices of $30 per barrel and
domestic consumption of 200,000 b/d.
b IMF import estimate for 1984. The government claims-unrealis-
tically in our view-that it will hold imports to $4.6 billion.
? Pay interest on some loans that have not been
serviced for as long as two years.
? Provide assurances that they will be paid when
the notes fall due.
Conflicts over the terms and the validity of some
claims are likely to produce further negotiating
delays, although we continue to believe a compro-
mise-perhaps in conjunction with an agreement
on guaranteed credits-is possible.
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 them to delay addressing critical problems such as
the overvalued naira and trade restrictions.
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We believe the "IMF question" has become a
potentially explosive domestic political issue. There
is little support for an IMF agreement within
Nigeria, and the government has pledged itself not
to take any steps that would "undermine" Nigeria's
sovereignty or independence. Although the govern-
ment may attempt to finesse the issue by agreeing
with the IMF to a phased "adjustment" rather
than a one-shot devaluation, the military fears
devaluation under any guise risks a popular back-
lash. Nonetheless, without an IMF agreement, it is
doubtful Nigeria can reschedule its debts
Lagos may hope a loan from Saudi Arabia and
possibly a loan syndication led by the Hong Kong
and Shanghai Banking Corporation could allow
Nigeria to avoid having to comply with IMF
conditions. Saudi Petroleum Minister Yamani's
visit to Lagos last February and a return visit to
Riyadh by Nigeria's number-two man, Brigadier
Idiagbon, have helped fuel rumors that a Saudi
loan may be in the offing. We have no evidence,
however, that either agreement is close or, in
particular, that Saudi Arabia is willing to commit
the resources needed to help Nigeria out of its
economic mess. Even so, we believe the increasingly
desperate military regime may hope that a Saudi
loan and the Hong Kong-based loan would allow
Secret
13 April 1984
To boost exports, the Buhari government is seeking
an official increase in its OPEC oil production
quota of as much as 500,000 b/d. Production is
already averaging about 1.6 million b/d-300,000
b/d above Nigeria's current OPEC ceiling. Lagos
is lobbying for Saudi and Libyan support for a
higher quota, even though a decision cannot be
made officially until the next OPEC ministerial
meeting in July. In the meantime, OPEC members
have been turning a blind eye to Nigeria's overpro-
duction. Although Lagos has announced it will cut
production back during the second quarter to keep
within its quota, we believe the Buhari government
may be trying to convince the Saudis to come
through with the loan or to give more forceful
support for Nigeria's production quota increase.
Even if Lagos is granted an increase in its OPEC
production quota and is able to sustain increased
output, an IMF agreement and debt reschedulings
still will be essential to begin turning the economy
around. In addition to $5-8 billion in short-term
arrears, debt service on Nigeria's medium- and
long-term obligations will exceed $4 billion this
year. Barring debt relief and extreme import cuts,
Nigeria's financial gap could top $8 billion in 1984.
On the other hand, should Lagos reach agreement
with the IMF and accomplish both reschedulings,
the financial gap would be reduced to under $1
billion, an amount we believe might be covered by
additional borrowings abroad.
Although senior officers now appear to better
understand the gravity of Nigeria's international
financial difficulties and the limited options open to
them, we believe they are more concerned with
finding ways to patch the domestic economy. The
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US Embassy reports that food is available in most
markets, but they selection is often limited and
prices for many staples are now beyond the reach of
the average Nigerian. Prices for rice and chicken,
for example, are three times what they were in late
1983. Drought and lack of foreign exchange to
purchase imports could produce even higher prices
and perhaps even food shorts a some areas over
the next several months.
public services while reintroducing unpopular
school fees and local taxes.
Moreover, the government is unable to point to
better economic times ahead. Buhari, for example,
took a hard line during discussions with the newly
elected labor leadership, noting that Nigeria was
"essentially bankrupt" and that workers could ex-
pect no improvements. Although striking Nigeria
Airways pilots recently backed down when the
government began mass firings, there is little public
Drought-particularly in the northern states-has
accelerated the long-term decline in food output
and contributed to price increases. Grain produc-
tion is down 30 percent from last year, while an
epidemic has ravaged Nigerian cattle herds for the
last 18 months, destroying at least 15 percent of
total stock. Egg and chicken production are down
because of lack of feed grains
Crop losses will hurt the country's processing in-
dustries. For example, about 80 percent of cotton
for the textile industry-Nigeria's largest private
employer-will have to be imported this year. Most
import-dependent industries are operating at 25 to
30 percent of capacity, and many companies have
had to lay off between one-fourth and one-half of
their workers. More businesses will have to close
this year due to the lack of import credits.
Government Moves
The Buhari government's indecisiveness in the face
of worsening economic conditions is rapidly tar-
nishing its image at home as well as abroad. Efforts
to force market prices down and ensure a steady
supply of food have had only marginal and tem o
rary effects, while alienating powerful traders.7
Some stopgap go ernment actions taken to cut
costs and stretch limited foreign exchange earnings
have only made domestic problems worse. Buhari
has ordered that deficit spending cease at both
federal and state levels, forcing governments to lay
off more civil servants and contractors. Many state
employees have faced delays of several months in
salary payments. Local grumbling has increased as
state military governors have been forced to reduce
tolerance for harsh austerity measures.
Buhari also has stated his intention to limit imports
to about $4.6 billion this year-half of last year's
already drastically reduced level. We doubt Nige-
ria will be able to hold anywhere close to this
figure. According to the US Embassy, about $2.3
billion is needed just to pay for food and agricultur-
al raw materials to keep people adequately fed and
industries running. Nigeria needs another $9-10 25X1
billion to import industrial raw materials to reo en
factories and to provide. greater employment.
Buhari recognizes that worsening domestic eco-
nomic conditions-especially growing unemploy-
ment, consumer goods shortages, and rising
prices-could spark domestic unrest and encourage
coup plotting. Lacking ready solutions, the govern-
ment has tried to shift attention from economic
concerns to the financial misdeeds of some 475
former civilian officials now under arrest. Even this
tactic has backfired, according to the US Embassy,
'by raising questions about the financial dealings of
current leaders-including Buhari-when they
served in the previous military government. The
Nigerian press has contributed to a growing xeno-
phobia by sensationalist reporting of supposedly
illegal economic activities by foreign companies
operating in Nigeria. More recently, the govern-
ment also has raised the specter of an invasion
financed by exiled followers of former President
Shagari.
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Although the exact level of support for the regime
is difficult to gauge, the government's failure to
move beyond promises of economic relief is already
raising serious questions among the public and the
military about the government's competence. Ac-
tions taken by senior officers thus far have kept
plotters off balance, but junior- and middle-level
grumbling over their superior's indecisive leader-
ship is likely to intensify as the domestic economy
worsens. Furthermore, the show of senior officer
unity displayed to date is likely to fray as the
government becomes desperate in its search for
economic solutions. Intensifying criticism of the
government's drift soon may tempt some senior
officers to portray Buhari as the problem and could
persuade them that a change at the top is needed.
Secret 36
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Secret
China: Energy and Economic Growth
To address the problem of energy shortages that
have increasingly become an obstacle to China's
economic growth, Beijing is seeking to double by
the year 2000 both energy output and the efficiency
of energy use, hoping to quadruple GNP by that
date without the need for importing energy. Beij-
ing's strategy evolved in the late 1970s when it
became apparent that Soviet-style growth driven by
heavy industry-without the Soviet Union's huge
energy resources-could prove disastrous.
Since 1978 Beijing has dealt with its energy prob-
lems on three fronts: ,
It has attacked the country's wasteful energy
consumption habits by restructuring industry,
closing inefficient plants, and placing quotas on
energy use. Political considerations and a lack of
flexibility in its price system have prevented
China from raising energy prices sharply, the
single most effective measure taken by other
countries to curb energy consumption. Neverthe-
less, the program has been successful; energy
consumption increased by only 2 percent per year
between 1978 and 1982, while industrial growth
averaged slightly more than 7 percent annually.
Higher priority, at least in theory, is now being
given to energy exploration and development, but
Beijing apparently has not been satisfied with
results. There have been few indications that the
long-term deeline.in proven oil reserves has been
stemmed, and capital-intensive hydroelectric and
nuclear projects have been slow to move out of
the planning phase.
Of the most interest to the United States and
other foreign countries, Beijing has opened im-
portant segments of its once highly protected
energy industries to Western and Japanese in-
vestment. In a remarkable turnaround, the Petro-
leum, Coal, and Electric Power Ministries, once
bastions of Mao Zedong's ideology of self-reli-
ance, have become leading proponents of Western
investment in China. Projects already under way
will, in our opinion, foster long-term commercial
links between China and the non-Communist
world. Although China's goals imply 7-percent
annual growth rates for the economy, we. believe 25X1
a 4- to-5 percent annual growth rate is more
likely.
China's Energy Supply
China produced about 700 million metric tons of
coal equivalent commercial energy in 1983, up 5
percent from 1982. Energy output in the past five
years, however, has increased at an average annual
rate of only 2 percent, in marked contrast to the 6-
percent annual growth registered in the preceding
two decades. The steady erosion of coal's share of
energy supply that occurred during 1950-78, how-
ever, has been reversed. Coal's share of energy
output rose from 70 percent in 1978 to 71 percent
in 1983. Petroleum, with output flat for the past six
years, now provides 22 percent of national energy
supply, down about 2 percentage points since 1978.
Hydropower has gained steadily to provide about 5
percent of the country's energy, while natural gas
has declined to only about 2 percent. Although
China ranks third in world energy output, Chinese
per capita energy production ranks in the bottom
one-third worldwide.
China's Sixth Five-Year Plan (1981-85) and less
definite but widely quoted long-range plans indi-
cate that energy output will continue to grow slowly
through the end of the century. Our energy projec-
tions,
fall slightly short of Beijing's general
guidelines for doubling the availability of energy by
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DI IEEW 84-015
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Secret
China's Energy Production a
Total million metric tons, coal 637 632
equivalent
Million metric tons 620 620
Million metric TCE 442 442
Oil
Billion kWh 58.2 65.5
Million metric TCE 24 27
Nuclear power
Billion kWh 0 0
Million metric TCE 0 0
a We use the Chinese definition of coal equivalent energy to
aggregate various energy types. One metric ton of coal equivalent
energy (TCE) is defined as the amount of fuel that is required to
provide 7 million kilocalories of heat energy. It is equivalent to 1.4
666
475
0 36
0 15
the year 2000. They imply growth rates of 3
percent a year through the rest of the.century.
Achievement of these energy production targets
will require a sharp boost in investment. Energy
investment now accounts for about 45 percent of
industrial investment, and Beijing's efforts to con-
trol its overall investment outlays have adversely
affected the energy sector. Beijing reduced state
investment in energy development from 11.4 billion
yuan-roughly $6 billion-in 1978 to only 9.0
billion yuan in 1981 and 10.2 billion yuan in 1982.
Data for 1983, however, indicate a sharp rebound.
Energy investment probably reached close to 13.6
billion yuan for the year, up about 35 percent from
1982. The largest increases went to the electric
power industry.
Secret
13 April 1984
Demand for Energy
China has slowed the rate of increase in energy
consumption in the last five years, despite fairly
rapid economic growth. Energy consumption in-
creased at an annual rate of 2.0 percent from 1978
through 1982 while national income increased at a
6.2-percent rate. This energy elasticity of national
income of 0.32 is in sharp contrast to an elasticity
of 1.47 for the Chinese economy from 1965 to
1978.
Most observers, inside China and in the West,
doubt this low elasticity can be maintained. Much
of the improved energy use between 1978 and 1982
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China: Energy Consumption and
Economic Growth, 1970-1983
Index: 1970=100 I
China: Coal Consumption, 1978-2000
Million Metric Tons
? Other industry Losses
- Household ? Rail
Electricity - Exports
Steel
I I I Iii I I I I I I I
50 1970 72 174 76 78 80 82
was the result of economic restructuring caused by
rapid growth in energy-efficient light industry and
agriculture and very slow growth in energy-inten-
sive heavy industry. Beijing officially attributes
two-thirds of the energy savings to these structural
changes and only one-third to conservation.
Our study of Chinese energy demand-based on
analysis of the key energy-consuming industries-
suggests that th1e Chinese economy will have an
overall energy elasticity of between 0.65 and 0.70
for the remainder of the 1980s and the 1990s-that
is to say that energy consumption will increase
between 65 andl 70 percent as fast as national
income. This is smaller than what is expected for
most major countries and much smaller than Chi-
na's historical record. We are optimistic, however,
only because we believe the Chinese Government
will continue to exert great control over the use of
energy-particularly oil and electricity.
We expect the use of oil to increase only 45 percent
as fast as national income in the 1980s but then rise
to a rate of 80 percent as fast in the 1990s as
opportunities for switching to coal are reduced.
This still will allow substantial growth in the
petrochemical industries. Coal consumption will
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China: Oil Consumption, 1978-2000
?Transportation ? Agriculture
Other =Oil industry
- Electricity . Exports
? Petrochemical
there-will be a definite tightness in the energy
balances that will force Beijing to make tough
decisions in allocating energy supplies. These pro-
jections suggest there will be little room for energy
exports-currently more than 20 percent of Chi-
na's foreign exchange earnings. Unlike the World
Bank, however, we do not believe China will have
to import oil unless the offshore exploration pro-
gram brings on line substantially less than the 50
million tons of annual capacity (1 million b/d)
expected by major oil companies. In the near term,
a shortage of electric power appears to be the most
likely constraint on economic growth.
Economic growth faster than 5 percent would, we
believe, quickly cause serious energy shortages
unless China was prepared to import substantial
volumes of energy. If our estimates of coal, oil, and
electric power demand prove accurate, the 7-per-
cent annual rate of economic growth envisioned by
Beijing would require major adjustments:
? The elimination of oil exports even to the point of
repurchasing-in effect importing-the offshore
oil that the Western oil companies expect to take
out as their profit share.
? Resolving a 100-million-ton shortfall in annual
coal supplies by 1990.
? Coping with a further 15- to 20-percent shortfall
in electricity supplies.
By the same token, long-term annual economic
growth of only 3 or 4 percent would probably not
run into an energy constraint. Energy exports could
be kept at current levels and perhaps even in-
creased.
increase about 75 percent as fast as national in-
come in the 1980s, falling to 60 percent in the
1990s, with a large part of the increase going to the
electric power industry. For electric power itself,
we agree with Chinese estimates that electricity
consumption will increase at the same rate, if not
faster, than national income.
Implications
If China maintains an annual 5-percent economic
growth rate, we foresee no major energy gaps, but
Secret
13 April 1984
Beijing Faces Tough Choices Ahead
Weakness in China's supply of energy has already
forced Beijing to make major changes in the coun-
try's long-term political and economic policies. The
measures taken so far have helped to push China's
economy away from its Stalinist and Maoist heri-
tage and have made it somewhat closer to Western-
style economies. Western capital and technology is
now being employed in ways that the leadership's
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Secret
China: Energy Balances Forecast a
618
666
900
1,150-1,300
618
662
894
1,210
1
5
5
- 60 to 90
104
102
105
150
92
81
97
145
13
21
8
5
Consumption j
257
328
482
786
a Assumes a 5-percent annual increase in national income.
b Includes losses and stockbuilding.
c Includes both capitallrecovery and profit oil.
d Assumes capacity increase of 5 percent per year; fuel is taken into
account in coal and oil'consumption.
e Power demand assumed to increase at least as fast as national
income-5 percent. j
Maoist predecessors would have considered "ex-
ploitationist." Offshore oil is the most dramatic
example, but Western and Japanese firms are
increasingly becoming involved in everything from
onshore seismic surveys to nuclear power develop-
i
We believe China's energy balances will continue
to tighten through the rest of the decade, thus
strengthening China's need to cooperate with the
West. At the same time, Beijing will have to make
difficult and politically divisive decisions. These
may threaten the leadership consensus that has
allowed Beijing to take bold action on the importa-
tion of Western capital and technology and to
accept the unavoidable "capitalist" influences that
come with it. This danger will be intensified if
major programs-such as the offshore exploration
- r 1 1 25X1
effort-are
At the least, hard choices will have to be made in 25X1
several areas over the next decade. In particular:
The relatively modest but steady growth that we
believe is possible without major energy problems
will require Beijing to consider its investment
programs carefully. In the electric power sector,
Beijing must decide whether to emphasize long-
term, capital-intensive hydroelectric and nuclear
power development or faster and cheaper coal-
fired capacity. In oil exploration, it must decide
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Petroleum
13.5
16.4
17.5
18.4
.20.5
Crude oil
11.3
13.4
13.3
13.8
15.2
Products
2.2
3.0
4.2
4.6
5.3
NA
Coal
3.1
4.6
6.3
6.6
6.4
6.4
Exports (billion US $)
Total exports
10.16
13.49
18.94
21.54
23.50
NA
Energy exports
1.34
2.63
4.62
5.01
5.14
NA
Petroleum
1.24
2.45
4.36
4.67
4.79
NA
Crude oil
0.96
1.75
3.01
3.29
3.40
NA
Products
0.28
0.70
1.35
1.38
1.39
NA
Coal
0.10
0.18
0.26
0.34
0.35
NA
Energy share (percent)
13
19
24
23
22
NA
whether to emphasize areas where discoveries can
be exploited quickly or areas-such as the Tarim
Basin-that may have more extensive deposits
but would take decades to exploit. In coal mine
development, Beijing must determine whether to
contin?te the rapid development of small, non-
state-owned coal mines or whether to step up
investment in large, state-owned, mining
operations.
? China's energy prices, by almost all accounts, do
not reflect market realities. To preserve price
stability, Beijing has held energy prices relatively
constant since the 1950s despite clear changes in
domestic and international supply and demand
conditions. Numerous articles in Chinese eco-
nomic journals now attack what their authors see
as poor decisionmaking based upon an irrational
price system. Beijing is formulating a sharply
higher schedule of energy rices
the increases will probably come in stages so they
will not create too large a shock, but obviously
they will not be welcomed by the public.
Secret
13 April 1984
? China's ability to increase oil exports during
1978-82 is remarkable, given the slow growth in
oil output. Crude oil and petroleum products now
contribute over 20 percent of export earnings and
are a major factor behind the country's strong
financial position. Our analysis suggests, howev-
er-and this judgment is increasingly reflected in
Chinese energy journals-that China may have
to phase out oil exports by 1990. This would allow
domestic consumption to rise by the 2-percent
annual rate that we calculate will be necessary
for a 5-percent rate of economic growth.
? An issue that we believe will come to the fore-
front later this decade and in the 1990s is the
limited degree to which China's commercial and
modern energy supplies are allocated to direct
household and personal use. Of the total energy
consumed by households for heating, cooking,
25X1
25X1
25X1
25X1
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Secret
and lighting,lonly 17 percent is provided by what
are considered "modern" energy sources-coal
and electricity. Most of the rest is provided by
agricultural wastes and firewood.
the rural energy situation is "an
exceedingly unfavorable development in China's
rural economy and is of extreme inconvenience to
the peasants'l livelihood" and it
is a matter of "urgency" tom ways to reso ve
the grave shortage of rural energy supplies.
Implications for the United States
China's need for new technology, both to explore
and develop new energy resources and to improve
efficiency, is one of the most important motivations
for Beijing to strengthen commercial links with the
Western world China, we believe, sees the United
States as the best source for much of this technol-
ogy and makes! access to it a pivotal consideration
in its official dealings with the United States. This
technology cant form a relatively stable underpin-
ning for China's opening to the United States.
Beijing did not, for instance, allow the mid-1983
political and economic controversies with the Unit-
ed States to hamper the offshore oil contract
negotiations occurring during the same period.
There are a number of areas in which energy
technology is already forging important commer-
cial links between the two countries:
? Offshore oil, where a dozen US firms are taking
the lead in exploring China's promising South
China Sea continental shelf. If successful, this
exploration will lead to long-term-up to 35
years-commitments by the firms to work in
China.
? Onshore oil, where China. is purchasing US tech-
nology to maintain output at mature fields.
? Technology for the generation and transmission
of electric power, where US firms are becoming
involved in upgrading China's obsolete
equipment.
The coal industry is also creating a demand for
US production equipment.
development
Two areas of potential cooperation-contingent
upon solving difficult investment and political
problems-are hydroelectric and nuclear power
In most of these areas China believes the United
States holds the most desirable technology. US
firms, however, usually meet fierce competition
from West European and Japanese firms. China,
moreover, has proven adept at playing competitors
against each other. This competition will probably
become more intense, particularly over the financ-
ing of energy projects, an area in which the United
States appears at considerable disadvantage.
Despite prospects for an advantageous commercial
relationship for the United States, China's energy
issue could create problems as well. A willingness
to experiment. with more capitalistic, decentralized
economic policies and a general openness to foreign
trade and investment are key features of the gov-
ernment's modernization strategy.
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25X1
25X1
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25X1
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25X1
Beijing's leadership is con-
cerned that, if energy shortages were to retard the
process of economic growth severely, a marked 25X1
change in leadership policy could result. Our analy-
sis suggests, however, that, with carefully chosen
policies that limit the increase in energy consump-
tion, and with only average luck in discovering new
oil resources, China can maintain a reasonable
economic growth rate that will limit the need for
major policy reversals
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