INTERNATIONAL ECONOMIC & ENERGY WEEKLY

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP97-00771R000707400001-4
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 33
• Document Creation Date: December 22, 2016
• Document Release Date: October 20, 2010
• Sequence Number: 1
• Publication Date: February 15, 1985
• Content Type: REPORT

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Directorate of -'SeCI'C~
Intelligence
Weekly
International
Economic & Energy
DI IEEW 85-007
IS February 1985
Copy 6 8
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Secret
International
Economic & Energy
Weekly
15 February 1985
iii Synopsis
1 erspective-The Oil Market Outlook: Another Difficult
Year for OPEC~~
3 Briefs Energy
International Finance
Global and Regional Developments
National Developments
13 OECD: Dealing With an Oil Price Drop
17 USSR: Problems Exporting Oil and Gas
21 Nicaragua: Economic Vulnerabilities
31 %IVlexico: Dim Prospects for Foreign Investment
Comments and queries regarding this publication are welcome. They may be
directed to Directorate of'Intelligence
Secret
/S February 1985
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International
Economic & Energy
Weekly
Synopsis
1 Perspective-The Oil Market Outlook: Another Di.,~icult
Year for OPEC 25X1
spring.
The oil market outlook in 1985 indicates that downward pressure on oil prices
will continue, and another price reduction is likely, possibly as early as this
13 OECD: Dealing With an Oil Price Drop
Most OECD governments would pass on to consumers the benefits of further
declines in oil prices-boosting GNP growth and lowering inflation. Although
some governments would consider taxing away an oil price decline to ease
budget deficits, they probably would wait to see the size and permanence of a
price cut before acting.
17 USSR: Problems Exporting Oil and Gas
The Soviets have substantially reduced oil and gas exports to some West and
East European customers. The USSR should be able to meet its gas export
commitments, but the the same may not be true for oil.
21 Nicaragua: Economic Vulnerabilities
Bleak export prospects promise a worsening of Nicaragua's serious economic
and financial problems. To step up military spending, the Sandinistas are
reducing subsidies to local consumers and producers and further stalling
international creditors.
Mexico: Dim Prospects for Foreign Investment 25X1
Tough regulations and poor prospects for economic performance are discour-
aging foreign investment in Mexico. As long as the government is unwilling to
create a favorable investment climate, Mexico will not attract enough new
overseas funds to offset the slump in domestic investment or limited access to
international credits.
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Perspective
International
Economic & Energy
Weekly
15 February 1985
The Oil Market Outlook: Another Di,,~"icult Year for OPEC 25X1
best hold relatively flat this year.
The oil market outlook in 1985 indicates that downward pressure on oil prices
will continue and another price reduction is likely, possibly as early as this
spring. Non-Communist oil consumption is expected to increase only marginal-
ly this year. At the same time, non-OPEC oil production will again increase-
albeit at a decreasing rate. As a result, demand for OPEC oil probably will at
The recent OPEC agreement on prices is generally viewed as too little too late.
The move reduced the average OPEC oil price by less than 50 cents per barrel,
not enough to dampen increases in non-OPEC oil capacity or to spur demand.
Lower revenues will encourage some OPEC members to cheat on their
production quotas at the earliest possible moment. Put simply, the perception
that the organization has lost control of the oil market remains widespread.
We believe OPEC members realize that a moderate reduction in oil prices is
unlikely to increase demand in the short-to-medium term and that cohesive-
ness is necessary. Nevertheless, the motivation for some members to overpro-
duce is substantial:
? Most important, Saudi ability to absorb further reductions in oil output is
limited
In our judgment, Riyadh currently is unwilling to take the lead on any
substantial reduction in oil prices. Rather, we believe the Saudis are hopeful
that the recent price agreement and institution of a mechanism to monitor
production and prices will allow further cuts to be avoided.
February-a move that avoids undercutting current Nigerian prices.
OPEC's efforts to gain the cooperation of non-OPEC producers, such as
Mexico, Egypt, Malaysia, and Brunei, have proved largely unsuccessful.
Indeed, Cairo and Mexico City apparently believe that OPEC members must
accept the role of residual supplier. Although North Sea producers have
maintained production at capacity, London deferred setting its "official" oil
price for two months because of concern that a reduction would lead to a
general round of price cuts-and a further fall in the value of the pound. As a
result of recent increases in spot prices, however, London is proposing to
reinstate its last official oil price of $28.65 per barrel for January and
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The market outlook for 1985 and the next few years indicates that OPEC
faces formidable challenges, even if the organization manages to avoid another
cut this year. OPEC has not formulated an effective strategy to:
? Equitably prorate its market share among members in a market where
reduced stock usage exaggerates seasonal shifts in demand and pressures on
Saudi Arabia, OPEC's swing supplier.
? Deal with the uncertainty on production levels and revenue streams that has
resulted from the movement away from term contracts.
? Control prices on the growing volume of product exports.
? Accommodate Nigeria's need-and pressure from other members-for a
higher output level while also meeting likely Iraqi demands for a quota
increase, perhaps later this year.
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Energy
Western Europe's Despite a drop of $6 per barrel in world oil pl`ices since March 1983, the dol-
Crude Oil Costs Rising lar's appreciation against West European currencies has more than offset
lower prices, because crude oil costs are denominated in dollars. The continued
strength of the US dollar has contributed to a further delay in the long-
anticipated recovery in oil demand in Western Europe. Data indicate Europe-
an oil consumption rose only by 1 percent in the first three quarters of 1984, as
compared with a 5-percent increase in the United States. Increased cost,
however, is one of several factors that continue to slow the recovery of oil de-
mand in Western Europe. Japan with its healthy economic recovery has seen
oil demand increase by 6 percent in the first three quarters of 1984 despite the
strength of the US dollar
Local Currency Crude Oil Cost Per Barrel
February 1983
30 January 1985
Percent Change
February 1983/
30 January 1985
US dollars (Saudi benchmark)
34
28
-17.6
Japan (yen)
8,032.2
7,125.2
-11.3
France (!rant)
234
270.8
15.7
West Germany (Dtl~
82.5.
88.7
7.5
Italy (lira)
47,532
54,586
14.8
United Kingdom (L)
22.2
24.8
11.7
Netherlands (guilder)
91.0
100.3
10.2
Spain (peseta)
4,411.8
4,905.6
11.2
Greece (drachma)
2,840.6
3,620.4
27.5
West European (average)
14.1
K-Norwegian Natural The United Kingdom rejected a proposal to buy 10-12 billion cubic meters of
Gas Deal Rejected gas per year from Norway's Sleipner field. UK Energy Secretary Walker said
that new estimates of domestic gas resources show the United Kingdom can
supply its needs without Sleipner. London rejected the $30 billion contract
because of concern about the balance-of-payments effect and the loss of tax
revenues resulting from importing gas rather than producing domestically.
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Oslo has decided to shelve development of Sleipner for the present and try to
negotiate with other West European countries for sales of gas from the larger
Troll field. Oslo is going ahead with planned discussions this year on
development of Troll gas, but the collapse of the Sleipner project will cool some
of its enthusiasm. Moreover, the high cost of Troll gas will make it difficult to
sell. Failure to develop and market Troll gas would increase the likelihood of
significantly greater European reliance on Soviet gas.
Bidding for South Seoul is expected to solicit tenders for nuclear power plants 11 and 12 in the
Korean Nuclear Plants second half of 1985, but the bidding-originally scheduled for 1982-could be
scuttled by opposition from energy planners who favor coal. Coal proponents
are being bolstered by an unreleased government study that gives coal a cost
edge over nuclear fuel and reported "coal lobby" backing. US Embassy
officials report US, Canadian, and West European firms have begun strenuous
prebid lobbying for the contracts in which technology transfer and domestic
content as well as cost will weigh heavily in Seoul's decision. The two 900-
megawatt units are scheduled for completion in 1996. Bids on units 13 and 14
will be delayed until 1988 because of concerns about South Korea's $43 billion
foreign debt, according to press reports.
Mexico Pledges More New austerity measures announced last week appear designed to gain IMF
Belt-Tightening approval for Mexico's 1985 economic program. The government disclosed it
will cut 1985 public spending by $465 million, sell or close 236 state
companies, and freeze hiring. In addition, Mexico City plans to rely more on
tariffs and reduce use of licensing. The IMF, which has been negotiating with
the administration since November, is currently in Mexico City reviewing the
revised 1985 economic plan. In January the IMF rejected Mexico's package
for this year and asked for tougher steps on the budget and inflation. Although
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/Portugal Seeks
` /Jumbo Loan
Turkish Loan
D~culties
likely to fight closures of large state-owned factories.
we believe these latest concessions will be sufficient for the IMF, we do not ex-
pect Mexico to fully implement them. Almost all of the 1985 budget will
probably be spent before the July elections, and the government will attempt to
keep its pledge to maintain real wages and employment. Moreover, unions are
cient commitments.
Lisbon is asking international bankers to participate in a $500 million credit
facility to help finance Portugal's current account deficit, which is expected to
reach $1 billion for 1985. An arrangement worked out between Lisbon and the
lead managers of the loan sets up a mixed facility: one-half of the total credit
will beta traditional syndicated loan for eight years at five-eighths percentage
point over LIBOR; the other half will be a revolving credit at three-eighths
percentage point over LIBOR. The deal probably requires participation in the
short-term facility if banks want to subscribe to the conventional syndicated
loan. Press reports indicate the Portuguese chose this route to attract financing
for the cheaper revolving standby facility. The heavy oversubscription of last
month's credit for the state-owned electricity company and the dramatic
improvement in Portugal's current account deficit during the last two years
suggest that Lisbon probably will not encounter difficulties obtaining suffi-
Turkey's reputation in the international financial community.
Turkey's attempt to arrange a new and innovative $500 million credit
continues to face difficulty. The credit requires the lead banks to underwrite
the successive issuance of short-term notes on the Euromarket over aseven-
year period. As of early February the syndication manager had lined up only
some $450 million. Problems began surfacing late last year when several banks
decided against participating. These bankers pressured the Turkish Central
Bank to abandon the so-called hybrid scheme in favor of a traditional bank
syndication because Turkey's, credit rating is far below that of others, such as
Sweden, that have successfully used this type of facility. Turkey's Central
Bank Governor, however, has predicted optimistically that the credit will be
completed by the end of February. Failure to finalize the deal could damage
Global and Regional Developments
Deb or LDCs Improve Foreign excHange reserves of the top 20 LDC debtors rose 20 percent from
eserve Positions yearend 1983 levels, reaching almost $69 billion by the end of third quarter
1984. The most impressive gains were registered by Brazil and Mexico-the
two largest LDC debtors. Argentine reserves grew to almost $2 billion but
were still below the 1982 level. Substantial declines were registered by the
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l5 February /985
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I S February .1985
Top 20 Debtor LDCs: Foreign Exchange Reserves e
Billion US $
Reserve-to-Import Ratio
(months)
1981
1982
1983
1984b
Total
68.26
52.63
57.16
68.64
Brazil
6.60
3.93
4.35
9.23
7
Mexico
4.07
0.83
3.91
7.01
9.5
Argentina
3.27
2.51
1.17
1.90
5.5
South Korea
2.68
2.81
2.35
2.56
1
Venezuela
8.16
6.58
7.64
8.69
12
Indonesia
5.01
3.14
3.72
4.75
4
Egypt
0.72
0.70
0.77
0.77
1
Philippines
2.20
1.72
0.79
0.26
India
4.70
4.31
4.94
5.87
4.5
Chile
3.21
1.8 k
2.04
2.23
8
Malaysia
4.10
3.77
3.78
4.05
3.5
Algeria
3.70
2.42
1.88
1.75
2
Nigeria
3.90
1.61
0.99
0.99
1.5
Peru
1.20
1.35
1.36
1.51
7.5
Thailand
1.73
1.54
1.61
1.61
2
Colombia
4.80
3.86
1.90
0.77
2
Morocco
0.23
0.22
0.11
0.10
Pakistan
0.72
0.97
1.97
1.05
2
Taiwan
7.24
8.53
11.86
13.52 a
8
Sudan
0.02
0.02
0.02
0.02
e Total reserves minus gold; end of period.
n Third quarter.
Less than one-half month.
a May 1984.
over four months of imports-a one-half month gain since 1983.
Philippines, Colombia, and Pakistan. The net increase was due largely to
improved sales in recovering developed-country markets. Most of the debtors
have held imports close to 1983 levels. For the group, reserve holdings equal
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Tighter COCOM
Controls
No Agreement
~ /Expected at
.:// Cocoa Meeting
Saudi-Turkish
/ Military Cooperation
COCOM members.
COCOM countries at their recent high-level meeting adopted several mea-
sures to tighten strategic export controls. For the first time, they agreed to
some restrictions on sales of COCOM-controlled products to Cuba, although
member countries still will have wide discretion on enforcement. The delegates
agreed to work more closely with other countries to prevent diversion of
COCOM items through their territories. They failed to resolve licensing
questions involving China and formed an ad hoc subcommittee to study the
problem. Exports to China now account for over 80 percent of COCOM
cases-up from only 1 percent five years ago. The meeting was less acrimoni-
ous than the last one, reflecting the growing consensus that more effective
multilateral control is necessary. Many COCOM countries probably already
impose restraints on sales to Cuba, although not in coordination with other
The cocoa producing and consuming countries meeting in Geneva next week
are not likely to agree on a replacement for the International Cocoa
Agreement (ICCA) that expires in September. Consumers are proposing a
midpoint of $1 a pound within an as yet unagreed-upon target range, and
producers want a $1.10 to 1.55 range. A less contentious issue will be export
restrictions to supplement the existing buffer-stock mechanism. Although most
producers favor export quotas, they might agree to some form of the EC's
proposal to withdraw cocoa from the market when prices fall to near the ICCA
minimum. Cocoa prices are several cents below the current $1.10 per pound
ICCA minimum, and many producers believe an effective new pact will be
necessary to prevent further price declines. Even though consumption has
outpaced production in the last two seasons, most observers expect the
production surpluses this year will put more downward pressure on prices.
Riyadh is negotiating with Ankara for training of Saudi officers at Turkish
military schools, the maintenance of Saudi aircraft at Turkish airbases, the
sale of a wide range of spare parts for the Saudi Army, and the possible
purchase of Turkish-built missile attack boats. Saudi Arabia is seeking to
expand ties to Turkey as part of its efforts to strengthen the informal coalition
of moderate Islamic nations, to offset the potential of a powerful postwar Iraq,
and to counter Soviet and radical influence in the region. The negotiations also .
reflect Saudi efforts to secure new sources of spare parts and to become less
dependent on US contractors and Pakistanis for aircraft maintenance. In
return, Riyadh is holding out the prospect of substantial financial aid and
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,~panish Exports
urge
Saudi Arabia, to bolster its arms industry.
- other economic benefits; the US Embassy believes Turkey may already have as
much as $4 billion in commercial contracts. with the Saudis. For its part,
Ankara has been trying to expand arms sales in the Middle East, particularly
National Developments
Developed Countries
policy and encourage investment growth.
A sharp increase in Spanish exports last year dramatically improved the
current account balance and allowed Madrid to meet its GDP growth target.
Madrid estimates real exports rose ~20 percent in 1984, versus 7 percent in
1983. Export earnings rose about $4 billion, helping swing the current account
from a deficit of $2.5 billion in 1983 to a surplus of $2 billion-the government
target was a $500 million deficit. Export performance was also almost entirely
responsible for raising real GDP growth to 2.5 percent, continuing the recovery
begun in 1983. We believe the export boom stemmed mainly from a gain in
competitiveness after the 1982 devaluation, slumping domestic demand, and a
pickup of growth in major trading partners. Spanish officials expect a slight
erosion of price competitiveness coupled with strengthening domestic demand
to slow real export growth to 4 to 5 percent this year. Another large current ac-
count surplus is anticipated, giving. Madrid, enough leeway to ease monetary
Japanese Workweek At a January international trade union symposium in Japan, representatives
roposals
nations.
from various industrialized nations .expressed concern that Japan's long
working hours constitute a "hidden export.subsidy." Domei, a major Japanese
.labor confederation, sponsored the meeting .as part of its efforts to reduce the
workweek from 48 to 40 hours and to make other;changes in the country's La-
bor Standards Law. A Ministry of Labor advisory. council report last year
recommended only a 45-hour workweek. The union hopes international
pressure will .force a favorable response from the government. Domei's
proposed changes, however, fail to tackle the more difficult issue of wage
increases, which could boost import demand and thus ease trade friction.
Japanese, wage gains have not come close to those in other industrialized
Secret
IS February 1985
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~rike Threat
New Jamaican
conomic Reverses
t
Cor~icts Over the
anese Economy
~ ...
announced plans to cut imports-primarily of automobiles, luxury goods, and
textiles-and to impose.petroleum rationing. In addition, Mengistu declared
that all Ethiopians will be called on to serve tours at relief shelters and
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Less Developed Countries
Bolivian General La Paz has devalued the peso by 80 percent and raised food, fuel, and
increases continue to fuel the country's hyperinflation.
transportation prices by an average of 400 percent. To blunt the effects of
these measures, workers have received a 330-percent pay hike. The country's
largest labor confederation has denounced the adjustments and is considering
calling an indefinite general strike. Labor leaders almost certainly will call for
the general strike in hopes of forcing President Siles to scale back austerity
measures. A strike would heighten military concern and provide radicals in the
labor movement with new opportunities for provoking violence. The economic
gains are likely to prove ephemeral, as financial concessions and repeated wage
not make him yield to opposition calls for an early general election.
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The worldwide alumina glut and Jamaica's high production costs are prompt-
ing Alcoa to suspend its bauxite and alumina operations in Jamaica for at least
one year, according to the US Embassy. The closure comes on the heels of
Prime Minister Seaga's announcement that tourism-the second-largest for-
eign exchange earner-has fallen sharply since the steep hike in petroleum
prices last month triggered three days of public protests. The shutdown will
cost Jamaica about $60 million in export revenues this year. This loss and a
possible $80-100 million drop in tourist receipts in 1985 will compound the 25X1
country's financial difficulties and may cause the collapse of its $165 million
IMF package. Alcoa's closure will cost 900 jobs, and unemployment already is
approaching 30 percent. Increasing economic hardships are likely to cause
Seaga's party to lose local elections to be called by June, but they probably will
Lebanon's rapidly deteriorating economy is becoming a new focus of antigov-
ernment actions that will add to the country's climate of violence.
Meanwhile, "Islamic Jihad"-probably the radical Shia
Hizballah-has c aimed it bombed several Beirut banks two weeks ago to
protest against those profiting from the fall of the Lebanese pound. The rapid
fall of the pound in the last two months has caused prices to rise 30 to 40 per-
cent-as much as the increase for all of 1984. Militias continue to siphon off
customs duties, the government's major source of revenue. The government
has aggravated the situation by appointing governors of the central bank who
have no financial experience.
Ethiopian Austerity Ethiopia this week announced the imposition of a national drought-relief tax,
Measure's ~ equaling one month's pay for all workers. Chairman Mengistu on Saturday
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the military, his primary power base.
resettlement camps. Government policies largely had protected the urban
population from the famine's effects, but the new austerity measures and
developing food shortages in the cities now will affect it adversely. Mengistu is
unlikely to extend these measures, particularly the tax and fuel rationing, to
/Papua New Guinea The four-year-old, $1 billion Ok Tedi gold and, copper project in western
/ Closes Gold Mine Papua New Guinea will close 28 February by government order. The
government was providing 20 percent of the project's cost in order to gain the
transport facilities and hydroelectric system associated with the copper-mining
phase. For several months, the mining consortium of US, Australian, and West
German firms had been denying charges that, because of falling copper prices,
it planned to abandon the project after stripping it of better-than-expected
gold ores. Workers who have threatened to destroy the mine if it is closed have
been pacified. by the consortium's promises to renegotiate, but the government
has yet to show sigris of relenting. Port Moresby-generally friendly to foreign
capital-undoubtedly intends the shutdown as a strong warning that investors
.will be expected to live up to original contract provisions.
Personnel Changes
at China's S&T
Commission
Secret
IS February 1985
China's State Science and Technology Commission. (SSTC) Minister, Song
Jian-who will lead the Chinese delegation to the United States for the April
meetings on US-China S&T cooperation-has appointed four new vice
ministers, according to Embassy reporting. All are younger, well-educated
men, with diverse backgrounds in industry as well as academic research. The
new appointments should strengthen SSTC ties to important segments of the
research and development community, and facilitate reforms designed to make
research more responsive to industry needs. Beijing has been working on
reform of the S&T system for several years. Song Jian's appointments indicate
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Vietnam's 1985
E~mic Targets
Record Rice
rop in Laos
scientific research is expected at the end of February.
that the minister, who took over the SSTC only last September, is moving
aggressively to surround himself with reform-minded personnel. A major
policy statement outlining changes in the management and funding of
few pragmatists in the party hierarchy.
According to the Vietnamese press, Hanoi's ambitious 1985 economic plan
calls for increases of 6.5 percent in GNP, 10 percent in foodgrain production,
11 percent in export earnings, and substantial boosts in the production of
electricity, coal, fertilizer, and cement. Hanoi also plans to relocate 180,000
workers-nearly double last year's figure-to the new economic zones. The
goals for electric power, fertilizer, and labor redistribution may be attainable.
Unless the weather is unusually favorable, however, Vietnam is almost certain
to fall far short of the key targets in foodgrain production and exports. The
foodgrain target of 19 million metric tons is especially surprising because 1984
output fell nearly 1 million tons short of the planned 18 million tons.
According to diplomatic reporting, another such miss may threaten the
position of the State Planning Commission Chairman, Vo Van Kiet, one of the
Favorable weather and expanded acreage led to a 1.3-million-metric-ton
harvest last year, according to a recent estimate by the FAO representative in
Vientiane, roughly matching domestic needs. This figure exceeds the 1983
crop by 200,000 tons. Earlier projections by the FAO of a poor harvest had
spurred an appeal for international food aid at midyear, resulting in contribu-
tions of roughly 20,000 tons of rice. The United States provided 5,000 tons.
Despite the record crop, distribution problems may still cause localized
shortages over the next few months, according to the US Embassy in
Secret
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OECD: Dealing With an
Oil Price Drop
Most OECD governments would pass on to con-
sumers the benefits of further declines in oil
prices-boosting GNP growth and lowering infla-
tion-but they would not take advantage of lower
inflation to stimulate their economies. Japan and
Italy, however, probably would offset at least part
of a substantial price drop with new taxes to trim
their budget deficits and hold down oil consump-
tion.
Economic Impact
We have estimated the impact of a $2 and a $5
drop in the price of oil on OECD economies using
our Linked Policy Impact Model (LPIM).` A $5
drop in the price of oil maintained throughout 1985
and 1986 would boost OECD GNP growth by an
additional 0.7 percentage point this year and 0.5
percentage point in 1986. This effect would occur
in three different ways:
? The net effect of the drop in the OECD oil import
bill and the decline in sales to oil-exporting
countries would boost OECD GNP growth by
about 0.3 percentage point in 1985.
? OECD inflation rates would be 1 percentage
point lower in 1985 than they otherwise would be;
the lower price level would add slightly more than
0.2 percentage point to OECD GNP growth in
1985.
? Slower inflation would help cut interest rates by
about 0.5 percentage point, on average, boosting
investment, and thus increasing OECD GNP
growth by slightly less than 0.2 percentage point
in 1985.
' A $2 scenario assumes an economic impact too small to require a
policy response, although we believe that a $5 decline-a possibility
frequently mentioned by oil market analysts-is the threshold at
Under this scenario, increased US import demand
would benefit the other OECD countries, particu-
larly Canada. Despite a decline in exports to its
important OPEC market, Japan would register the
largest current account improvement of any indus-
trial economy. Among the Big Four West Europe-
an countries, a $5 drop in oil prices probably would
spur the recovery enough to keep unemployment
from worsening in 1985-86.
A $2 oil price drop obviously produces smaller
benefits. In this case, GNP growth in the OECD
would accelerate 0.3 percentage point in 1985 and
0.2 percentage point in 1986. The increase in
growth, however, would barely affect unemploy-
ment. Inflation would ease 0.4 percentage point in
1985 and 0.2 percentage point in 1986 from the
rates that would exist without any oil price decline.
The Policy Response
Because the increased strength of the dollar largely
has offset the decline in the price of oil since early
1983 for OECD economies other than the United
States, most governments would now welcome the
opportunity to pass on to consumers any decline in
the price of oil. Although some governments would
consider taxing away an oil price decline to ease
budget deficits, they probably would wait to see the
size and permanence of a price cut before acting.
Although depreciation of the dollar would magnify
a drop in oil prices, the gains would be reversed if
the dollar strengthened again. Because of continu-
ing problems with inflation and budget deficits, we
believe that few, if any, OECD governments would
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OECD: Impact of a $5 Drop in Oil Prices a
Change from baseline
OECD
United Kingdom
GNP growth rate (percentage point)
0.7
0.5
GNP growth rate (percentage point)
0.2
0.3
Inflation (percentage point)
-1.0
-0.5
Inflation (percentage point)
-0.5
-0.5
Unemployment rate (percentage point)
-0.2
-0.3
Unemployment rate (percentage point)
-0.1
-0.2
Current account (billion US $)
15.8
2.2
Current account (billion US $)
-0.7
-1.1
United States
Itsly
GNP growth rate (percentage point)
0.8
0.7
GNP growth rate (percentage point)
1.0
0.5
Inflation (percentage point)
-1.1
-0.5
Inflation (percentage point)
-0.8
-0.9
Unemployment rate (percentage point)
-0.2
-0:5
Unemployment rate (percentage point)
-0.2
-0.2
Current account (billion US $)
5.4
-2.2
Current account (billion US $)
2.0
1.0
Japan
Canada
GNP growth rate (percentage point)
0.7
0.3
GNP growth rate (percentage point)
0.7
0.8
Inflation (percentage point)
-0.7
xECt.
Inflation (percentage point)
-0.7
-0.4
Unemployment rate (percentage point)
-0.1
-0.2
Unemployment rate (percentage point)
-0.1
-0.4
Current account (billion US $)
7.9
8.2
Current account (billion US $)
0.5
0.8
West Germany
Smaller OECD countries
GNP growth rate (percentage point)
0.6
0.5
GNP growth rate (percentage point)
0.7
0.6
Inflation (percentage point)
-1.0
-0.5
Inflation (percentage point)
-1.2
-0.5
Unemployment rate (percentage point)
-0.3
0.5
Unemployment rate (percentage point)
-0.2
-0.4
Current account (billion US $)
0.1
-1.3
Current account (billion US S)
-0.4
-3.3
France
GNP growth rate (percentage point)
0.9
0.4
Inflation (percentage point)
-0.9
-0.2
Unemployment rate (percentage point)
=0.3
-0.6
Current account (billion US $)
1.0
0.2
e In the baseline, we assume an oil price of $29 per barrel in both
1985 and 1986 and that nominal government spending and money
supply targets would not change. For the scenario, we assume that
the.$5 price drop occurs at the beginning of 1985 and that the price
of oil remains unchanged through 1986. Exchange rates stay
constant.
respond to lower oil prices by adopting more expan-
sionary policies, despite their desire to reduce un-
employment.
The Japanese Government is one of the few that
would consider action to keep retail oil prices from
falling. According to the US Embassy, Tokyo
thinks the current softness in oil prices will last only
Secret
IS February 1985
a few years, and producers will regain control of
the oil market by the late 1980s. Consequently, if
the market continues to weaken this year, Tokyo
probably would raise oil taxes to maintain current
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retail prices and to avoid an increase in oil depen-
dence. Moreover, this would help Prime Minister
Nakasone reduce the government budget deficit-
coalition partners-the Christian Democrats, in
particular-are calling for stimulative measures.
still an important goal for the government.
Although our results indicate that the United King-
dom would benefit from declines in oil prices, the
near-term effects of reduced government oil reve-
nues as well as additional downward pressure on
the pound would be unwelcome. Ultimately, Lon-
don probably would have to let the pound decline,
no matter how politically unpopular it would be to
see sterling continue to slide. In this case, the
British probably would again ask the other major
governments for temporary help in supporting the
pound-a positive response is unlikely. On the
brighter side, higher unemployment in the coal and
petroleum industries would eventually be more
than offset by job gains in the rest of the economy,
particularly in the nonoil export sector where the
cheaper pound would make goods and services
more attractive.
The Canadian Government would pass on any
decline in world oil prices to consumers. Ottawa
also might phase out domestic oil price controls
faster than planned. Nonetheless, an oil price de-
cline would make reducing the sizable deficit more
difficult because lower oil prices would reduce tax
revenues from Canada's petroleum sector. More-
over, alarge fall in oil prices probably would
hamper Ottawa's plans to cut federal payments to
the provinces. The oil-producing provinces, in par-
ticular, would press for maintaining the payments
to offset their own losses in energy revenues.
Both West Germany and France are likely to allow
domestic oil prices to decline as the market price of
oil goes down. Better performance on growth and
inflation would do more to revive French Socialist
Party prospects in next year's National Assembly
elections than a smaller budget deficit paid for by
Britain's alternative strategy of defending the
pound by hiking interest rates would be costlier for
the Thatcher government, economically and politi-
cally. London already has raised the commercial
base lending rate by 4.5 percentage points to 14
percent-almost 10 points above the inflation rate.
Another hike in interest rates would further cut
growth and employment prospects for the economy.
Moreover, when the economic damage from the
current hikes becomes apparent, we believe
Thatcher will have to lower interest rates and hope
that the pound will only ease downward. In any
case, a further drop in the oil price would make it
more difficult to implement the proposed income
tax cuts for the fiscal year beginning on 1 April.
an increase in oil taxes.
Almost all other OECD governments would let
domestic oil prices go down in line with a world oil
price decline. Lower revenues from natural gas,
would make reduction of the budget deficit almost
impossible for the Netherlands. Those with major
deficit problems-Greece, Portugal, and Iceland-
probably would consider raising oil taxes.
In Italy, the government of Prime Minister Craxi
almost certainly would try to impose new taxes on
petroleum products to offset partially the drop in
oil prices. With a budget deficit equal to more than
13 percent of GNP, Rome would be helped by a
new source of revenue that would not reduce after-
tax income. Infighting among the coalition mem-
bers, however, would make passage difficult. Na-
tionwide elections are scheduled for May, and the
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USSR: Problems Exporting
Oil and Gas
The Soviets have substantially reduced oil and gas
exports to some West and East European custom-
ers, largely because an unusually harsh winter in
the USSR has caused spot shortages of domestic
energy. Later this year, the USSR should again be
able to meet its gas export commitments. The same
may not be true for oil, however. The currently
depressed level of oil output and sharply reduced
stocks will make it difficult for the USSR to meet
its domestic and East European oil commitments
while sustaining hard currency exports. Although
reactions have been muted, this supply crunch
could be causing concerns among some customers
about the USSR's reliability as an energy supplier
during the winter.
Recent Energy Export Difficulties
Underlying Causes
The cutbacks have been caused or aggravated by
several factors:
? This year's winter weather has been unusually
severe.
? Soviet oil production has fallen in recent months.
? There is little room for increased domestic con-
sumption once oil and gas commitments to East-
ern Europe and hard currency customers are
Normally, harsh winter weather at Soviet ports and
oil and gas fields makes it difficult for Moscow to
meet its energy export commitments without some
interruptions in supply. Poor planning, transporta-
tion problems, inadequate storage capacity, and
substantial seasonal increases in domestic demand
are mostly to blame. The USSR attempts to fully
In recent weeks, the Soviets notified several West commit its oil and gas supplies, so imbalances
European customers that the USSR will not export between supply and demand or impediments to
any crude oil or oil products to them during the distribution-such as those caused by this winter's
month of February. According to West European harsh weather-almost always cause shortages for
press services and industry spokesmen, the Soviets some end users, domestic or foreign. In the case of
told some customers that the stoppage was caused oil, the shortages appear to be getting worse each
(press sources indicate a
scarcity of Soviet oil sold on the spot market since Buyers' Concerns
early January.
In addition to the suspension in oil exports, the
USSR this winter has reduced substantially natural
gas deliveries to several West and East European
customers. Soviet gas deliveries to Austria, for
example, were reduced by 40 percent last month.
So far, the impact of the recent export cutoffs on
affected countries has been marginal. Alternative
supplies of both oil and gas are still plentiful, even
though the market has firmed somewhat recently.
Cutbacks of similar proportions affected customers How Soviet cancellations in energy deliveries dur-
in at least two other countries. Moreover, the ing periods of harsh weather and peak domestic
cutbacks appear to have lasted far longer than demand are affecting the USSR's reputation as a
normal during periods of peak demand in the
USSR.
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reliable energy supplier is unclear. Some West
European business concerns have complained in
recent months about dependence on the USSR for
energy supplies. Reactions in West European capi-
Dependence on Soviet Oil, 1983
tals to the recent delays have been limited.
Because of the soft oil market, West European
dependence on Soviet oil is not a crucial issue.
Nevertheless, Moscow is the largest single supplier
of fuel oil to Western Europe, and some OECD
countries buy a large portion of their oil needs from
the USSR. Finland and Iceland, for example,
receive 95 percent and 70 percent of their oil needs,
respectively, from the USSR. Six other West Euro-
pean nations buy at least 15 percent of their total
oil imports from the USSR.
In contrast to Western Europe, the Communist
countries are probably more concerned about the
Soviet cutoff. All of Moscow's East European
allies, except for Romania, depend on the USSR
for at least three-fourths of their oil supplies. Most
of these countries also reexport some Soviet oil to
earn hard currency. In Asia, the USSR is almost
the sole source of oil for the economies of Vietnam,
Mongolia; Cambodia, and Afghanistan. In Latin
America, Cuba depends on Moscow for all of its oil
imports, and Nicaragua depends on the Soviets for
over half of its oil.
Moscow has promised its East European allies that
it will not reduce oil exports to them through 1990
as long as they meet their export and other obliga-
tions to Moscow on time. We have some doubt,
however, that the USSR will live up to this com-
mitment.
Imports of
Soviet Oil
(thousands
b/d)
Share of
Total Oil
Imports
(percent)
Share of
Total Oil
Consumption
(percent)
OECDe
Austria
30
18
15
Belgium
114
16
28
Finland .
253
95
122
Greece
53
16
23
Iceland
7
70
70
Netherlands
271
18
47
Sweden
72 .
15
18
Switzerland
46
18
19
Other
Nicaragua b
7
55
55
Afghanistan ~
9
95
95
Communist e
CEMA
Bulgaria
269
88
94
Czechoslovakia
342
94
101
East Germany
342
77
95
Hungary
159
75
80
Poland
300
86
91
Romania
4
1
1
Cuba
190
100
90
Mongolia
19
100
100
Vietnam ~
33
85-90
85-90
Other
Yugoslavia
112
54
39
North Korea
15
30
30
Laos
1
20-25
20-25
Cambodia ~
3
95-100
95-100
Implications for Hard Currency Earnings
The suspensions of oil and gas deliveries will reduce
first-quarter hard currency earnings, but the out-
look for the year as a whole is less certain. In recent
years, Soviet shortfalls during the first quarter have
been offset by greater deliveries later in the year. In
the past three years, the USSR managed to export
record amounts to OECD countries by the end of
Secret
i5 February 1985
e Other countries belonging to these organizations buy less than 15
percent of their oil imports from the USSR.
b These data are for 1984.
Information on energy use in these countries is scarce. These are
rough estimates.
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the year. Most of the increases in 1982 were at the
expense of deliveries to Eastern Europe. In 1983
and 1984, however, the. reexports of OPEC oil
accounted for much of the rebound. The USSR
receives oil from OPEC nations mostly in return for
arms deliveries. Soviet imports of OPEC oil have
increased from about 80,000 b/d in 1981 to about
220,000 b/d in 1983: By third quarter 1984, these
imports had increased again, to roughly 250,000 to
270,000 b/d.
Earnings from sales of oil and gas provide the
USSR with almost 60 percent of its total hard
currency receipts from merchandise exports (in-
cluding arms sales). Oil sales make up about 50
percent-earning about $15.6 billion in 1983 and
probably more than $15 billion again last year.
This year, however, the USSR will have to over-
come some unfavorable trends if it is to maintain
the value of its oil exports to the West without
disrupting deliveries to its socialist partners:
? Exports are off to a very slow start during the
first quarter.
? Oil prices may continue to slide somewhat in
1985.
? Soviet oil production could well decline again this
year in the wake of the roughly 65,000-b/d drop
in 1984.
Soviet reexports of OPEC oil will help sustain
earnings from oil sales, but they do not represent a
net improvement to the USSR's overall hard cur-
rency position. Resale of this oil represents an extra
step required of the Soviets to translate its arms
deliveries into hard currency.
Gas sales earned the USSR about $3.3 billion in
1983, and probably close to the same amount last
year. Contract deliveries to Western Europe are
scheduled to increase slightly in 1985. The Soviets
should have no trouble meeting these commit-
ments, given their considerable success in increas-
ing gas output in recent years. These sales should
earn them about $3.3-3.5 billion this year.
Secret
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Nicaragua: Economic
Vulnerabilities
Bleak export prospects promise a worsening of
Nicaragua's serious economic and financial prob-
lems. Managua is virtually broke, has already spent
the revenues from this year's presold agricultural
exports, and is likely to fail to make numerous
promised deliveries. To .maintain government im-
ports and step up military spending, the Sandinistas
are reducing subsidies to local consumers and
producers and further stalling international credi-
tors. As a result, we expect the economic situation
to deteriorate as consumer good shortages worsen
and more producers face bankruptcy.
The Sandinistas fear they may be faced with
economic sanctions and already have begun to
diversify trade and to try to secure more financial
support. Although US sanctions probably would
result in foreign exchange losses of about $25
million-which Managua could withstand-the in-
direct costs probably would be substantial. Even if
there are no sanctions, increased Communist sup-
port would be needed to bolster the troubled econo-
At the same time, government mismanagement and
harassment of the private sector has gutted busi-
ness confidence, led to steep business losses, and
derailed productive investment. According to the
US Embassy and press reports, punitive exchange
and price policies are driving businessmen to black
markets and smuggling to avoid bankruptcy.
Huge budget deficits and growing shortages have
sent consumer price inflation soaring toward triple-
digit levels. The public deficit jumped from 21
percent of GDP in 1983 to 25 percent in 1984. At
the same time, inflation more than doubled to 60
percent in 1984. Unemployment, currently estimat-
ed at 30 percent, is rising.
Public services have deteriorated, and, according to
the US Embassy, government-provided water, elec-
tricity, and telephones function only sporadically.
Various sources report severe shortages of such
basics as milk, rice, beans, toilet paper, soap, and
light bulbs.
Exports are in serious trouble. Earnings from coffee
and cotton-Nicaragua's largest exports-are like-
ly to be as much as 50 percent below the Sandinis-
ta's target this year. Insurgents have hit govern-
ment plantations hard, and coffee beans and cotton
on private plots are rotting, because of inadequate
government prices and critical labor shortages.
Private growers report that chronic fertilizer and
pesticide shortages and equipment problems are
also hampering agricultural out ut.
Recent measures to ration foreign exchange and
cut the budget deficit will put further economic and
financial pressure on consumers and businessmen:
? On 4 February Managua more than doubled
prices on many consumer goods in an attempt to
get staples back into official channels. The 50-
percent wage hike given at the same time-the
first adjustment in two years-will only partially
restore purchasing power.
? On 8 February Managua announced a new series
of exchange rates, effectively devaluing the Cor-
doba by half. Revised rates will further undercut
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Nicaragua: Econol>dic Ialdicators
Real GDP Growth
Percent
10
Central Government Budget
Deficit as a Share of GDP
Percent o
-5
-10
-15
- 20
-25
Share of Bank Credit Prodded
Private Sector
Percent 80
60
40
20
0
Index of Exports Volume
120
100
80
60
40
20
0 1975-77 78 79 80 81 82 83 84
Secret
IS February 1985
Consumer Price Inflation
Percent
External Public Debt (yearend,
medium- and long-term)
Million US $ 5000
4000
3000
2000
1000
0
150
120
90
60
30
0 1975-77
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private-sector access to imported consumer and
producer goods. Under the system, exchange
rates will range from 20 cordobas to the dollar for
essential imports to 50 cordobas to the dollar for
most nongovernment purchases.
? To finance increased defense spending, Managua
has also announced a freeze on government em-
ployment and education spending, and a reduc-
tion in consumer subsidies, government invest-
ment, and social programs.
Stalling Creditors
Managua is promising some debt payments in
order to keep Western credit lines open, but arrear-
ages continue to mount. Unless overdue IMF obli-
gations are settled, Nicaragua will probably be
declared ineligible to make further drawings. Com-
mercial bankers have recently agreed to give Nica-
ragua more time to work out arrangements for
token payments on interest now two years past due.
Nicaraguan Exports to United States Million US S
Commodity 1975-77 1984 a
(annual average)
We estimate Nicaragua would need a 10-percent
increase in Communist financial support to com-
pensate for export losses from unilateral trade
sanctions. The Soviets, however, already have dem-
onstrated their willingness to assist the Sandinistas
further by offering increased oil financing. Nicara-
gua also probably would be able partially to evade
US sanctions through third party front operations
~ International Economic Leverage by relying on Cuban experience.
Managua recognizes its economic vulnerabilities
and has made an effort to diversify its markets and
search for additional financial support. Its concerns
probably have been heightened by the insurgents'
calls for US trade sanctions on Managua. Sanc-
tions by the United States alone, however-we
doubt broad support from other Western nations-
probably would lead to foreign exch nge losses
equal to less than 1 percent of GDP. ~ade with the
United States has already fallen sharply from pre-
revolution levels. Nicaragua's US sugar quota has
been lifted; the United States has never imported
much Nicaraguan cotton; and coffee sales have
been shifted to Western Europe and CEMA coun-
tries.
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The impact of unilateral US sanctions on imports
probably would be harder for Managua to over-
come. The $112 million in critical intermediate
goods, spare parts, and machinery imported from
the United States in 1984 would be difficult to
replace in the medium term. A unilateral cutoff
world, at least temporarily, add to consumer short-
ages and idle US-made equipment.
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Nicaragua: The Foreign Financial Gap
-
?Mi[[ion us S
(except where notetlJ
1975-77
1982
1983
1984
Trade balance
-86
-418
-485
-685
Exports, f.o.b.
518
406
428
365
Imports, f.o.b.
604
824
913
1,050
Military
0
100
135
250
Other
0
724
778
800
Net Services
-62
-273
-283
-280
Interest obligations
43
217
200
200
Other
-19
-56
-83
-80
Net tiansfer
13
86
150
200
Military grants
0
34
64
100
Other
0
52
86
100
Current account balance
-135
-605
-618
-765
Debt principal due
35
150
155
160
Financial gap
170
755
773
925
Medium- and long-term capital inflows
163
645
826
850
Commercial bank loans
74
NEGL
NEGL
NEGL
External debt (yearend, medium- and long-term)
703
2,800.
3,500 -
4,300
Commercial bank debt
368
964
1,030
1;120
Net international reserves a
31
-431
-450
-470
Debt service ratio n
Obligations due (percent)
15.1
90.4
82.9
986
Obligations paid (percent)
15.1
45.1
35.0
27.4
a Foreign exchange reserves minus short-term liabilities.
b Debt interest and principal as percent of merchandise exports.
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Beyond the Simple Economics
The indirect costs of sanctions-further strains on
an already shallow managerial pool-probably
would be substantial. Sandinista managers would
have to assess the impact of export and import
cutbacks, locate alternative markets, set new sales
terms and shipping arrangements, coordinate deliv-
ery dates, and line up new financing and import
priorities. Moreover, sanctions would intensify the
Sandinistas' siege mentality and probably would
cause the regime to shift resources to defense to
counter a perceived US invasion threat.
Even if there are no sanctions, the Sandinistas will
need increased Communist support to shore up the
economy. It is uncertain, however, whether Soviet
support would ever be sufficient to assure the
steady growth of the Nicaraguan economy.
25 Secret
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Mexico: Dim Prospects for
Foreign Investment
Tough regulations and poor prospects for economic
performance are discouraging foreign investment in
Mexico. Although the de la Madrid administration
claims to be seeking foreign capital and technology
to spur growth, Mexico City recently imposed new
regulations on industries~with heavy foreign partici-
pation in order to ensure that less effiicient local
producers would not be driven out of business. As
long as the government is unwilling to create a
favorable investment climate, Mexico will not at-
tract enough new. overseas funds to offset the slump
in domestic investment or limited access to interna-
tional credits.
Changing Atmosphere
Traditionally, Mexico has viewed foreign invest-
ment as a "necessary evil." Government control
reached new highs in the early 1970s with legisla-
tion that limited foreign ownership to 49 percent,
established a formal review commission to screen
all applications, restricted patent protection, and
sought to reduce dependence on foreign technology.
Other regulations in the late 1970s imposed local
content requirements in an effort to increase tech-
nology transfer, local employment, and net foreign
exchange earnings.
Investors were still attracted by Mexico's large and
growing domestic market, relatively cheap labor,
lack of exchange controls, ease in finding capable
Mexican partners, and proximity to US and Latin
American markets. During 1976-82 the stock of
direct foreign investment more than doubled to
$10.8 billion, accounting for an estimated 4 percent
of total investment. Nonetheless, foreign businesses
played an increasingly important role; by 1981
almost 60 percent of total overseas sales of manu-
factured goods were produced by Mexican affili-
ates of foreign firms.
Impact of the Financial Crisis
Foreign investment has plunged as a result of
Mexico's rapidly deterigrating economic situation.
Only some $700 million in foreign investments
entered Mexico in 1982 compared with $2.4 billion
in 1981. During the first six months of last year,
only $29 million was invested by foreigners, pri-
marily in assembly operations where the domestic
value added is extremely low. The surprise bank
nationalization in 1982 raised concerns among both
foreign and domestic investors that the government
planned to greatly expand its control over the
economy. At the same time, the imposition of
exchange controls and sharp devaluations greatly
added to the operating problems and stimulated
capital flight. In 1983 the government-imposed
austerity program caused a deep cut in consumer
demand that slashed industry operations to only
about 50 to 60 percent of capacity.
Foreign investors with large equity stakes sought to
boost exports to compensate for the drop in domes-
tic sales and the increase in financial restrictions.
The sharp peso devaluations had made Mexican
products competitive abroad. Moreover, many for-
eign subsidiaries were forced by exchange controls
to depend on their parent companies financially
manu acture goods exports
jumped almost 30 percent in 1983, giving Mexico a
$600 million trade surplus in manufactures.
De la Madrid Sends Negative Signals
In early 1983 following President de la Madrid's
inauguration, the administration articulated the
Secret
D! lEEW 85-007
15 February 1985
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Mexico: Foreign Investment Factors, 1977-83
Foreign direct
investment
Foreign Direct Investment in Mexican Manufacturing Sector,
By Industry, 1980
u
Finance and
insurance
Petroleum
Trade
Manufactured Exports of Mexican Companies With Foreign
Participation, By Industry, 1980
equipment 19 Nonelectrical
machinery 6
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Secret
need for new foreign investment, but, as the eco-
nomic crisis became less acute, traditional political
sensitivities to foreign investment again surfaced.
De la Madrid appeared increasingly skeptical of
foreign investor motives and sensitive to pressures
from highly protected local producers. He began
siding with advocates of more regulation, such as
Foreign Minister Sepulveda and Minister of Plan-
ning and Budget Salinas de Gortari, against propo-
nents of liberalized foreign investment, such as
Under Secretary for Foreign Investment and Tech-
nology Transfer Adolfo Hegewisch and Finance
Minister Silva Herzog. Controls were tightened on
the auto and pharmaceutical industries-two sec-
tors with extensive foreign participation-and are
being considered for electronics and food process-
ing. Moreover, several close observers have noted
that de la Madrid's drift away from a favorable
foreign investment view has made bureaucrats re-
luctant. to be associated with any politically sensi-
tive investment project.
De la Madrid promised in February 1984 that
Mexico would interpret the 1973 Investment Code
more flexibly and allow up to 100-percent foreign
ownership in such priority sectors as computers,
communications, and oilfield and petrochemical
equipment. Majority foreign equity participation,
however, continued to be discouraged. Foot-
dragging on foreign investment applications contin-
ued, and, even when firms offered export promo-
tion, new technology, or expanded employment, few
exceptions were granted. Last month the govern-
ment refused IBM's request for 100-percent control
of its planned operation-which would have gener-
ated about $20 million in net foreign exchange
earnings annually-after nearly a year of negotia-
tions. The rejection was backed by a broad coali-
tion of local producers, the political left and at least
two economic cabinet ministers.
Prospects for New Foreign Investment
interpreting the new decrees and guidelines. Those
already there probably will concentrate on reinvest-
ing earnings as they retool for export promotion,
work to use excess capacity, or in some cases merge
with local companies to take advantage of govern-
ment incentives designed to boost local industries.
For example, several US automakers, which al-
ready have multibillion-dollar investments in Mexi-
co, are expanding their exports of parts and some
vehicles to the United States. The $500 million
Ford plant in the state of Sonora has received the
most publicity.
We expect the largest of the already established
firms to use their bargaining power as large em-
ployers to cut mutually beneficial deals with the
government. By selectively bending implementing
regulations, Mexico hopes to gain foreign ex-
change, improve competitiveness, and generate new
Many potential new investors, however, have told
the US Embassy and financial press that they
remain skittish about investing in Mexico because
they fear that the rules will change when the
economy improves. Many firms also are intimidat-
ed by controlled prices, recent loss of peso competi-
tiveness, poor access to peso credit, export and local
content requirements, protection of technology, and
the government's general attitude toward the pri-
vate sector, according to the US Embassy. Pros-
pects for continued slow economic recovery will
dampen any return of interest in Mexico's domestic
market. Few expect a resurgence in consumer
demand that will reduce excess capacity. Moreover,
business sources also claim that growing state
domination of the economy has begun to outweigh
many of the economic advantages associated with
investment in Mexico in the past. Nevertheless,
firms that expect to be able to make special
arrangements with the government-particularly
those in high-priority areas-probably will advance
investment proposals.
Without presidential support for a better invest-
ment climate, new foreign investment in Mexico is
unlikely to rise significantly over the next several
years. Many companies say they will not invest
until Mexico demonstrates greater flexibility in
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Tightening Control
New industry guidelines, issued in late 1983, cov-
ered the largely foreign-owned automobile assem-
bly operations. The regulations severely restricted
the types and models of vehicles that foreign
investors could produce, banned eight-cylinder en-
gines, tightened local content requirements, and
forced investors to boost the positive trade balance
between exported final products and imported
components. It also made DINA, a parastatal
producer of heavy trucks and buses, the sole
mant4facturer of medium-duty trucks. As a result
of the regulations, many manufacturers had to
extensively retool production and forfeit their most
profitable lines.
In February 1984 new restrictions were announced
for retail pharmaceutical production, 80 percent of
which is produced by foreign-owned.firms. The
decree requires uniform generic packaging and
labeling, a move multinational labs claim will
erode their patent protection, according to the US
Embassy. Moreover, the decree increases restric-
tions on local sourcing, product registration, and
pricing. The Embassy also reports that these meas-
ures have already cut into the profitability and
As long as the government is unwilling to create an
investment climate that is favorable for foreign
enterprises, the economy will remain dependent on
oil market trends and foreign bankers' largess.
Mexico cannot expect to offset limited access to
international borrowing or continued capital flight
with large inflows of foreign investment funds. As a
result, capital needed to retool and to start up new
export industries will be limited. Moreover, Mexico
will have poor access to new technology, experi-
enced entrepreneurship, and marketing techniques
necessary to increase competitiveness with other
export-oriented countries.
The apparent unwillingness of the de la Madrid
administration to adopt a more liberal and consis-
tent foreign investment policy is likely to continue
Secret
l5 February 1985
production of specialized medicines. Almost SO
multinational labs, both American and European,
are challenging the constitutionality of this decree.
Some have threatened to leave Mexico if a com-
promise with the government is not reached.
The government also has proposed an electronics-
sector plan that, if implemented, would increase
local content to 80 percent within five years and
.force local assembly of circuit boards and other
components. Foreign-owned firms dominate all but
the microcomputer end of this market. Several of
these firms have indicated that local assembly of
intricate components probably would cause a sig-
nificant decrease in the efficiency of production.
A sectoral reorganization similar to those above is
also rumored to be under study for the food-
processing industry. Thefood industry has sub-
stantial foreign participation and has long been the
target of government and leftist criticism for alleg-
edly diluting the traditional Mexican diet with
high-cost, low-nutrition `junk foods. "
aggravating investment and trade relations with the
United States. Recent US attempts to cajole the
Mexicans into softening restrictions on foreign
pharmaceutical companies by threatening to hold
up approval of the agreement on export subsidies
have produced few results. Meanwhile, other US
businesses, fearing Mexico's retaliation, are press-
ing Washington to ease up and allow them to make
their own arrangements with the de la Madrid
administration.
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