INTERNATIONAL ECONOMIC & ENERGY WEEKLY

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP97-00771R000706990001-1
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 47
• Document Creation Date: December 22, 2016
• Document Release Date: July 14, 2010
• Sequence Number: 1
• Publication Date: May 11, 1984
• Content Type: REPORT

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Directorate of Secret
Intelligence
International
Economic & Energy
Weekly
DI IEEW 84-019
11 May 1984
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International
Economic & Energy
Weekly
11 May 1984
iii Synopsis
1 / Perspective-Mexico: The Politics of Austerity
Energy
International Finance
Summit Issues
Global and Regional Developments
National Developments
15 Mexico: A Gloomy Economic Forecast
27 ~ummit Issues: Acid Rain
mmit Issues: Big Six Views on High Technology
35 Argentina: Medium-Term Financial Outlook Under Alternative Economic
Scenarios
43 Implications of a Significant Oil Discovery in North Yemen
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Comments and queries regarding this publication are welcome. They may be _ r
directed to Directorate of Intelligence, telephone 25X1
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11 May 1984
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International
Economic & Energy
Weekly
Synopsis
Perspective-Mexico: The Politics of Austerity
De la Madrid's ability to address Mexico's financial crisis without triggering
widespread unrest reflects the nation's capacity to handle unaccustomed stress.
Nonetheless, considerable downside risks remain as austerity measures contin-
ue to depress living standards.
15 Mexico: A Gloomy Economic Forecast
Mexico will continue to face serious economic problems even if it can avoid
political dislocations and maintain austerity through 1984. We see no source of
economic revival that can stem the decline of the economy during the next few
years.
27 Summit Issues: Acid Rain
Acid rain is likely to be a controversial topic at the London Summit
31 Summit Issues: Big Six Views on High Technology
All of the Big Six governments perceive a need to promote high technology to
maintain their international competitiveness, and, in varying degrees, all
intervene in the market to achieve this end. Japan appears to have achieved the
greatest results.
35 Argentina: Medium-Term Financial Outlook Under Alternative
We project Argentina will be plagued by serious foreign financial difficulties
throughout the decade.
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DI IEEW 84-019
11 May 1984
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43 Implications of a Significant Oil Discovery in North Yemen
Oil may have been discovered near North Yemen's border with Saudi Arabia
and South Yemen. A major find would have a substantial impact on North
Yemen's economy, internal politics, and relations with Saudi Arabia and the
United States.
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11 May 1984
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Perspective
Weekly
International
Economic & Energy
11 May 1984
Mexico: The Politics of Austerity
strations have occurred; the government remains firmly in control.
President de la Madrid's belt-tightening measures have earned high marks
from foreign observers and relieved Mexico's foreign liquidity crisis at least for
the moment. His ability to implement the harsh steps necessary to address the
financial crisis he inherited from Lopez Portillo without causing widespread
unrest or instability reflects the capacity of the nation's political system and its
leaders to handle unaccustomed stress. Although most elements of society are
chafing under austerity's heavy burden-higher prices for imports, spot
shortages of basic goods, reduced public services, and falling real income-
serious social and political unrest has not materialized. This is in sharp
contrast to other Latin American nations facing analogous situations. Orga-
nized labor and peasants-the ruling Institutional Revolutionary Party's (PRI)
largest constituencies-are quiescent. So far, only isolated strikes and demon-
De la Madrid's mastery over the PRI-one of Latin America's most effective
political machines-and his skill in juggling the conflicting demands of
powerful interest groups have boosted public confidence. By displaying a keen
sense of the political consequences of his economic moves, he has consolidated
his power, built a consensus behind austerity, and undercut issues around
which antigovernment sentiment could coalesce. Focusing job creation pro-
grams on hard-hit regions, continuing politically sensitive subsidies for food
and transportation, and the dispensing of food in urban slums have helped de
la Madrid to fulfill campaign pledges to protect the needy. A vigorous
anticorruption campaign has been the centerpiece of efforts to demonstrate
that under his aegis Mexicans can expect a more honest and responsive
government. Judicious use of the regime's imposing security apparatus, by
putting potential troublemakers on notice to keep a lid on protests, has boosted
confidence in the government's ability to maintain order.
Continued success is by no means guaranteed, however, and we see pitfalls
ahead as the President maneuvers to maintain the ruling party's longstanding
hegemony. We project that, even under the best of circumstances, real
personal consumption will not reach levels achieved under his predecessor for
the remainder of de la Madrid's term. We believe maintaining social and
political peace-even though key elements of the polity show few signs of
radicalization-will become increasingly difficult.
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DI IEEW 84-019
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To preserve political stability in the face of continuing austerity, the President
will have to balance calls for an end to falling standards of living with pressure
from the international financial community to maintain-economic adjustment
policies. Even though most Mexicans still support the need for belt tightening,
de la Madrid's room to maneuver has been reduced by the sacrifices already
made by the population. Political missteps by the President, internecine
bickering among the ruling elite, alienation of key interest groups, or growing
opposition-party muscle could turn around the prevailing. favorable political
outlook.
Retaining the support of organized labor will be key to keeping austerity
going. If opposition parties could convert discontent with the economy into
enough national political support to end the PRI's monopoly on power, this
would shake the foundations of Mexico's political system. Moreover, differ-
ences among the governing elite over economic or political tactics-now
manageable-could grow to become irreconcilable. De la Madrid's efforts to
alter the political system to better reflect the growing importance of the middle
class could fuel divisive intraparty rivalries. Perceived inequity in public
policy-or a loss of confidence in the government's management of a
particular issue-could cause important interest groups to increase pressure on
de la Madrid to reverse key aspects of his economic package.
Over the short term, we expect some disruptive incidents. The greatest
potential for unrest probably is in urban squatter areas. Moreover, resistance
by regional powerbrokers to political reform measures could cause existing
tensions within the ruling party to lead to sporadic outbursts of violence.
Opposition-party frustration with PRI electoral fraud could also translate into
antigovernment demonstrations. Nevertheless, the PRI's well-established lines
of communications with its grassroots constituency and the demonstrated
flexibility of the governing elite probably will minimize serious disorders. If
needed, de la Madrid will employ force to maintain order.
The middle years of the President's six-year term in office-1985 and 1986-
will be pivotal for de la Madrid and the Mexican political system. A viable
longer term economic strategy will be needed to resolve the current conflicts
among the government's economic goals of (a) meeting austerity guidelines
under its IMF-supported adjustment program, (b) maintaining basic consump-
tion to reduce the likelihood of public disturbances, and (c) stimulating
economic growth. If economic recovery lags in 1985 and 1986, we believe the
President will be unable to resist pressure to loosen austerity. More expansion-
ary policies, however, would risk reigniting rapid inflation and cutting off
access to international funds. In these circumstances, the domestic business
community would be hard pressed to continue their tacit support for de la
Madrid. Poor PRI showings in midterm elections would aggravate intraparty
tensions and embolden the political opposition.
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On balance, we expect the political system to adjust enough to allow Mexico to
weather the storm. The fluidity of the situation, however, makes for consider-
able downside risks. Although a political crisis is by no means inevitable, latent
frustration could well create one. We have no accurate way to gauge how long
the.discipline exhibited by Mexicans in the face of economic adversity will be
maintained. We think, however, the enormous social and economic tensions
already created by the financial crisis are sufficiently great that further
economic decline, bad luck, or bad decisions risk igniting a political upheaval.
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Soviets Step Up Oil
eliveries to
Nicaragua
Energy
consumption.
Mexico's harsher terms for oil deliveries are prompting Nicaragua to turn to
the USSR to cover most of its oil requirements. Mexico cut its deliveries to
only $19 million worth of oil during the first four months of this year-about
one-third of 1983 levels. Over the same period, however, the Soviets sent
Managua $27 million worth of oil-equal to about 60 percent of Nicaragua's 25X1
Moscow's willingness to supply oil to Nicaragua indicates the high
Another Iraqi Attack
on hipping
Iran and Syria
Agree on Oil
priority it attaches to shoring up the Sandinistas. Although the Soviets
probably are urging Managua to find other sources, they apparently are
willing to be suppliers of last resort0
may try to interfere with shipping for Iraq.
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Iraq's attack on an oil tanker on Monday probably will not cause changes in
the spot market price for crude oil. A 117,000-ton Saudi tanker was hit and
abandoned about 90 nautical miles south of Khark Island, where it had just
been loaded. This is the fourth tanker to be attacked since 27 March. Insurers
have raised insurance rates by as much as 2 percentage points for tankers. 25X1
calling at Khark Island. Freight rates have risen moderately since the last
Saudi ship was hit on 25 April. To entice shippers, Iran may discount oil
prices. It already is offering insurance to cover damage inflicted in Iraqi
attacks: Iran also will try harder to intercept Iraqi aircraft over the Gulf and
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Iran recently agreed to renew its oil agreement with 25X1
Damascus despite Syria's inability to pay for all the oil. Tehran will continue
to provide Syria with about 120,000 barrels of oil per day-100,000 b/d at a
reduced price and the balance at no charge.. Despite easy terms on previous
sales, Syria owes Iran about $900 million.
sayn-the financial incentive to keep the pipeline shut down. Syria, however,
now requires larger Iranian credits, partly because of a reduction in aid from
its Arab supporters. 25X1
Syria's debt to Iran has been a source of friction since the oil agreement was
first signed in 1982, but it is unlikely to jeopardize new oil deliveries. Iran
wants to make sure Syria keeps the oil pipeline from Iraq closed, and its aid
gives Syrian President Assad-who distrusts Iraqi President Saddam Hu-
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Nigeria Orders The US Embassy reports that Nigeria has reversed a decision to hold oil
Increased Oil production to its OPEC-mandated ceiling of 1.3 million b/d and is directing oil
production companies to increase daily production immediately by between 300,000 and
400,000 barrels. Lagos is warning the companies that failure to comply will re-
lt i
f
th
ti
li
ti
Ni
i
dl
i
i
h
i
su
n
ur
er na
ona
za
on.
ger
a reporte
y wants to ma
nta
n t
e h
gher
production until it earns $2.5-3 billion, an amount Lagos estimates is necessary
to meet its financial needs this year
additional downward pressure on prices.
The threat of further nationalization underscores the government's need for
additional oil revenues to ease its economic crisis. Head of State Buhari
announced a new austerity budget this week and probably realizes that,
without IMF credits or aid from other sources, current oil output will not
finance essential imports and debt servicing needs. To earn the needed
revenue, Nigeria would need to maintain production at 1.8 million b/d and
hope that OPEC would ignore the overproduction for at least six months. The
oil market remains weak, however, and.higher output by Nigeria will put
Greek-Soviet Gas talks are still underway between
Talks Continue Athens and Moscow on the proposed gas pipeline from the southern USSR to
Pressure on Higher-than-expected inflation in the first quarter and the widening gap
the Mexican Peso between the exchange rate available on the Mexican and the US side of the
the northern Greek industrial area. We doubt, however, that any formal
agreement will be reached for several years. The proposed pipeline to Greece
would have a capacity of 2 billion cubic meters per year. The Greek-Soviet
talks have centered on a starting date for the previously agreed-on pipeline
feasibility study expected to last two years. The parties are also discussing the
barter exchange of Soviet natural gas for Greek aluminum products from a
new plant.
border is spurring rumors of an accelerated peso devaluation. Local bankers
have told the US Embassy that the Mexican Government is considering either
depreciating the peso by 20 instead of 13 centavos a day or devaluing by 10
percent and then retaining the current daily peso slide. We and US Embassy
officials believe the government will wait until after the midyear wage
adjustment and then increase the daily slide of the peso. Mexican Government
officials probably are concerned that a faster depreciation would fuel inflation
and be an admission that the 50-percent target for increases in the cost-of-
living index this year is unattainable. Mexico City, however, does not have
enough reserves to support the current exchange rate policy for very long if
capital flight accelerates. Moreover, Mexico City needs to maintian a
competitive exchange rate if it is to meet its goal of increasing manufactured
exports by at least 17 percent this year to $4.3 billion.
Secret 6
l ! May 1984
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,ecrer
Peru's Economic.Policy The Belaunde government's sustained commitment to its austerity program
will be severely tested this year. According to US Embassy reporting, the IMF
in late April approved $340 million in credits under the compensatory
financing and standby credit programs after Lima agreed to new austerity
measures. Despite slightly easier terms than the previous agreement, the
public-sector deficit target-relaxed at Lima's request from the previously 25X1
agreed 3.8 percent of GDP to 4.1 percent-will still require sharp cuts in
government spending and large tax increases. Moreover, the relaxation of price
controls and higher import surtaxes will probably cause inflation to accelerate
beyond last year's 111-percent rate, further eroding living standards and
raising social tensions. 25X1
Although the US Embassy reports that Peru met first-quarter IMF perform-
ing criteria, we believe Peru will have severe difficulties remaining in
compliance with the agreement because of social unrest. Prices rose by 33
percent in the first quarter, and we doubt Lima will be able to meet its goal of
70-percent inflation for the year. Public employees are demanding wage
increases to compensate for the rising living costs. According to the US
Embassy, there is a threat of another nationwide labor strike against the
adjustment policies of the agreement with the. IMF that could further pressure
Belaunde to ease austerity. Moreover, the tendency to spend during an election
year will be strong. An alternate scheme for economic revitalization mainly
through easier credit for employment-intensive industries and new export
incentives for nontraditional goods is gaining the support of Central Bank
President Webb and other government officials. Should Lima switch to such a
program, its relations with the IMF would deteriorate, and this would risk
commercial bank financing and other foreign financial assistance 25X1
Guatemala-IMF Guatemala and the IMF appear to be heading for a major disagreement. The
Confrontation Looming Fund maintains that unless Guatemala alters its fiscal policies it will fall out of
compliance with agreed-on limits to its budget deficit. As a result, the
remaining $60 million under Guatemala's standby agreement might not be
made available. Although the Fund is suggesting an immediate 10-percent tax
hike, Chief of State Mejia and other senior Guatemalan officials have'publicly
repudiated any tax increases. The Fund also has suggested an 11-percent cut
in spending, based on projections that the government's current policies will 25X1
severely erode Guatemala's foreign payments position later this year. Despite
worsening economic prospects, Guatemala is unlikely to accede to the Fund's
conditions easily. According to the US Embassy, if Mejia does make policy ad-
justments to secure IMF credits, he might dismiss some of the country's senior
finance officials in an effort to create scapegoats. 25X1
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Big Six Exports
Prosper in the
US Market
Copper Price
Developments
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11 May 1984
Last year, the rebounding US economy coupled with the strong dollar provided
the major bright spot for exports by the Big Six countries. Their sales to the
United States grew 15.0 percent in real terms compared with a 3.8-percent in-
crease in total Big Six exports. Canada and Japan, the two major US trading
partners, garnered the largest gains from the US recovery, while the United
Kingdom received the least benefit because oil sales dropped. The slow-
growing West European countries were the weakest developed country market.
Although Japan was able to boost its sales, the four major West European
countries experienced only sluggish sales gains to their neighbors. West
Germany, in particular, was hurt by import cuts by France-its major, export
market. Big Six exports to the LDCs fell by 3.5 percent because of continuing
Big Six: Average Annual Real Export Growth, 1983 a Percent
World
Developed Countries
LDCs
Communist
Countries
Total
United
States
Japan
Western Canada
Europe
Total
3.8
6.0
15.0
6.5
3.1
22.4
-3.5
12.6
Japan
8.6
13.8
18.3
9.3
28.4
2.8
12.6
West
Germany
0.3
1.8
15.2
7.3
0.6
23.7
-9.0
9.2
France
3.6
5.5
15.4
5.5
4.5
45.1
-4.4
27.6
United
Kingdom
0.3
3.5
3.2
7.5
5.3
0.2
-10.4
3.0
Italy
5.2
6.4
11.8
10.8
4.5
20.8
-0.2
24.1
Canada
8.4
11.8
16.5
4.9
-9.4
-13.4
0.1
a Growth calculated from constant 1980 US dollars.
Global and Regional Developments
After a strong price surge during March, copper prices have plunged below
their pre-rally levels. According to industry statistics, during 13' of the past 18
years, first-quarter prices have displayed seasonal upswings because the
housing and automobile industries began accumulating inventories for summer
sales. The unusual March increase this year apparently was spurred by a
shortfall in Zambian deliveries of good-quality metal. Although we expect
prices to rise slowly throughout the rest of the year, the 1984 average is likely
to be little changed from the 1983 average of 72 cents a pound. Robust buying
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by the US housing and auto sectors continues. Japanese and European demand
is increasing, and, according to press reports, the Chinese are expected to make
major purchases this year. Most LDC producers, however, are operating at or
near capacity to maximize foreign exchange earnings. Even slightly higher
prices are extremely important to debt-troubled producers; a 5-cent rise in
copper prices would generate approximately $140 million annually in addition-
al export earnings for Chile, $60 million for Zambia, and $45 million for Peru.
Argentina Barters
in for Fertilizer
Argentina's Latin Grain
Trap Growing
the Argentine Farmers' Federation recently 25X1
struck a barter deal with the USSR to exchange about 160,000 metric tons of
wheat for 65,000 tons of urea fertilizer. The deal follows similar grain for ,
fertilizer arrangements with Mexico and Bulgaria. Barter deals such as these
are a way for Buenos Aires to export wheat in the current soft market. These
transactions underscore the Alfonsin regime's efforts to boost grain production
by using.more fertilizer. Argentine fertilizer imports could reach 275,000 tons
this year, a 60-percent increase over the 1983 level.
creased its share of Argentine grain trade.
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The US Embassy reports that President Alfonsin's drive to boost grain exports
to neighboring countries stems from his desire to strengthen regional economic
ties and to reduce dependence on sales to the USSR, which currently takes
about 40 percent of Argentine grain exports. The share of Argentina's grain
exports going to other Latin American countries jumped from 6.4 percent last
year to 21.6 percent during the first quarter of 1984. A willingness to provide
credits has helped buoy sales. The US Embassy reports that Mexico, which
purchased no Argentine grain in 1983, is likely to be a growing market this 25X1
year as a result of the recent 18-month bilateral agreement. Brazil, however,
which sharply increased its purchases of Argentine grain in the absence of US
commodity credits during the first quarter of 1984, is likely to slow its
purchases from Buenos Aires now that US financing is available. Cuba,
recently the recipient of a $200 million trade credit from Buenos Aires, has in-
National Developments
Developed Countries
Attempt To Limit
Israeli Inflation
The Israeli Government's May price hikes of 9 percent on government-
controlled items such as milk, bread, and gasoline are smaller than recent
monthly increases. This is in keeping with the government's desire to limit
inflation prior to the 23 July election. As a result, the government will increase
the subsidies on these goods. Finance Minister Cohen-Orgad is under great
pressure from his cabinet colleagues to engage in "election economics,"
according to US Embassy sources in the Finance Ministry. We believe he will
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 try to avoid blatant manipulation of the economy prior to 23 July, but he
probably will succumb to pressure to hold the line on prices controlled by the
government and to ignore the proposed cuts in government spending that are in
Ty'kish Exports Rise Turkey's first-quarter exports were up 37 percent in dollar terms over a year
Spanish Labor
Negotiations
Jam can Bauxite
D elopments
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11 May 1984
earlier. Imports declined by 7 percent, reducing the trade deficit to around
$325 million. The promising trade figures will be a boost to Prime Minister
Ozal's new economic program, which emphasizes export growth as a key to
long-term development. Moreover, with large payments on Turkey's resched-
uled debt falling due later this year, a good export performance is necessary to
limit foreign borrowing needs and sustain the growing confidence of interna-
management concessions.
Prime Minister Felipe Gonzalez has reasserted his intention to pursue an
austerity program and has called on trade unions to tighten their belts. He has
requested new labor contract negotiations and signaled his willingness to
participate directly in collective bargaining sessions with business and union
leaders. Gonzalez is banking on his personal influence to win support for
austerity in these talks. If-as seems likely-labor and business agree to the
negotiations, they will cover wage gains for 1985-86 and labor regulations.
Madrid probably hopes to persuade both sides to agree to real wage cuts, more
flexible labor laws, and reductions in both employers' social security contribu-
tions and employees' benefits. We believe agreement on these issues is essential
for Madrid to curb inflation and unemployment. Although Gonzalez has made
it clear that he will not depart from his austerity program, he may make
commitments to create jobs and stimulate investment in return for labor and
Less Developed Countries
Jamaica and the four US and Canadian aluminum companies operating on the
island have reached a new five-year tax agreement to replace the one that
ended last December. The package includes production incentives, a slight
reduction in the levy charged on sales of aluminum, and an increase in the roy-
alties paid per metric ton of bauxite. The companies also have agreed to
maintain investment at the 1983 level and to make monthly rather than
quarterly payments to the government. This should help smooth Jamaica's
chronic cash flow problems. Jamaican officials estimate that the new incen-
tives and the upturn in world aluminum demand will help boost bauxite
production almost 20 percent to 9 million tons this year. Higher production
and the new tax schedule could add as much as $10 million to government rev-
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Labor negotiations this summer, however, still cloud the outlook for the mining
industry. Bauxite workers and management have been awaiting the outcome of
the tax discussions before negotiating a new contract. The quickening pace of
inflation and the probability that opposition leader Michael Manley will
represent labor could politicize and prolong the talks.
Dominican Republic The arrests of more than 100 members of opposition groups last weekend and
Kuwaiti Stock
Market Activity
He continues to be aided by the inability of opposition elements to decide on a
common approach. The newly formed Popular Struggle Committees-active
in last month's disturbances-are a new feature in domestic politics. Consist-
ing largely of the unemployed, they apparently are not controlled by any of the
of two labor leaders on Monday probably were designed to head off more
strikes and demonstrations. various
groups are considering strikes to force changes in the government's economic
policies, but they are not acting In concert. President Jorge Blanco has
maintained control so far by using tough tactics to intimidate the opposition.
established political parties.
than government. estimates
The Kuwaiti Government recently halted its 18-month-old program to support
share prices on the official stock exchange. After the government withdrawal,
the fall in share prices was accompanied by an increase in trading activity in
both the official and the unofficial Manakh markets. US Embassy sources
report that the decision to withdraw from the market indicates that the .
government has recognized the failure of its $3 billion program to stimulate in-
vestor confidence, badly shaken after the market crashed in 1982: Instead, the
government now plans to underwrite funds to pay off creditors of bankrupt
traders. The plan would provide almost $2 billion to payoff creditors if
approved by the cabinet. Many Kuwaitis believe this program indicates that
the government finally is coming to terms with the stock market crisis, and we
expect this spending will boost Kuwait's flagging economy. The actual outlay,
however, could run higher than $2 billion because losses probably are higher
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Chad's Good
Economic News
The relative tranquility Chad has experienced since the arrival of French
peacekeeping forces in July 1983 has sparked an increase in economic activity:
? Production of cotton,'the country's principal export, has regained pre-1978
levels.
? Significant increases have been made in cattle and food crop production
despite the prolonged drought.
? The Habre government has been able to restore some basic public services.
? Most of Chad's industries-including textile factories, sugar plantations, and
breweries-have increased production, putting many Chadians back to work.
Progress on the economic front nonetheless could be short lived if political
stability cannot be maintained or if aid donors and investors reduce their
Economic Reforms Guinea's new military government, in a move calculated to win public favor,
has eliminated some of former President Toure's socialist economic policies.
President Conte has ended tax payments for trade unions and regional
development schemes that had caused riots when they were initiated by the
previous regime in January. He has also moved to gain the confidence of
merchants by reinstating their rights to privacy in financial transactions and
the use of banking institutions of their choice. In addition, a limit on local cur-
rency withdrawals has been discarded. In the livestock industry, Conte
abolished ENCOBE, the state's livestock marketing board, which previously
purchased cattle at controlled prices that reportedly were less than production
costs. The government has yet to tackle the problems of Guinea's numerous
unproductive and inefficient state enterprises.
Labor Opposition to Mali's labor leaders on May Day attacked President Traore's IMF-supported
Malian Economic economic policy program at their annual rally. The unions demanded a return
Reforms to state enterprises, salary increases when Mali reenters the French-backed
West African Monetary Union (UMOA) in June, and denounced the policy of
examinations for new civil servants. The US Embassy reports that these
demands represent the first organized opposition to the government's economic
reform program since it was introduced two years ago. Although the May Day
rally ended peacefully with union officials promising to negotiate their
demands with the regime, the potential for unrest will increase as the
government deals with economic deterioration. In recent years Mali has begun
turning from socialism toward a more open economy and to Western donors
for increased aid. Moreover, it has been one of the few black African countries
to date to successfully meet IMF performance criteria.
Secret 12
11 May 1984
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Secret
Yugoslavia Lifts
Price Freeze
in the months ahead.
Yugoslavs are bracing for higher prices after the government last week lifted a
price freeze that was imposed last December. The move complies with one of
the conditions for a $380 million IMF standby credit that will help secure $3.4
billion from Western governments and banks needed this year. Although the
new price policy conforms to the IMF agreement, the federal government can
still intervene in cases where prices rise too rapidly. This could occur, because
we expect financially strapped enterprises to attempt to cover mounting losses
by seeking much higher prices. As a result, Belgrade is likely to face increasing
consumer frustration as well as pressures from financially troubled industries
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Secret
Mexico: A Gloomy Economic Forecast
Harsh austerity policies implemented since Presi-
dent Miguel de la Madrid took office in December
1982 have relieved Mexico's international liquidity
crisis but only through unprecedented cuts in in-
vestment, economic activity, and living standards.
We believe de la Madrid's economic team remains
committed to austerity, but further belt tightening
will be more difficult to achieve. We expect signifi-
cant slippage from the tough IMF-supported stabi-
lization program as Mexico City is confronted with
growing antiausterity sentiment, including perhaps
some violent demonstrations.
Mexico will continue to face serious economic
problems even if it can avoid political dislocations
and maintain austerity through 1984. Although
Mexico has succeeded in reducing imports and the
growth in foreign debt, we see no source of econom-
ic revival that can stem the decline of the economy
during the next few years. The need to accommo-
date the ruling party's populist constituency and
stave off potentially explosive public demonstra-
tions severely limits de la Madrid's decisionmaking
flexibility. As Mexico continues to be plagued by
both extremely depressed economic activity and
high inflation, we believe debates over economic
policy will take an increasingly nationalistic turn
and will force the ruling party to reinstate populist
consumer policies and reflate the economy. This
policy relapse would in turn lead to a recurrence of
financial crisis, triple-digit inflation, and economic
decline.
Improved Foreign Accounts
The most visible aspect of Mexico's austerity has
been the sharp turnaround in Mexico's foreign
payments situation. In 1983, Mexico stood alone
among Third World countries in its record of
addressing its financial problems. This success
earned the respect and applause of the foreign
financial community. Citing the financial turn-
around, the international banking magazine Euro-
money honored Jesus Silva Herzog as the Third
World's outstanding finance minister for 1983.
By yearend 1983-after nearly a year of moratori-
um on interest payments-Mexico had largely
caught up on "interest arrears and has since stayed
current on the $1 billion per month it pays in
foreign interest obligations. Net foreign exchange
reserves at yearend had risen to $4 billion, up from
virtually nothing when de la Madrid took office.
By depressing domestic demand, Mexico achieved
its first current account surplus since 1955. Mer-
chandise imports in 1983 were one-half the 1982
level. Imports for the private sector fell sharply
because of stringent import licensing; imports for
the public sector fell only slightly because of the
need for larger food purchases. The surplus on
current account of $5.5 billion contrasts to a deficit
of $4.9 billion in 1982.
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Mexico's tough deflationary steps have kept the
country just within the bounds of its IMF-support-
ed stabilization program. Official statistics released
in March 1984 indicate that Mexico missed its
public-sector budget deficit target slightly in 1983
(8.7 percent of actual GDP compared with the
target of 8.5 percent). Because the shortfall oc- 25X1
curred as a result of GDP falling more than
anticipated, the IMF is overlooking this small
breach. Targets in the IMF accord on increasing
net international reserves and reducing debt service
arrears were met by comfortable margins; criteria
for limits to foreign borrowing and domestic credit
expansion were barely met
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Mexico: Foreign Financing Gap
-12,544
-4,879
5,546
3,000
Trade balance
-3,003
7,644
14,508
13,000
Exports, f.o.b.
20,927
22,081
22,228
23,000
Oil and gas
14,573
16,477
16,002
16,300
Manufactures
3,665
3,869
4,494
4,700
Agriculture
1,481
1,233
1,285
1,400
1,208
502
447
600
23,930
14,437
7,720
10,000
-9,541
-12,523
-8,962
-10,000
Interest
-8,383
-11,264
-9,861
-11,000
Debt amortization due
6,629
8,000
9,000
8,000
Financial gap
-19,173
-12,879
-3,454
- 5,000
New medium- and long-term capital inflows
18,325
15,700
8,500
6,000
Rescheduled medium- and long-term debt payments
0
2,000 c
28,700 c
6,000
Net short-term capital
10,233
356
-29,208 d
-1,000
Errors and omissions
-8,373
-8,362
-1,432
-2,000
Changes, in reserves
1,012
-3,185
3,106
4,000
Other financial items
External debt (at yearend)
75,061
87,875
90,000
94,000
Short term
22,654
28,641
10,000
9,000
Debt service ratio (percent)
a Estimated.
b Projected.
Includes debt relief on $2 billion in 1982, $7 billion in 1983, and
$6 billion in 1984 on medium- and long-term debt principal due;
and $22 billion in 1983 in short-term debt rescheduled as long-term
obligations.
d Includes rescheduled short-term debt.
High Cost to the Domestic Economy
Mexico's stabilization program has been severely
deflationary:
? Real wages fell by about one-fifth during 1983.
Although organized labor is disillusioned, it has
accepted de la Madrid's explanations for the need
for austerity and has shown more concern over
protecting jobs.
Secret
11 May 1984
? Real government spending in 1983 was slashed
by 30 percent. Public investment was cut by 40'
percent, the impact falling heavily on oil develop-
ment expenditures.
? Subsidies were cut 20 percent in 1983, nearly in
line with the IMF program. Producer subsidies
were slashed 40 percent, substantially more than
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Mexico: Economic Indicators, 1975-84
Real GDP Growth Consumer Price Inflation
Percent Percent
6
4--
LIO
Merchandise Imports Public-Sector Deficit as a Share of GDP
Billion US $ Percent
11
11
6
3
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the IMF goal of 20 percent. Consumer subsi-
dies-such as public transportation and basic
staples-increased 7 percent, compared with the
IMF goal of a 25-percent cut.
? Despite the decline in economic activity, in-
creased peso earnings from foreign oil sales kept
the fall in public-sector income at only 4 percent
The deflationary impact was even greater than
anticipated. The economy is so depressed and the
economic environment so changed that-after 16
months of harsh austerity-the public debate has
switched to the halting of further economic de-
clines.
According to official estimates, which may be
optimistic, output fell 4.7 percent in 1983, and
investment dropped by one-fourth. Utilization of
industrial capacity decreased by one-third or more
in numerous industries. Industrial production de-
clined 10 percent last year and 13 percent at an
annual rate in the last quarter. The commercial
sector has suffered because of dwindling supplies,
lower purchasing power, and higher taxes. Sales
data show that commercial activities have fallen 15
percent. Although sales of basic consumer goods
have changed little, merchants report retail sales of
other goods off 20 percent to 50 percent
Agriculture has improved somewhat as favorable
rains in 1983 ended two years of widespread
drought. Farm recovery was limited, however, by
lower real farm price guarantees, shortages of
imported inputs, and a tightening of crop credits.
As a result, the farm sector was not able to take
advantage of good weather, and plantings and
harvests last year were still far below predrought
Job losses-particularly among unskilled labor-
have become severe. We believe the-rate of unem-
ployment has more than doubled since mid-1982
and now stands at over 20 percent; it is close to 30
percent in urban areas. Official statistics indicate
that the number of workers employed in modern
manufacturing has fallen 15 percent from its 1981
peak. The bulk of the 800,000 young Mexicans who
Secret
11 May 1984
normally enter the labor force each year are resort-
ing to make-work jobs, staying in school, or cross-
ing the US border for temporary work. Most new
entrants have been added to the ranks of the
underemployed.
Growing unemployment and underemployment and
lower real wages have substantially reduced pur-
chasing power. Moreover, import cuts and the
slowdown in economic activity have resulted in
growing scarcities of some manufactured goods.
Price imbalances caused by government controls on
basic foods have led to reduced production of such
key goods as milk, eggs, meat, and tortillas.
These trends have lowered personal consumption.
Organized labor, including government workers,
has been shielded by substantial fringe benefits.
Workers earning the official minimum wage or
less-at least 60 percent of the work force-and
many independent merchants and other business-
men have not been so lucky. The government has
continued subsidies on basic foods and public trans-
portation to lessen the blow. Even so, the situation
has forced most Mexicans to eliminate luxuries and
draw down savings. it
has also resulted in increased illegal work trips to
the United States, particularly as poor families find
coping more difficult.
To Mexico City's chagrin the tough austerity meas-
ures and the effects of depressed demand have not
yet curbed inflation. Mexico City eased price con-
trols moderately over the course of 1983, and the
higher costs associated with peso devaluation have
just begun working their way through the economy.
In addition, the peso's continuing devaluation at a
34-percent annual rate maintains upward pressure
on prices of a number of critical imports. Despite
the reduction in the budget deficit, domestic fi-
nancing requirements remained as high as ever
because of much lower foreign borrowing. More-
over, continued capital flight also has kept interest
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rates and inflationary expectations high. Prices in
1983 were 100 percent higher than in 1982. Al-
though inflation eased slightly in the second half of
last year, it has recently picked up, running at a 96-
percent annual rate in the first quarter.
Policy Dilemmas
The Mexican leadership faces enormous difficulties
in developing a politically palatable economic strat-
egy. In addition to divergent opinions on the respec-
tive roles of the public and private sector and on the
utility of foreign investment,-economic decision-
makers must take account of the inherent conflicts
among the government's three economic goals of.
(a) meeting IMF guidelines by reducing inflation
and government budget deficits, (b) avoiding re-
gime-threatening public disturbances by maintain-
ing basic consumption levels to keep the lid on
public discontent, and (c) stimulating economic
.growth.
Maintaining the Austerity Course. The most press-
ing short-term issues facing de la Madrid lie in
keeping Mexico within the IMF guidelines at a
time of continuing high inflation and rising public
discontent over austerity. Foreign adulation of the
austerity record has reinforced the determination of
de la Madrid's financial advisers to meet the IMF
guidelines. Others, such as labor boss Fidel Velaz-
quez, demand loosening policies that retain real
wages and consumer subsidies.
At the beginning of 1984, Mexico City and the
IMF agreed to extend the stabilization package for
the second year of its three-year schedule. Perform-
ance targets, however, will be tougher. Domestic
credit will remain tight and foreign borrowing low,
and Mexico City will be required to slash its budget
deficit again-lowering the deficit as a share of
GDP another 2 percentage points, to 6.5 percent.
Financial authorities agree that cutting the budget
deficit this year will be harder than in 1983. Little
margin remains for savings on foreign exchange
losses, which provided a major portion of budget
cutting last year. Mexico City will again have to
slash spending. To do this, it is planning to further
lower public investment, reduce its wage bill 20
percent, and cut consumer subsidies by nearly 40
percent. To meet these goals, the. government al-
most certainly must cut back on heretofore un-
touched food and transportation subsidies, and on
military, parastatal, and central bureaucracy bud-
gets, a necessity that gives pause to the top leader-
ship
Mexico City is concerned-we believe justifiably-
that further austerity measures may provoke vio-
lence. Public criticism is mounting. Organized la-
bor has openly conditioned its crucial support on
maintenance of union jobs and on basic consumer
subsidies. The grudging cooperation of the business
community and the middle class remains even more
fragile. Moreover, opposition politicians and labor
leaders have become more strident in their calls for
an end to austerity.
De la Madrid must soon make some tough choices
between austerity and stability in the near term:
? Inflation is highly unlikely to close out the year
anywhere near the 50-percent IMF target, unless
drastic measures are taken.
? Rising costs of basic inputs are squeezing busi-
nessmen, who are forced to produce and sell at
controlled prices; shortages are becoming more
prevalent and instances of illegal price hikes more
common.
? Discussions will soon begin on midyear wage
adjustments affecting all Mexican workers.
We judge that de la Madrid will hold fast to the
spirit of the IMF-supported austerity program,
although we foresee significant slippage as political
considerations cause Mexico to fail to live up to the
letter of the agreement. The most difficult areas
will be wage policy and budget cuts (including
lowering subsidies). Mid-April adjustments on
some staple prices convince us that Mexico City
will face up to these sensitive standard of living
items.
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The sensitive issue of prices and austerity is illus-
trated by tortillas, the dietary staple for most
Mexicans. The government reacted to price control
violations by tortilla makers with widely publicized
fines and closures in March. The administration
realizes that the tortilla makers must be compen-
sated for higher corn prices, either by an increase in
the subsidy on corn or a boost in the price of
tortillas. To overcome this problem, de la Madrid's
economic team has tested the waters unsuccessfully
with a combination tortilla price hike and food
stamp program.
Attempts To Stimulate Economic Growth. Presi-
dent de la Madrid believes-and we agree-that
the revival of private investment is essential to
restore Mexican economic growth. His approach
contrasts with the philosophy of the.past decade,
which called for increased government control of
the economy and reached its height with the bank
nationalization in 1982. It has set the President
squarely against the bureaucratic mainstream,
Mexican popular opinion, and the views of key
party figures such as Fidel Velazquez. De la Ma-
drid, despite some false starts, has attempted to
revitalize investment by:
? Streamlining the foreign investment bureaucracy,
sending financial emissaries abroad, and courting
foreign investors.
? Widely publicizing selected offers of 100-percent
foreign equity participation in Mexican-based
investments.
? Engaging in personal dialogues with industrialists
and instructing officials to ease regulations to
boost exports and stimulate industrial expansion.
Even so, the President has been unable to restore
domestic or foreign business confidence. The entre-
preneurial spirit among businessmen is flagging
because of low demand and persistent high infla-
tion; they doubt de la Madrid's ability to ease
government restrictions on private investment and
resent the pervasive antibusiness cast of official
policy. We see few signs of major deals, and those
in the works are largely by foreign business groups
already in Mexico through previous investments.
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11 May 1984
Continued Economic Deterioration
We believe that de la Madrid has little chance of
stimulating the economy any time soon:
? Preliminary industrial statistics in 1984 indicate
that the economy is still declining.
? Domestic demand continues to fall. Personal sav-
ings have been depleted in many cases, and wages
and government spending are declining further.
Many plants are running at a fraction of
capacity.
? Potential exporters fear that Mexico City will
support the peso at an artificially high level
because of the need to protect existing businesses
and hold down inflation.
? Many US businessmen and bankers believe that
Mexico will return to a hard line on foreign
investment once the economy regains momentum;
they are particularly concerned that de la Ma-
drid's overtures for majority equity participation
are not legally binding.
? Those Mexican industrialists who could invest are
concerned about the durability of the govern-
ment's commitment to the private sector; many
prefer to maintain their financial holdings
Because of these problems, most US econometric
services, the IMF, and the Mexican Government
project a zero- to 2-percent growth in the GDP for
1984. We are more pessimistic. Preliminary esti-
mates using our econometric model of Mexico
indicate that falling consumption and investment
called for by continued austerity in Mexico's IMF
program will result in at least a 2-percent decline in
economic activity in 1984.
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Mexico: Forecasts of Key Economic Variables, 1984
GDP Growth
('percent)
Consumer Price
Growth
(percent)
Current Account
Balance
(billion US $)
Imports
(billion US $)
Exports
(billion US $)
Data Resources, Inc.,
1.0
58
-2.2
Wharton Econometric Forecasting b
2.0
60
0.6
13.0
22.2
Chase Econometrics 1
0.3
62
2.3
10.6
22.2
International Monetary Fund d
1.0
50
-1.0
14.0
23.9
Mexican Government.
0
50
1.0
12.0
24.0
a Latin America Forecast Summary, Data Resources, Inc., March
1984.
b World Economic Outlook, Vol. VI, Number 1, Wharton Econo-
metric Forecasting Associates, May 1984.
Latin America Forecasts and Analysis, First Quarter 1984, Chase
Econometrics, March 1984.
,d IMF Staff Report, 30 January 1984.
Looking Ahead
Steering a stable course through the next 18
months will require expert timing, nerve, consider-
able luck, and continued outside support. Specifi-
cally, precipitous cuts in staple prices or growing
food shortages could trigger violence. Strikes by
independent labor unions over meager wage adjust-
ments or major plant closures are possible. Reduc-
tion of the bureaucracy, at a time when a depressed
economy offers loyal government workers no ready
alternative, would undercut essential support. Un-
favorable international developments, higher inter-
est rates, or reduced international lending would
put additional strains on Mexico's austerity. For
example, recent increases in the US prime interest
rate will cost Mexico an additional $1 billion on
existing debt this year
The days of relying on increasing oil revenues,
The days of relying on increasing oil revenues,
more foreign borrowing, big government, and an
overvalued peso are gone. As the social fallout of
continuing stagflation forces the government to act,
the populist base of the ruling party probably will
prevent timely changes to encourage private invest-
ment and government efficiency. We thus envision
tremendous pressures on Mexico to reflate the
economy under government stimulus. Such a refla-
tion, after temporarily boosting personal consump-
tion and investment, almost surely would lead to
another economic crisis, involving a plunge in
output and employment, triple-digit inflation, and
massive arrears in debt payments.
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Summit Issues: Acid Rain
Acid rain is likely to be a controversial topic at the
London Summit. The Canadians and West Ger-
mans probably will seek general agreement from
the Big Seven countries to reduce sulphur dioxide
(SO2) emissions by 30 percent over the next decade.
Chancellor Kohl and Prime Minister Trudeau en-
joy nearly universal domestic support for this goal.
France and Japan probably will support reductions,
while Britain probably will insist that further acid
rain research is necessary before expensive abate-
ment procedures begin. London will expect support
for its position from the United States.
Background
Since the early 1970s, many scientists, especially
those in Scandinavia, have claimed that SO2 emit-
ted by industrial and power plants, along with
nitrogen oxides (NO) from automotive exhausts,
combine with atmospheric moisture and return to
earth as acidic precipitation. They claim the result-
ing deposition of acidic materials destroys fish life
in fresh water, depletes fertile soil, and damages
forest areas. The Norwegian Government, for ex-
ample; asserts that 1,750 of Norway's lakes are.
devoid of fish and 900 others show reduced fish
stocks because of acid rain. The Scandinavian
governments were the first to focus on the problem
of long-range transboundary air pollution (LRTAP)
and have been the strongest advocates of interna-.
tional arrangements to reduce SO2 emissions. In
recent years they have been joined by the Canadi-
ans and, more recently, by the West Germans.
In 1979 the United Nations Economic Commission
for Europe concluded a "Convention on Long-
Range Transboundary Air Pollution" (CLRTAP).
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The Convention, which came into force last year, is
the only multilateral air pollution agreement and
has 30 signatories, including all the Big Seven
countries.
In March of this year a group of the signatories
held a conference in Ottawa to mark the first
anniversary of the Convention. The March confer-
ence produced the "Ottawa Declaration" in which
Canada, West Germany,, France, Austria, Switzer-
land, the Netherlands, Denmark, Norway, Sweden,
and Finland promised to:
? Reduce SO2 emissions by 30 percent by 1993,
using 1980 as a base year.
? Undertake further SO2 reductions if environmen-
tal conditions do not improve sufficiently by
1993.
? Work for measures on the national and interna-
tional levels to decrease NO emissions by 1993.
? Urge all CLRTAP signatories to reduce their
SO2 emissions by 30 percent.
CLRTAP nations in Geneva in September.
The Ottawa Declaration was intended to launch,
according to a Canadian environmental official, a
"diplomatic offensive" against the "villains of acid
rain"-in his estimation, the United States, Brit-
ain, East Germany, Poland, and Czechoslovakia.
All of those countries signed the Convention but
have not pledged specific SO2 reductions. The
Ottawa meeting was meant to focus international
attention on these states and to serve as a spring-
board for two conferences, that will discuss acid
rain for later in 1984: the Multilateral Environ-
mental Conference in Munich in June and the
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Acid rain is believed by many scientists to occur
when sulphur dioxide (SO2) and nitrogen oxides
(NO) oxidize and then combine with atmospheric
moisture to form mild solutions of sulphuric and
nitric acids. The sulphur dioxide generally is
believed to emanate from the smokestacks of
utility plants or smelters, the nitrogen oxides
primarily from smokestacks and automobile and
truck exhausts. Sulphur oxides currently are
thought to be the main cause of acid rain.
Acidity is measured by the pH scale of zero to 14.
For example, bodies of water with a pH reading of
7 are neutral, those with higher readings are
alkaline, and those with lower ones acidic. Clean,
normal rain over continental areas usually is
slightly acidic with pH readings of around 5.6.
(The carbon dioxide naturally present in the air
sometimes combines with moisture to form weak
carbonic acid). When the pH drops one point, the
acidity is 10 times greater. A pH of 4, for example,
Acid Rain on the pH Scale
I
I
I
I
i
12.0
is 100 times more acidic than one of 6.
Country Positions at London
Because the Summit is the most publicized of
regularly scheduled international meetings, Bonn
and Ottawa almost certainly will seek to make acid
rain a prominent topic of discussion. Both consider
US and British cooperation indispensable to a
workable international accord and probably will
pressure the United States and Britain to begin SO2
reductions immediately.
Canada. In the mid-1970s, Ottawa concluded that
acid rain was seriously damaging Canada's envi-
ronment and since then has aggressively sought a
treaty with the United States to reduce SO2 emis-
sions in both countries. Ottawa's efforts to secure a
treaty thus far have failed, and it currently is
seeking to move the issue from the bilateral to the
Ottawa believes acid rain is endangering sectors of
its economy that account for nearly 8 percent of
GNP; the Canadians are particularly concerned
about damage to their forests, which provide one of
every 10 jobs in Canada. Ottawa claims that at
least 50 percent of the acid rain that falls in
Canada is caused by pollutants emitted in the
United States
Prime Minister Trudeau is retiring in June and
probably will seek to make a distinctively Canadian
contribution to his last Summit. He is likely to
refuse to compromise on his demands for immedi-
ate SO2 reductions. His attitude will be steeled by
recent Gallup polls showing 86 percent of Canadi
ans favoring emission controls regardless of cost. In
addition, Trudeau's personal truculence will be
multilateral sphere.
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reinforced by Canada's belief that the United
States is not cooperating in acid rain abatement
and by Ottawa's delight in having, for the first
time, a major ally in Kohl and the West Germans.
West Germany. Chancellor Kohl has said the reso-
lution of the acid rain problem is a matter of
"inestimable importance" to West Germany. Envi-
ronmental officials in Bonn estimate that 34 per-
cent of West Germany's forest areas, with a value
of about $1 billion, have been damaged by acid
rain. Government statistics indicate that 50 percent
of the 7 million metric tons of acidic materials
falling in West Germany annually come from
foreign sources, particularly France, Britain, and
East Germany.
The importance of forest areas to the German
psyche, the electoral success of the ecologically
oriented Green movement, and the evidence of the
damage attributed to acid rain-which in terms of
total damage to trees, fish, soil, and buildings is
estimated to approach $1.5 billion per year-have
produced outrage and a sense of urgency among
West Germans. In response, Kohl's government is
attacking acid rain in two ways: strict domestic
antipollution regulations that will require the in-
stallation of costly emission-control devices and an
ongoing effort to promote international environ-
mental cooperation
Bonn believes air pollution has peaked in West
Germany but at much too high a level and main-
tains that SO2 emissions must therefore be cut
"prior to obtaining decisive scientific evidence"
linking them to acid rain. Moreover, the govern-
ment is promoting international cooperation on
acid rain. Within the European Community, Bonn
is seeking EC-wide standards for SO2 emissions and
automotive exhausts. In addition, West German
representatives were prominent at the Ottawa Con-
ference, and Bonn has signaled its intention to do
likewise at the Munich and Geneva conferences
later this year.
Chancellor Kohl is likely to support the Canadian
acid rain position at the Summit. Kohl probably
enjoys domestic support on acid rain as nearly
unanimous as Trudeau's-both leaders draw sup-
port internally from an ethos that stresses the
importance of pure forests and other natural re- 25X1
sources to the national identity. Bonn's bottom line
for the Summit probably was expressed at the
Ottawa Conference by Carl-Dieter Spranger of the
Ministry of the Interior, who stated, "Those advo-
cating delay under the pretext that we still know
too little, must receive a definite `no.' "
United Kingdom. London urges there is not enough
evidence to demonstrate conclusively that SO2
emissions cause acid rain and believes that expen-
sive abatement procedures are not justified until an
irrefutable link is made. The Treasury Department 25X1
and the public-sector Central Electricity Generat-
ing Board (CEGB) estimate that a 30-percent
reduction in British SO2 emissions would cost $6
billion for installation of scrubbers, boost the
CEGB's operating costs, and drive u electricity
prices 10 to 15 percent.
Refusing to begin reductions has left Britain isolat-
ed within the European environmental community.
Britain currently is estimated to.produce 4 million
tons of SO2 annually-the most of any West Euro-
pean country-and nearly two-thirds of it reported-
ly is carried eastward out of the country by the
wind. The Scandinavians long have contended that 25X1
British SO2 is blown across the North Sea and
deposited-in the Nordic region; the British recog-
nize this possibility, as witnessed by the CEGB's
allocation of $7.5 million to study acid rain jointly
with the Swedish and Norwegian Governments.
Nevertheless, at the Summit, Britain is likely to
stand squarely behind its Department of Trade and
Industry's report on acid rain, which concluded, in
January 1984, that there is "insufficient basic
information available ... to say with certainty that
manmade acid deposition is a significant environ-
mental problem in the United Kingdom."
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France. French interest in acid rain is a recent
phenomenon, prompted by the damage to West
Germany's forests and the discovery of similar
damage to forests in northern and eastern France.
Paris has undertaken surveys of the problem-
which indicate damage in French forests is growing
rapidly-and is moving toward a comprehensive
national policy. The principal French objectives
regarding acid rain appear to be:
? A 50-percent reduction in S02 emissions by
1990-largely the byproduct of conversion to
nuclear power and the resulting elimination of
coal-fired electricity plants.
? Cooperative efforts with other European coun-
tries to reduce SO2 emissions.
? A publicity campaign to educate the French
population on the dangers posed by acid rain.
President Mitterrand probably will support Kohl
and Trudeau on acid rain at the Summit. Paris
already is committed to SO2 reductions greater
than those being urged by Bonn and Ottawa.
Endorsing Kohl's position gives Mitterrand an op-
portunity to strengthen the recent trend toward
more intimate Franco-German cooperation in other
fields. In addition, Paris's support for the German-
Canadian position could win Mitterrand points
among the small domestic environmental constitu-
ency.
Japan. Tokyo is actively reducing domestic SO2
emissions and pollutants in automotive exhaust. In
1983, for example, fewer than 3 percent of Japa-
nese cars burned leaded fuel. Japanese industry has
cut SO2 emissions by one-half since 1970, and the
number of flue scrubbers operating in Japan rose in
the same period from 100 to more than 1,000.
Tokyo also created a Committee on Acid Rain
Countermeasures in 1982 that is now conducting a
five-year research program on acid rain.
Prime Minister Nakasone is likely to feel uncom-
fortable on the acid rain question at the Summit.
Tokyo has scientific and technical cooperation
agreements with the United States and West Ger-
many under which acid rain and other environmen-
tal problems are discussed. The Japanese do not
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I1 May 1984
want the Summit disrupted by a controversy over
acid rain, but because of Tokyo's own environmen-
tal policies and the presence of an ecological con-
stituency in Japan, Nakasone probably will support
Bonn and Ottawa in the attempt to gain reduction
pledges from the United States and Britain.
Italy. Rome has shown little interest in addressing
the problem of acid rain in either its domestic or
international context. At London, Craxi probably
will be sympathetic to Kohl and Trudeau but would
be satisfied if the Summit simply concluded that
the issue should receive more study before major
pollution abatement programs begin.
The East-West Angle
West German and French interest in promoting
agreement on acid rain at the Summit will in part
be influenced by their desire to negotiate SO2
emission standards with Eastern Europe and the
Soviet Union. Bonn and Paris share the view of
Scandinavian governments that some of the pollut-
ants causing acid rain in their countries come from
the East. Seasonal fluctuations in prevailing wind
patterns permit atmospheric pollutants produced in
Eastern Europe and the Soviet Union to be carried
into Western, Nordic, and Southern Europe. Mos-
cow has indicated a willingness to begin a 10-year
SO2 abatement program in 1985, according to "'
Norwegian officials. The Soviets and East Europe-
ans will attend both environmental conferences
later this year. Bonn, Paris, and Ottawa probably
believe that a definite Summit commitment to SO2
reductions will strengthen the West's hand in deal-
ing with the Soviet Bloc.
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Summit Issues: Big'Six Views on
High Technology
All of the Big Six governments perceive a need to
promote high technology to maintain their interna-
tional competitiveness and, in varying degrees, all
intervene in the market to achieve this end. Al-
though there is little solid evidence as to what these
efforts have accomplished, Japan appears to have
achieved the greatest results. In the computer,
telecommunications, and semiconductor sectors,
Tokyo has supported all phases of the innovation
process, from initial research and development
through sale of the final product. Recently, new
materials and biotechnology also have become the
focus of research and development activity.
The major West. European countries and Canada
share a common. fear that they are falling behind
the United States and Japan technologically. All
five are also burdened by declining industries that
absorb large amounts of government funds that
might otherwise go to support new technologies.
With its long tradition of government involvement
in the economy, France probably has been the most
active in this area, achieving mixed results. Even
the market-oriented governments in Bonn and Lon-
don, however, are unwilling to leave technological
innovation entirely to the private sector; both pro-
vide.various forms of financial support for research
and development activities. Rome is working on
new measures to promote high technology, al-
though we expect greater results from the trend
among Italian firms to establish ties with US and
Japanese companies. Ottawa tends-to rely on direct
investment of government funds in selected high-
tech fields.
In an effort to catch up with the United States and
Japan in the field of information technology, the
West European members of the Big Six this March
joined with their EC partners to implement a
Community research and development effort. The
ESPRIT program-the European Strategic R&D
Program in Information Technology-is the Com-
munity's principal cooperative effort to support
research activities of business and academic institu-
tions. It is intended to improve the EC's technologi-
cal base in advanced microelectronics, computer
software, advanced data processing, computer-
controlled manufacturing, and office systems. The
program is scheduled to cost a total of $1.3 billion
over the next five years with equal shares provided
by the EC and the private sector. Although well
received throughout the Community, ESPRIT
nonetheless is a relatively small program-IBM
and AT&T together spend $2 billion annually on
similiar research. Moreover, ESPRIT does not
address the EC's more fundamental problem-the
inability to adapt technological innovations to com-
mercial applications.
Japan
Among the Big Six governments, Tokyo has been
the most visible and probably the most successful in
promoting high technology. The Japanese Govern-
ment views high technology as the seed from which
new, internationally competitive industries will
grow and as a means of reinvigorating mature or
declining industries. Acting mainly through the
Ministry of International Trade and Industry
(MITI), Tokyo assists all phases of the innovation
process in selected industries. MITI, in conjunction
with other government agencies, often encourages
research and development, financial assistance for
new production facilities, and an assured market.
Procurement by the government-owned telecom-
munications monopoly, NTT, for example, helped
launch the computer and semiconductor industries.
Today, MITI relies heavily on cooperative research
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projects with large corporations to promote re-
search and development in a broad range of high-
technology fields. A major problem now facing the
government is the apparent shortage of risk capital
for new, small businesses.
MITI places special emphasis on computers, tele-
communications, and semiconductors because these
are high-value-added industries with expanding
markets. Support is also provided for areas such as
composite materials and biotechnology that could
add to the competitiveness of major existing indus-
tries. Advances in biotechnology, for example, are
expected to lead to new, less energy-intensive pro-
duction processes for many chemicals.
Next to Tokyo, Paris probably has been the most
visible among the Big Six governments in promot-
ing technological development. The results have
been mixed. Government-sponsored research has
developed a wide range of sophisticated military
equipment and has also made France a leader in
nuclear power technology-especially fast breeder
reactors. Paris also played a key role in the growth
of the telecommunications sector and in the emer-
gence of the Airbus consortium as an effective
competitor on the world market for large jet airlin-
ers. On the other hand, Paris has tried for well over
a decade-without great success-to bring the
computer and machine tool industries up to the
standards of their international competitors.
Since the 1981 election campaign, high technology
has been a basic component of Socialist plans for
the future of France. Technological innovation is
expected to lead to the growth of new industries as
well as improved productivity in traditional sectors.
Although aging industries have continued to absorb
a large share of government aid, recent decisions
concerning coal, steel, and automobiles indicate
that high technology will get growing support from
Socialist decisionmakers. The new strategy will go
beyond increased allocations of aid and credit to
high-technology sectors. Awed by the Silicon Val-
ley example, the French have decided to reduce
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11 May 1984
bureaucratic barriers to launching new businesses
and have taken steps to bolster the nearly non-
existent venture capital market.
West Germany
Although West German manufacturing technology
is among.the most advanced in the world, govern-
ment and business leaders fear that the country is
being surpassed by Japan. This is a source of
growing concern to a nation whose prosperity de-
pends to an unusual degree on the export of
relatively sophisticated manufactured products.
Japan has overtaken West Germany in certain key
technologies, such as microelectronics and robotics,
and is challenging West German industry in other
areas-including precision forging technology,
medical electronics equipment, and advanced met-
alworking equipment. West Germany also lags
behind some of the latest developments in the new
industrial fields of biotechnology and high-tech
West Germany has been slow to translate new
technology into mass production-laser technology
and photographic equipment, for example. Possible
reasons include an overconfident attitude in the
past toward foreign competition and socioeconomic
obstacles to new small-scale ventures that are often
in the forefront of high-tech industries. The Kohl
government's basic response to this and to other
economic problems is to increase further West
Germany's reliance on market forces. Bonn, how-
ever, is beginning to expand its support for research
and development-particularly in smaller firms-
by providing subsidies and tax breaks. Areas being
aided include microelectronics, computers, biotech-
United Kingdom
Prime Minister Thatcher and her key advisers
believe that widespread application of high technol-
ogy is essential if Britain's position as an advanced
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industrial nation is to be maintained. Although
their Conservative ideology leads them to place
considerable emphasis on creating a predictable
climate for business and to use macroeconomic
measures, such as tax policy, to foster private-
sector initiative and productive investment, in prac-
tice they have been somewhat reluctant to rely
entirely on market forces.
London has established a number of programs
available to all firms, while others target only
specific sectors. The effort in general focuses less
on the development of new technology than on its
implementation in the production process-even if
the new technology must be imported. Government
seed money has been made available, for example,
to fund programs in computer-aided design, manu-
facture, and testing; the use of flexible manufactur-
ing systems; fibe:roptics; biotechnology; advanced
computer design; and further development of the
microelectronics industry. London also has provid-
ed funds to old-line industries hard hit by recession
and foreign competition but considered too impor-
tant in terms of employment and export earnings to
sacrifice. An example of the latter is a new pro-
gram to encourage the use of advanced equipment
by small- and medium-sized firms in the clothing,
footwear, knitting, and textile industries. The gov-
ernment hopes that the $425 million of new money
allocated to its incentive programs in the current
budget will generate an additional $1.7 billion in
private investment by 1990.
Italy
With some notable exceptions-such as numerical-
ly controlled machine tools and nuclear technol-
ogy-short-term profit pressures, an underdevel-
oped capital market, and mismanaged government
policies have contributed to a technological gap
between Italy and the other major industrialized
nations. According to a recent study by Confindus-
tria, Italy's employers' association, Italy lags these
countries by approximately five to 10 years in
moving from a reliance on traditional industries to
a high-technology structure. Key government, busi-
ness, and labor leaders generally agree that the
remainder of the 1980s will be a critical transition
period as Italy strives to improve its competitive-
ness by developing new high-tech industries and by
introducing technological innovations to lower pro-
duction costs in traditional industries.
To close the technology gap, Rome plans to stream-
line existing government programs and institute
new ones. Based on past experience with Italian
Government programs, however, we believe that a
more important development is the recent trend
toward joint ventures and equity participation with
US and Japanese companies. Italian public- and
private-sector firms see these linkages as the least
time-consuming and least costly way to gain access
to technological developments. Since 1980, for ex-
ample, Olivetti has purchased equity shares in over
20 small- and medium-size US firms operating in
fields from microchip manufacture to mainframe
computers, and has signed an accord with AT&T to
provide access to Bell Laboratories. Some govern-
ment officials and labor leaders are concerned,
however, about the employment effects of introduc-
ing laborsaving technology. In addition, according
to US Embassy sources, government study groups
are meeting periodically to review potential prob-
lems of increasing foreign dependence in key sec-
tors such as telecommunications.
Ottawa is convinced that it must encourage the
development of high-technology industries to en-
hance Canada's international competitiveness and
provide future employment opportunities. Indeed,
the cornerstone of the Liberal government's much
ballyhooed but largely unformulated industrial pol-
icy is a move away from resource-based and smoke-
stack industries toward such high-tech endeavors as
aerospace, telecommunications, communications
electronics, and advanced oil and gas field equip-
ment. In all of these fields, Canada has demon-
strated-albeit on a relatively small scale-some
ability to compete effectively in international
markets.
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The government considers direct public-sector in-
vestment the best means of ensuring adequate .
levels of Canadian involvement in new high-tech-
nology industries. Ottawa consequently has invest-
ed large sums of federal money in such industries,
most recently to spur the domestic production of
helicopters. In addition, federal research grants and
tax incentives are provided to promote research and
development activities within Canada. The present
high level of unemployment, however, has made it
politically imperative for Ottawa to divert funds to
support the more traditional, labor-intensive indus-
tries. Budget constraints are likely to prevent Otta-
wa from implementing its investment strategy for
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Argentina:
Medium-Term Financial
Outlook Under Alternative
Economic Scenarios
Although the 11th-hour agreement that narrowly
prevented US commercial banks from classifying
over $4 billion in Argentine loans as nonperforming
eased Argentina's immediate financial crisis, many
observers remain skeptical that Buenos Aires can
obtain sufficient funds to satisfy its longer term
borrowing needs and avoid a prolonged financial
crisis. Our projections indicate that if favorable
global economic conditions prevail through 1,990
the country's annual net borrowing needs in 1985-
90 would average 55 percent of peak borrowing in
1979-81.1 Many experts believe lenders almost
certainly would be unwilling to finance even this
level. In the event of shocks to the,global economy,
however, Argentina's net borrowing needs would be
even higher, and we believe lenders would be
unwilling to satisfy these needs. Recognizing that
economic shocks to the world economy are likely
and that many experts are convinced that Buenos
Aires's projected borrowing needs would not be
satisfied by lenders even under favorable economic
conditions, we believe Argentina will be plagued by
serious financial difficulties throughout the decade.
Argentina's recent financial difficulties can be
understood by analyzing the surge in gross borrow-
ing that began in 1979. This was caused initially by
a shift of the trade account from a surplus into a'
deficit and- later by sharply rising debt service
obligations. In 1979 and 1980 a deterioration in the
' This article is the second in a series that assesses the longer term
financial outlook for key debt-troubled LDCs based on simulation
model results.
' Net borrowing-the sum of the trade deficit, interest payments,
and miscellaneous net capital outflows-represents the required
inflow of "new money" or the increase in foreign lender exposure in
the country. Gross borrowing-net borrowing plus principal repay-
ments-is the sum of "new money" loans and loans that "roll over"
trade accounts, the result of a sharp real apprecia-
tion of the peso, occurred when exports and imports
grew at average annual rates of 15 percent and 62
percent, respectively. During 1981-83, concurrent
with a steady improvement in the trade balance,
debt service costs rose dramatically to an annual
average of $19 billion-up from $11 billion 'in
1980-because of sharply higher interest rates and
a near doubling of principal repayments. As a
result of this one-two punch, gross borrowing in the
1979-83 period totaled $86 billion-3.5 times the
amount in the previous five years. This surge in
borrowing pushed outstanding debt from $10 bil-
lion in 1978 to $40 billion in 1983.
In addition to lenders' attitudes toward Argentina,
the key to determining whether Buenos Aires's
financial difficulties will persist throughout the
decade is estimation of the country's net borrowing
needs through 1990. Toward this end, we have
developed a balance-of-payments simulation model.
Given assumptions. about future global economic
conditions-such as economic growth, interest
rates, oil prices, and export'price inflation-and the
future course of the Argentine economy, the simu-
lation model projects the trade balance, interest
payments, principal repayments, and other vari-
ables required to calculate net borrowing. We
examined Argentina's net borrowing needs under
four sets of assumptions regarding global economic
conditions. One scenario assumed that favorable
economic conditions would prevail through 1990,
while each of the others assumed that the world
economy would be buffeted by a different economic
shock. Argentina's medium-term financial outlook
in turn depends on lenders' willingness to finance
the net borrowing projected in each scenario and
the probability of each scenario occurring in the
rest of the decade.
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Argentina: Trends in International Trade and Finance, 1974-83 a
a Values for 1983 are based on incomplete data. The short-term components of
debt service and gross borrowing are estimated prior to 1980.
Favorable Economic Conditions:
Net Borrowing Remains High
We first projected Argentina's net borrowing needs
through the rest of the decade assuming favorable
economic conditions. We assumed that during the
next seven years:
? World real GDP would grow at an average
annual rate of about 4 percent. .
? Interest rates would fall slowly by a total of 3
percentage points.
? Oil prices would rise by $1.00 per barrel each
year.
? World export prices would grow, on average, at
about 5 percent each year.
In addition, we assumed in this, and the other
scenarios, that during the same period:
? Argentine real GDP would grow, on average, at
Buenos Aires's target growth rate of about 5
percent per year, high by historical standards.
? The rate of Argentine price inflation and curren-
cy depreciation would slow nearly 80 percent.
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11 May 1984
? The prices and volumes of Argentine exports and
imports would respond to changing economic
conditions as they have in the past two decades.
Under these favorable economic conditions, our
simulation model indicates that Argentina's net
borrowing needs through 1990, at 55 percent of the
level in the peak borrowing years of 1979-8 1, would
remain high. Net borrowing would rise to $6.5
billion in 1984-up from $3.3 billion in 1983-
before falling back to an average of $4.5 billion per
year in the 1985-90 period. Taking into account the
rollover of principal repayments, gross borrowing
would double over the decade rising from $16.5
billion in 1983 to $34 billion in 1990. Based on this
projected level of borrowing, outstanding debt
would rise by $34 billion, reaching the $74 billion
level in 1990. Although the stock of debt is expect-
ed to grow at an average annual rate of 9 percent
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Argentina: Key Assumptions for Alternative Scenarios
Favorable Economic Classical Recession a
Conditions
percent in 1984 and 1985 lower in 1985
4.2 percent in 1986 2 percentage points
through 1990 lower in 1986
1 percentage point
lower in 1987
World interest rates Fall from an average of 10 1.5 percentage points
percent in 1984 to 7 lower in 1985
percent in 1990 1.0 percentage point
lower in 1986
0.5 percentage point
lower in 1987
World oil prices Rise from $30 in 1984 to $4 lower 1985 through
$36 in 1990 1990
World export price 4.0 percent and 4.7 3 percentage points
inflation percent in 1984 and 1985 lower in 1985
5.4 percent in 1986 2 percentage points
through 1990 lower in 1986
1 percentage point
lower in 1987
Argentine real GDP 4.0 percent and 4.5
growth percent in 1984 and 1985
5.0 percent in 1986
through 1990
Argentine prices and Close parity between Same
exchange rate price inflation and
exchange rate devaluation
rates
Both rates fall sharply from
250 percent in 1984 to 60
percent in 1990
Tight Money Recession a Oil Supply Disruption e
3 percentage points
lower in 1985
2 percentage points
lower in 1986
1 percentage point
lower in 1987
4.5 percentage points
higher in 1985
3.0 percentage points
higher in 1986
1.5 percentage points
higher in 1987
$4 lower in 1985 through
1990
3 percentage points
lower in 1985
2 percentage points
lower in 1986
1 percentage point
lower in 1984
3 percentage points
lower in 1985
2 percentage points
lower in 1986
1 percentage point
lower in 1987
4.5 percentage points
higher in 1985
3.0 percentage points
higher in 1986
1.5 percentage points
higher in 1987
$60 per barrel vs. $31 in
1985
$55 per barrel vs. $32 in
1986
$50 per barrel vs. $33 in
1987
$45 per barrel vs. $34, $35,
$36 in 1988 through 1990
4.5 percentage points
higher in 1985
3.0 percentage points
higher in 1986
1.5 percentage points
higher in. 1987
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Argentina: International Trade and Financial Trends Under
Favorable Economic Conditions, 1980-90a
' Values for 1983 are based on incomplete data.
b Negative value indicates a trade surplus.
over the rest of the decade, the ratio of outstanding
debt to exports-one measure of the burden of
debt-would be unchanged in 1990 from last year's
Argentina's net borrowing would remain high un-
der favorable economic conditions because of an
evaporating trade surplus and slowly rising interest
payments.' Our projections-implicitly assuming
that the level of import control and export promo-
tion returns to historical norms-indicate that ex-
ports and imports in real terms would grow at
average annual rates of 3.2 percent and 9.0 percent,
respectively, in the 1984-90 period. As a result of
faster import growth, the trade surplus would
' This finding contrasts sharply with Brazil's projected net borrow-
ing needs under favorable economic conditions. Under similar
assumptions, we projected that a widening trade surplus would
outstrip increases in interest payments and cause Brazil's net
borrowing needs to dwindle in the 1984-90 period.
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11 May 1984
shrink to $300 million in 1990, down from a
healthy $2.3 billion in 1983. At the same time,
interest payments would rise from $4.1 billion in
1983 to a peak of $5.5 billion in 1990-an increase
of one-third. Although this sluggish trade perform-
ance and rising interest payments would require
lenders to increase their exposure in Argentina,
burgeoning principal repayments would force an
ever larger rollover of old loans. Principal repay-
ments are projected to rise from $13 billion in 1983
to $28 billion in 1990.
Economic Shocks: Net Borrowing Soars
Although we believe that Argentina's net borrow-
ing needs would be high under favorable economic
conditions, they are projected to be considerably
higher under scenarios incorporating economic
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shocks. In the event of shocks to the global econo-
my-a classical recession, a tight money recession,
or an oil supply disruption-we estimate the coun-
try's net borrowing needs would approach 85 per-
cent of the average level in the peak borrowing.
years 1979-81, compared to 40 percent in 1983.
The classical recession would raise borrowing less
than the other two economic shocks examined-
adding $1 billion per year, on average, to net
borrowing during the 1985-90 period. The oil sup-
ply disruption and the tight money recession sce-
narios would do significantly more damage-rais-
ing the projected level of average annual net
borrowing during: the period by $2.2 billion and
$2.8 billion, respectively.
As one alternative to the favorable economic condi-
tions case, Argentina's net borrowing needs were
projected assuming the occurrence of a classical
recession. We assumed in this scenario that the
global economy would be struck by a worldwide
recession in 1985 as a result of sagging demand-
possibly induced by tight fiscal policy in the indus-
trial countries.
Of the three shocks to the global economy exam-
ined, a classical recession would raise Argentina's
net borrowing needs the least, compared with the
favorable case. Such a recession would push Argen-
tina's net borrowing to an average of $5.5 billion
per year in the 1985-90 period, compared with a
projected $4.5 billion under favorable economic
conditions. Using the favorable economic condi-
tions scenario as a baseline, the additional amount
of net borrowing generated by such a recession in
this period would be $6 billion, and Argentina's
outstanding debt would rise from last year's level of
$40 billion to $79 billion in 1990.
Oil Supply Disruption
As another alternative to the favorable economic
conditions case, we assessed the impact of another
oil supply shock on Argentina's net borrowing
needs by assuming an oil supply disruption would
occur in 1985. The assumed oil supply disruption
Argentina: International Financial Trends
Under Alternative Economic Scenarios,
1984-90
Billion US $ Note scale change
Gross Borrowing
Oil supply
disruption
recession
Classical recession
Favorable
economic
conditions
22~~I I I I I
20 1984 85 86 87 88 89 90
1 I I I I I I I
Tight money
recession
-Oil supply
disruption
Classical recession
Favorable
economic
Oil supply
disruption
Tight money
recession
Classical recession
Favorable
economic
conditions
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would be similar in magnitude to the one that
would occur if Persian Gulf oil shipments.were
substantially curtailed.
Our projections indicate that an oil supply disrup-
tion would raise Argentina's net borrowing needs
significantly more than a classical recession but less
than a tight money recession. An oil supply shock
would lift Argentina's net borrowing to an annual
average of $6:7 billion in the 1985-90 period-
nearly 50 percent higher than under favorable
conditions. Total net borrowing following the oil
supply disruption would exceed the favorable eco=
nomic conditions baseline by $13 billion during this
period and outstanding debt would jump nearly 120
percent from last year's level to $87 billion in 1990.
Tight Money Recession
As a third .alternative to the favorable economic
conditions case, Argentina's net borrowing needs
were projected under the assumption that a tight
money recession occurs. This recession, assumed to
strike the global economy in 1985, might evolve if
the central banks of the industrial countries adopt
restrictive monetary policies
In terms of its effects on Argentina's net borrowing
needs, we believe that a tight money recession
would do more damage than the other two global
economic shocks examined. In the event of a tight
money recession, Argentina's net borrowing would
rise to an average of $7.3 billion per year in the
1985-90 period-nearly 85 percent as high as the
average in the peak borrowing years of 1979-81.
Compared to the favorable economic conditions
baseline,. the additional amount of net borrowing
generated in the 1985-90 period by this recession
would be about $16.5 billion, and, outstanding debt
would rise by $50 billion from its 1983 level
reaching $90 billion in 1990.
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11 May 1984
Will Projected Net Borrowing
Needs Be Satisfied?
Although it is difficult to predict lender attitudes
toward any LDC several years in the future, many
financial experts are convinced that lenders would
be unwilling to finance Argentina's projected bor-
rowing needs even under favorable economic condi-
tions-an annual average of $4.5 billion in net
borrowing during the 1985-90 period. They believe
that Buenos Aires would not benefit from the
modest recovery in voluntary bank lending to LDCs
that many observers agree could occur under sus-
tained favorable economic conditions. These ex-
perts believe that the projected long-term weakness
of Argentina's financial position, as reflected in the
alarming size of several financial measures-such
as the debt service to exports ratio-and Argenti-
na's unpredictable and intransigent behavior dur-
ing the past two years have permanently soured
lender attitudes toward the country. If lenders
refuse to satisfy the projected net borrowing needs,
Buenos Aires would have to institute harsher aus-
terity measures and lobby for concessions from
creditors even under favorable economic conditions
in order to live within its external financing con-
straint. We tend to agree with those experts who
believe that'the country's projected net borrowing
needs under favorable economic conditions proba-
bly would not be satisfied by lenders and that the
need for tough austerity measures, and some con-
cessions from creditors will persist.
There are, however, other observers who contend
that' Argentina's projected net borrowing of $4.5
billion annually in the 1985-90 period under favor-
able economic conditions could be satisfied. They
believe that the country would indeed benefit from
a modest recovery in voluntary bank lending to
LDCs. They believe that the banking community
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Secret
has a relatively short memory and that the lure of
potential profits could lead to a resumption of
voluntary bank lending to Buenos Aires within a
few years. If this limited resumption of voluntary
bank lending occurs and official lenders step in to
fund any shortfall in financing, these observers
believe that Argentina could muddle.through under
favorable economic conditions.
There is little disagreement that Argentina's pro-
jected net borrowing needs-$5.5 billion to $7.3
billion per year-following the shocks to the global
economy that we examined would be more than
lenders would be willing to provide. Although
lenders financed an average of $8.6 billion per year
of Argentine net borrowing in the peak borrowing
years of 1979-81, we believe new lending of this
magnitude can, be ruled out, given the recent sharp
contraction of voluntary bank lending to LDCs.
Shocks to the global economy, by reminding lend-
ers of the frailty of their LDC loans, would further
erode lender confidence in the longer term ability
of debt-troubled LDCs to service their debt. As a
consequence, lenders might decide"to cut their
losses by reducing even further their lending to
these LDCs. In the event of such a cutoff of new
credit, Argentina probably would have to adopt
harsh austerity measures as well as reach a com-
prehensive agreement with creditors to stretch out
repayment periods and reduce the interest burden
of outstanding debt.
On the basis of our projections of Argentina's
borrowing needs and our assessment of lenders'
willingness to satisfy this demand for credit, we
believe that the country will be plagued by severe
financial difficulties at least through 1990. There is
a chance that Buenos Aires might succeed in
muddling through under favorable economic condi-
tions. If it fails or the global economy is buffeted by
economic shocks, however, Argentina would experi-
ence a prolonged period of serious financial diffi-
culties.
41 Secret
/! May 1984
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Recent Oil Exploration in North Yemen
O
Red Sea
3
People's Democratic
ic of Yemen
Republ~~ .~
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;e
~...~ ~ Y
-b a R-e p u I I C? Area of
oil exploration
Yemen)
Hajh(Norh
}
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Secret
Implications of a Significant Oil Discovery
in North Yemen
Preliminary reporting indicates that oil may have
been discovered near North Yemen's border with
Saudi Arabia and South Yemen. The discovery of
oil reserves comparable with those in southern
Oman would have a substantial impact on North
Yemen's economy, internal politics, and relations
with Saudi Arabia and the United States. It would
be at least four years, however, before substantial
quantities of oil could be exported because North
Yemen would have to develop the oilfield and build
pipelines and shipping facilities.
Economic Implications
A US firm is drilling for oil in the eastern portion
of North Yemen in the Ma'rib desert. The US
Embassy in Sanaa reports that already there has
been a significant show of hydrocarbons. Further
testing will be required to determine the quantity
and quality of the petroleum reserves. According to
the Embassy, the company's break-even point to
develop a find would be the discovery of about 250
million barrels of oil and production of around
100,000 b/d. We speculate that the size and type of
oil deposits in North Yemen would resemble those
found in southern Oman. Proved, recoverable re-
serves in the Dhofar region of Oman are about 1
billion barrels and consist mainly of heavy oil.
Reserves of this magnitude could support a produc-
tion rate of about 100,000 barrels per day for at
least 20 years.
Such a discovery would not significantly affect the
world market for oil, but it would be of major
significance to North Yemen. Once oil revenues
start flowing, Sanaa would be less beholden to
foreign aid suppliers, and President Salih's develop-
ment program would no longer be as threatened by
the country's precarious financial position. New
employment and trade opportunities would develop
Although the construction of oil facilities might
take three to four years to complete, North Ye-
men's economy would benefit in the interim, espe-
cially if Yemenis were able to contain their rising
expectations. We believe Sanaa would obtain for-
eign financing more easily as its ability to repay
debts improved. In the early stages of construction,
contractors might provide their own financing, and
the need for infrastructure and building materials
probably would stimulate imports and foreign
trade. On the other hand, North Yemen would face
short-term economic problems if it overextended
itself in the international capital markets
Many of the estimated 700,000 North Yemenis
who work in Saudi Arabia and the smaller-Persian
Gulf states probably would return to North Yemen
in anticipation of oil boom jobs. Their return,
however, would be a mixed blessing. Although they
would provide a ready supply of labor, they also
would burden North Yemen's inadequate housing
and social welfare programs as well as reduce the
income from worker remittances.
President Salih almost certainly would use an oil
find to strengthen his hold on power by taking
credit for the discovery and the resulting economic
growth. We believe economic modernization based
on oil revenues would eventually reduce the politi-
cal importance of Yemeni tribes and increase the
importance of Western-educated technocrats in the
central government. Until the discovery is exploit-
ed, however, the influential and largely independ-
ent tribes would remain a significant problem for
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DI IEEW 84-019
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North Yemen's Crippled Economy
North Yemen is one of the world's least developed
countries per capita income was less than $500 in
1982. In addition, Sanaa has one of the world's
worst commodity trade imbalances, with exports
typically financing less than 1 percent of imports.
Instead, imports are financed primarily by worker
remittances and aid. With worker remittances
declining, foreign exchange reserves have fallen
from $1.5 billion in 1978 to $313 million in
October 1983, sufficient to cover two or three
months of imports. Inadequate revenues forced
Sanaa to scrap its original 1983 budget and cut
back imports.
North Yemen has little prospect of improving its
economic situation barring an oil discovery. For-
eign aid, on which Sanaa relies, was $900 million
in 1983, about half the 1982 level, and new
commitments for 1984 are unlikely. If more for-
eign aid is not forthcoming, and current drought.
conditions persist, we expect little or no economic
growth this year.
the central government, and the prospect of reve-
nues from oil and construction would increase
competition among tribes. A major oil find also
would increase the already substantial political
influence of North Yemen's military, because the
military is Salih's power base and he would spend
some of the early oil revenues on weapons
North Yemeni-Saudi Relations
We believe that an oil discovery would reduce
Saudi influence as North Yemeni dependence on
Saudi financial aid declined. Even before a discov-
ery could be exploited, North Yemen would seek
greater independence from, Riyadh, although
Sanaa would still be constrained by its need for
Saudi financial aid until oil revenues began to flow.
The Saudis would probably try to retain their
leverage by increasing the subventions they pay to
prominent North Yemeni tribal leaders and politi-
cians or by increasing project aid. Riyadh might
press for immediate concessions on outstanding
issues, such as border demarcation, out of concern
that its bargaining position would deteriorate as
North Yemen became more financially independ-
The Saudis' longstanding fear of an independent
North Yemen could lead Riyadh to overreact to a
discovery. Riyadh might attempt to persuade the
US Government to encourage the US firm to cease
its operations, arguing that the exploration was in
territory, claimed by Saudi Arabia. Alternatively,
the Saudis might move troops to North Yemen's
borders, as they did after an incident in late
December, although Riyadh probably would not
seek a major military confrontation.
North Yemeni-South Yemeni Relations
We judge that an oil find would encourage North
Yemen to improve relations with South Yemen. A
reunification of the two Yemens almost certainly
would not result, although discussions of unity
probably would increase markedly as Sanaa sought
to express its independence from Riyadh.
We believe South Yemen would try to strengthen
its recent rapprochement with Sanaa. South Ye-
men might offer to allow North Yemen to build a
pipeline to Aden, which has a refinery and harbor
well suited for oil exports. We doubt that North
Yemen, however, would allow its oil exports to
become dependent on Aden's good will.
Aden would also seek to build good will with the
US firm working the North Yemeni concession.
The same firm might conduct exploration in South
Yemen, and the geology of the North Yemeni-
South Yemeni border region is such that an oil find
in North Yemen would increase interest in looking
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Secret
Implications for the United States
We judge that an oil discovery would help foster
better relations between North Yemen and the
United States. We believe that President Salih
would seek Western technology and financial ex-
pertise to fully exploit potential oil and mineral
resources, and that he favors closer cooperation
with the West. An oil discovery-and reduced
Saudi influence in Sanaa-would also help bring
about a more direct US-North Yemeni relation-
ship. The US agreement in 1979 to supply arms to
North Yemen has led to problems among Washing-
ton, Riyadh, and Sanaa. Spare parts and mainte-
nance for North Yemen's US-made equipment are
funded by Riyadh, and the Saudis hold back on
parts and repair to influence North Yemen's poli-
cies. A more direct US relationship with Sanaa
probably would require high-level US discussions
with Riyadh to define Washington's relationship
with both countries. We would expect Riyadh to
continue to discourage more direct ties between
Washington and Sanaa.
The extent to which the United States is able to
respond to Sanaa for a relationship independent of
Riyadh's influence largely will determine, the fu-
ture of North Yemeni-Soviet relations. An expand-
ed US presence in North Yemen would reduce the
possibility. that Moscow could increase its already
substantial presence at the expense of US interests.
Moscow has about 500 military advisers in North
Yemen, and most North Yemeni military officers
are Soviet trained. We judge, however, that any
perceived reluctance by the United States to ex-
pand ties with North Yemen would cause Sanaa to
turn to Moscow for increased technical aid, weap-
ons, and political support
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