INTERNATIONAL ECONOMIC & ENERGY WEEKLY

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP97-00771R000707510001-2
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 32
• Document Creation Date: December 22, 2016
• Document Release Date: August 24, 2010
• Sequence Number: 1
• Publication Date: May 3, 1985
• Content Type: REPORT

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Directorate of
Intelligence
Weekly
International
Economic & Energy
DI IEEW 85-018
3 May 1985
0 Copy 680
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International
Economic & Energy
Weekly
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iii
Synopsis
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Perspective-Implications of Third World Economic Prospects
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3
ersian Gulf Bankin : The Slowdown Continues
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M laysia: Pitfalls of Privatization
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Mexico: Limited Impact of the New Banking Laws
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IS el: Economic Development of the Occupied Territories
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mbodia: 1984/85 Rice Shortfall
Energy
International Finance
Global and Regional Developments
National Developments
directed to Directorate of Intelligence
Comments and queries regarding this publication are welcome. They may be
Secret
3 May 1985
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Secret
International
Economic & Energy
Weekly
Synopsis
1 Perspective-Implications of Third World Economic Prospects
We believe moderate improvements in economic performance will enable
Third World governments to "muddle through" the next five years. In our
judgment, these Third World economic prospects have several important
economic and political implications for the industrialized West.
3 Persian Gulf Banking: The Slowdown Continues
Slower economic activity in the Gulf and the 1982 Kuwaiti stock market crash
have left many local and foreign banks in the region burdened with bad debts.
Gulf financial problems could spill over into other financial markets as a result
of US and West European bank exposure in the region.
7 Malaysia: Pitfalls of Privatization
Over the past year Malaysia has begun moving ahead with its highly touted
program of privatizing selected state enterprises as a means of easing budget
deficits and foreign borrowing strains. Public-sector spending will remain high
as the ambitious industrialization program offsets any savings from privatiza-
tion.
11 Mexico: Limited Impact of the New Banking Laws
Mexico's recently published guidelines for the nationalized banking system are
designed to increase the authority of the Central Bank to make monetary
policy, to stimulate the small private parallel financial market, and to reaffirm
the nationalized banks' domination of the financial sector. We believe,
however, that Mexico will fall short of these goals.
15 Israel: Economic Development of the Occupied Territories
Continued Israeli military occupation has held back the economic development
of the West Bank and Gaza Strip even though Arab residents of the occupied
territories have benefited somewhat
19 Cambodia: 1984/85 Rice Shortfall
We estimate that Cambodia's 1984/85 rice harvest will decline for a second
straight year to 1.4-1.5 million metric tons-the smallest since 1979/80.
Despite a smaller crop, we do not expect widespread food shortages during the
coming months, because a substantial part of the rice shortfall will be made up
by other foods.
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Perspective
International
Economic & Energy
Weekly
3 May 1985
Implications of Third World Economic Prospects) 25X1
deficits; and external debt will rise more slowly.
We believe moderate improvements in economic performance will enable
Third World governments to."muddle through" the next five years. With
varying degrees of policy compromise, the LDCs should be able to maintain
their economic austerity programs and avoid dramatic political or economic
upheavals. According to several private forecasts, economic growth in the
LDCs will likely average between 4 and 5 percent annually through 1990. This
would be a marked improvement over the depressed pace of the past few years
but still well below that of the 1960s and 1970s. Concurrently, consumer price
inflation is expected to slow; higher exports will help reduce current account
In our judgment, these Third World economic prospects have several impor-
tant economic and political implications for the industrialized West:
? Trade. An improved LDC trade surplus means the United States and other
industrial countries will have to absorb increasing amounts of Third World
exports. Trade frictions will grow, especially if export-oriented Latin Ameri-
can and Asian countries make greater use of subsidies and other trade-
distorting measures. In addition, the newly industrialized countries pose a
potential threat of becoming an alternative supplier of sensitive, high-
technology products to Communist countries by the end of the decade.
? Finance. Although no major financial crises are expected to emerge during
the latter half of the decade, the need for periodic financial rescue packages
will continue, and their use probably will broaden to such second-tier debtors
as Egypt and Colombia. The investment incentives implemented by the
Third World are not expected to attract a substantial amount of foreign
direct investment. As a result, we believe the Third World's demands for
concessional aid particularly by Sub-Saharan Africa will heighten.
the Africans, on aid; and the Asians, on protectionism
? Interest Groups. In our judgment, the developing countries will increasingly
divide into relatively small blocs or ad hoc groups with common economic
problems and press the industrial countries to adopt policies that are tailored
to their members' unique conditions. The Cartagena group of Latin Ameri-
can debtors is one such group. Others could crystallize around aid and
industrial country protectionism. These special interests could lead to
growing regionalism as the Latin American countries concentrate on debt;
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DI IEEW 85-018
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The growth projections, moreover, are sensitive to several external factors. The
most disruptive would be heightened protectionism or a slowdown in indus-
trial-country growth. Aware that their economic prospects depend in large
measure on US economic performance, we believe the Third World countries
will bring increasing pressure on the United States to manage its economy
with international economic goals in mind. Specifically, they will call for
reduced interest rates, lowered US trade barriers, and tolerance of continued
protection of their own markets, particularly in new areas such as services.
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Persian Gulf Banking:
The Slowdown Continues
Slower economic activity in the Gulf and the 1982
Kuwaiti stock market crash have left many local
and foreign banks in the region burdened with bad
debt. Concurrently, depressed financial markets
have heightened regional competition, forcing in-
creased bank insolvency and mergers. Continued
recession, coupled with intensified regional instabil-
ity, could severely damage the Persian Gulf bank-
ing sector. Gulf financial problems could spill over
into other financial markets as a result of US and
West European bank exposure in the region. Al-
though individual Gulf governments probably could
act to stabilize the situation before a collapse
occurs, it might accelerate their drawdown of for-
eign reserves.
Emerging Strains
The turnaround in the Gulf states economies since
1980 has reversed the condition of many Gulf
banks. Lower oil revenues have stunted Gulf eco-
nomic development; the Iran-Iraq war has closed
two large markets to development lending and
trade finance; and, as a result, regional bank profits
have slumped:
? For 1983, UAE commercial bank assets declined
slightly after a previous three-year average in-
crease of 40 percent. The National Bank of Abu
Dhabi (NBAD) reported profits in 1983 at about
60 percent of the 1982 level, and we believe 1984
profits were no better. Khalij Commercial Bank
was badly shaken by loan losses in 1982. Large
deposits and capital injections helped it survive,
but competitors are still unsure of its prospects.
? In Saudi Arabia, the National Commercial Bank
(NCB)-the second-largest Arab bank in terms of
assets-recorded a second year of declining prof-
its in 1984. Several smaller Saudi banks have
recorded similar declines, and the US Embassy
expects more to follow. Commercial bank assets
rose less than 4 percent during 1983-84 with
NCB recording no increase.
? For Kuwait, total assets were down 4 percent in
1984. Sharply lower profits forced banks to slash
dividends to shareholders by two-thirds or more.
Even these reduced dividends were paid only
because of bankers' fears of shaking confidence in
the system.
A major contribution to the fall in profits was the
increase in the number of nonperforming loans-
mainly to construction companies and individuals.
As property values have plunged, loans that were
previously adequately secured are now vulnerable.
The Saudi Government's refusal to bail out the
Shobokshi construction group left $400 million in
unpaid loans to domestic and foreign banks. An
Abu Dhabi institution is rumored to have at least
50 percent of its loans nonperforming. In addition,
the takeover of the Emirates National Bank (ENB)
by the Union Bank of the Middle East (UBME)
was the result of ENB carrying $55 million in
doubtful loans. Foreign lending has also caused
problems. Recently, the Dubayy Bank, previously
owned by the Galadari family, had to be purchased
by the UAE Government as a result of that bank's
ill-timed real estate investment in Singapore.
The collapse of the Souk al Manakh-the Kuwaiti
unofficial stock market-is still looming heavily on
regional Gulf bank balance sheets. According to
press reports, as the government has declared re-
ductions in the collectible value of debt backed by
shares in the Manakh crisis, the capital of even
some blue-chip Kuwaiti firms fell by 50 percent
early last year. As a result, the value of the
collateral held by banks against these firms' loans,
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DI IEEW 85-018
3 May 1985
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(million US $)
Assets
Earnings
Capital
Asset Ratio
2
National Commercial Bank, Saudi Arabia
14,624
0
-5.7
5.5
8
Riyadh Bank, Saudi Arabia
9,252
17.3
-4.0
10.5
9
National Bank of Kuwait, Kuwait
9,046
14.0
15.0
6.0
11
Arab Banking Corporation, Bahrain
8,762
11.0
-6.3
11.7
13
Gulf International Bank, Bahrain
7,434
20.3
12.4
6.1
14
Gulf Bank, Kuwait
7,088
14.6
6.9
6.8
15
Commercial Bank of Kuwait, Kuwait
6,552
8.4
4.7
6.2
16
National Bank of Abu Dhabi, UAE
6,132
-3.2
-40.4
8.1
19
Alahli Bank of Kuwait, Kuwait
5,728
16.6
12.3
6.4
27
Saudi American Bank, Saudi Arabia
3,473
14.2
1.4
9.6
30
Al Bank Al Saudi Al Fransi, Saudi Arabia
3,180
15.8
18.2
7.3
32
Kuwait Finance House, Kuwait
2,731
40.4
-19.9
4.4
35
Burgan Bank, Kuwait
2,344
22.9
10.9
7.9
38
Bank of Bahrain and Kuwait, Bahrain
2,291
1.1
0 C
10.5
39
Bank of Oman, UAE
2,205
-1.4
NA
5.9
41
Albank Alsuadi Alhollandi, Saudi Arabia
2,079
3.5
-13.2
7.2
42
Saudi Cairo Bank, Saudi Arabia
2,057
-16.2
62.1
4.2
43
Arab National Bank, Saudi Arabia
1,984
14.4
-5.8
12.3
44
National Bank of Dubayy, UAE
1,948
30.5
56.5
15.9
45
Saudi British Bank, Saudi Arabia
1,892
9.4
-8.0
8.8
47
Arlabank International, Bahrain
1,723
-21.0
-7.0
13.1
52
National Bank of Bahrain, Bahrain
1,492
26.4
9.9
10.0
53
Saudi Investment Bank, Saudi Arabia
1,459
-8.8
-66.9
3.9
54
Bank Al Jazira, Saudi Arabia
1,409
12.4
0.2
7.9
57
United Gulf Bank, Bahrain
1,289
27.2
-31.8
19.6
58
Arab Bank for Investment and Foreign Trade, UAE
1,280
5.9
-17.4
5.9
59
Gulf Riyad Bank, Bahrain
1,269
2.1
-14.1
2.5
62
Dubayy Bank, UAE
1,132
7.4
-42.6
5.5
69
Khalij Commercial Bank, UAE
965
18.0
0.6
10.0
72
Union Bank of the Middle East, UAE
865
-28.7
NA
14.0
79
Arab Asian Bank, Bahrain
605
4.1
-2.0
11.8
85
National Bank of Shurjah, UAE
530
28.3
26.5
19.1
87
Emirates Commercial Bank, UAE
463
12.6
4.1
16.1
89
Kuwait Asia Bank, Bahrain
449
87.1
71.1
26.7
93
Investment Bank for Trade and Finance, UAE
442
13.6
2.4
11.0
97
Bahrain Middle East Bank, Bahrain
392
218.7
-42.0
29.9
100
Al-Ahli Commercial Bank, Bahrain
364
8.1
-72.7
13.1
a None of these banks are in the Global Top 100. Total results for
1984 unavailable. We, however, feel 1984 will mirror 1983 with the
exception of Kuwait.
b The Arab Top 100 from The Banker magazine, December 1984.
c Adjusted for abnormally high profits in 1982.
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as well as the borrower's ability to pay, is question-
able. Press reports indicate that nonperforming
loans comprise 30 to 50 percent of most Kuwaiti
bank portfolios.
Competition, Mergers, and Regulation
Lack of lending opportunities is creating intensified
domestic and regional competition among Gulf
banks that is likely to lead to a wave of mergers. In
an effort to provide more business for domestic
banks and prevent the internationalization of the
riyal, the Saudi Arabian Monetary Agency
(SAMA) is moving to reduce competition to Saudi
banks by offshore banking units (OBU) in Bahrain.
Saudi Arabia currently is the prime outlet for OBU
lending. Since mid-1984, however, offshore banks
must request permission to participate in riyal
syndications in Saudi Arabia and may be forced to
pay a withholding tax on interest paid by Saudi
borrowers. SAMA followed these restrictions by
recently issuing money market instruments de-
signed to draw riyals back to Saudi banks.
A $5.5 billion capital outflow during the first half
of 1984 forced the UAE Central Bank to issue local
currency-denominated CDs to commercial banks
earlier this year in a less than successful attempt to
draw deposits from Bahrain. Recently the Central
Bank started to require all banks operating in the
UAE to place with it on a weekly basis an interest-
free deposit equal to 30 percent of any placement or
loans made to nonresident banks. Kuwait reported-
ly had more success in controlling capital outflows
with the implementation of a two-tier exchange
rate regime in 1984.
Stiff competition among Gulf banks probably will
cause more to fail or leave the region this year. As a
result, central banks are encouraging more mergers
and buyouts. Embassy reports indicate that a con-
solidation of three or four banks appears imminent
in Abu Dhabi and another two-bank merger is
possible. Also, the UAE has recently limited for-
eign banks to eight branches to curb competition.
The Arab Asian Bank in Bahrain was recently
taken over by the Middle East Financial Group of
Luxembourg, according to Embassy reports. In
addition, many banks in Bahrain have scaled down
operations and reduced credit lines. In Kuwait, the
government is planning a merger between Burgan
Bank and the Bank of Kuwait and the Middle East.
Gulf governments now are trying to enforce rules
requiring timely and accurate reporting by banks in
order to examine debt problems. Even so, many
financial institutions in the region have yet to
divulge their 1984 results. Gulf banks generally
shun government interference, especially in Kuwait
and the UAE. Bank-owning families in the UAE
have strong ties to Emirate rulers who make bank-
ing decisions. The Central Bank plays a minor role,
usually employing moral suasion to influence
banks.
Outlook and Implications
We expect another poor financial showing for Gulf
banks in 1985 largely because of the continuation
of the regional recession and the Iran-Iraq war.
Profits probably will decline as banks continue to
make provisions for bad debts. In addition, compe-
tition among banks will ensure a narrow spread
between interest rates paid to depositors and those
charged for loans-further squeezing profitability.
Larger Gulf banks are beginning to look for other
markets in Asia and some have opened offices in
Europe and the United States. Smaller banks,
however, probably will be at the mercy of economic
conditions in the Gulf.
The Gulf recession is cutting into US and European
bank profits as well. According to press reports, one
US bank reported a $70 million quarterly loss last
year largely because of the Shobokshi bankruptcy.
Further bankruptcies could aggravate problems in
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other financial markets. Embassy reporting indi-
cates that US branches are increasing their reli-
ance on banking services to generate revenues until
commercial activity resumes. Even though US
banks have a competitive edge over Arab banks in
providing services, there may not be enough busi-
ness for all.
Weaker' banks. probably will continue to fail, but
mergers with healthier institutions and government
buyouts probably will avoid a total loss of confi-
dence in the banking systems: Should failures
markedly increase, however, troubled banks short
on capital might need Central Bank support, and
efforts to support the system could require a sub-
stantial liquidation of Gulf government reserves. In
addition, an increase capital flight from the region
could lead to drawdowns of foreign assets to main-
tairi regional liquidity.
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Malaysia: Pitfalls of
Privatization
Over the past year Malaysia has begun moving
ahead with its highly touted program of privatizing
selected state enterprises as a means of easing
budget deficits and foreign borrowing strains.
Divestiture, however, is constrained by the New
Economic Policy (NEP) that limits the economic
participation of the country's large Chinese minor-
ity and foreign investors in favor of the Malays-
the largest, but most economically backward, eth-
nic group. In the near term, we believe Kuala
Lumpur will have to provide a large portion of the
investment capital needed to ensure Malay partici-
pation in privatization even though such financial
support has been largely responsible for the high
budget deficits. Over the longer term, public-sector
spending will also remain high as an ambitious
industrialization program offsets any savings from
privatization. We believe that Kuala Lumpur under
pressure of these budget strains will seek foreign
investment-most notably from Japan and the
United States-to help underwrite its development
program.
Malaysia, Incorporated
Despite a record of good economic growth-aver-
age annual GDP growth was more than 6 percent
into the 1980s-Malaysia has in recent years expe-
rienced increased financial strains. Record budget
deficits have resulted from steadily rising govern-
ment expenditures-because of industrialization
and NEP-sponsored programs-and reduced ex-
port revenues because of low commodity prices.
These deficits have been exacerbated by a rising
debt service burden as foreign debt has more than
tripled since 1980, reaching an estimated $22
billion in 1984.
Efforts to ease financial strains have resulted in
major cuts in direct development spending since
1981, when the budget deficit hit a record 22
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The New Economic Policy (NEP) is a 20-year
program aimed at achieving greater economic pari-
ty between Malaysia's ethnic groups. It was insti-
tuted in 1971 following racial rioting between
Malaysia's main ethnic groups, the poorer Malays
who constitute 55 percent of the population and the
Chinese who account for 35 percent. Since indepen-
dence in 1957, the Malays have held the political
power, but the Chinese along with foreign investors
dominated the economy.
A primary objective of the NEP is to restructure
Malaysia's corporate sector by 1990 to reflect 30-
percent ethnic Malay ownership, 40 percent other
Malaysian, and 30 percent foreign ownership. At
the inception of the NEP, Malays held a scant 4
percent of the nation's corporate wealth. To help
raise the Malays corporate stake, the NEP set up
trust agencies to act as proxies for the Malay
community in acquiring shares and establishing
new enterprises on their behalf. In 1983 these
agencies held $2.3 billion in trust for the Malays-
a major factor in boosting Malay ownership to
nearly 20 percent.
Despite the substantial progress Malays have
made under the NEP, it is likely that many of the
equity targets will not be achieved by 1990. This
would damage the prestige of any government in
office and would be particularly harmful if the
Mahathir government is still in office because his
idea of an affirmative action program for ethnic
Malays is the philosphical underpinning of the
NEP. As a result, we believe the Malay leadership
will find it necessary to push back the NEP targets
and-continue the policy into the next decade.
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Malaysia: Public-Sector Growth, 1975-84
/ -\ Development
expenditures a
I I I I I I I I I
0-197 5 76 77 78 79 80 81 82 83 84
a Expenditures on Malaysia's 19 off-budget agencies (Petronas, MAS,
Hicom, etc.) are excluded. In 1984 these agencies represented an additional
$1.6 billion in public authority spending.
Debt service b /
Exports
Budget
deficit/GDP
2 1 1
0 1975 76 77 78 79 80 81 82 83 84
b Debt servicing as a share of export earnings; 1975-78 excludes short-term
debt repayment.
percent of GDP. As a longer run policy to deal with
these strains, Prime Minister Mahathir in 1983
adopted a program of privatization under the
theme of "Malaysia, Incorporated." This policy is
Mahathir's concept of the country as a corporate
entity with the government providing the policy
framework and infrastructure, although the private
sector provides all commercial expertise. Malaysia,
Incorporated is part of Mahathir's "Look East"
policy based on his conviction that Malaysia should
emulate the Japanese model of close cooperation
between government and the private sector.
The Privatization Agenda
Mahathir's concept of privatization includes selling
state enterprises and permitting private-sector par-
ticipation in sectors formerly monopolized by the
government. The government, however, does not
plan to divest itself totally of all the enterprises
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3 May 1985
targeted for privatization-Kuala Lumpur plans to
retain a minority stake in the national airline.
The enterprises already sold or slated for sale are:
? TV 3, a commercial television channel, added to
the government-owned systems.
? Airod, a military aircraft maintenance and repair
facility.
? Malaysian Airline System (MAS).
? Telecoms, the telephone system.
? Port Klang container facility.
? Bernama, the national news agency.
? Tourist Development Corporation.
? Electric and water utilities.
? A gas pipeline project of Petronas, the national
oil corporation.
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The program so far has had mixed success. The
commercial television channel begun last April has
proved profitable. In fact, later this year the station
plans to add a new transmitter to extend its
coverage to the wealthy Singaporean market.
The major test will come later this year with the
divestiture of three of the government's largest
assets-MAS, Telecoms, and the Port Klang con-
tainer terminal. The government is eager to sell 60
to 70 percent of its stake in MAS by early 1986.
With more capital, MAS would be able to add new
domestic and international routes, also helping to
promote the nation's tourist industry. In anticipa-
tion, MAS signed an agreement last March for
joint operations with a US airline for direct flights
to the United States and is currently negotiating
with the United Kingdom and West Germany for
landing rights.
Telecoms is the largest and most complicated
scheme currently under way. It requires the valua-
tion and transfer of government staff, assets, and
liabilities to a government corporation, including
separate land title transfers negotiated with indi-
vidual states. Moreover, Telecoms is already com-
mitted to a $4.2 billion capital expenditure pro-
gram over the next five years for which financing
will have to be arranged under its new corporate
status. Kuala Lumpur hopes to convert the utility
from a government department to a wholly owned
government company by yearend, followed by its
transfer into private hands in 1987.
Privatization will be constrained by the goals of the
NEP to increase Malay participation in the econo-
ment plans to provide loans to Malay businessmen
that can be repaid when the newly private compa-
nies become profitable.
Although favoring Malays in privatization projects
would boost their lagging progress on the NEP's
corporate ownership goals, Kuala Lumpur must
balance this with opportunities for the Chinese
community. Already worried that choice public
enterprises might be transferred to Malays, the
Associated Chinese Chambers of Commerce and
Industry of Malaysia is closely monitoring the
situation. If they believe the Malay leadership is
disregarding their interests, the Chinese could de-
sert the national coalition in the next general
election in favor of the opposition Chinese party.
We believe Mahathir probably will permit Chinese
participation up to the 40 percent ceiling imposed
by the NEP because he needs the Chinese vote to
maintain his governing coalition.
Although foreign participation is also limited under
the NEP, the government recently indicated its
willingness to permit higher foreign participation in
privatization projects where foreign expertise is
required or sufficient domestic capital cannot be
raised. In fact, Mahathir may find it politically
more acceptable to relax the NEP guideline on
foreign ownership than to allow greater Chinese
participation. He can promise to increase Malay
ownership when sufficient domestic capital is accu-
mulated.
Kuala Lumpur also faces opposition from civil
service unions, despite government guarantees that
no one transferring to the private sector will lose
money, seniority, or retirement benefits. The tele-
phone union, for example, has demanded continued
low-cost government loans and a 3-percent pay
increase in anticipation of the sale of the telephone
system. Although it is unlikely that these and
similar demands by other unions will be met, union
slowdowns and protests are likely and may slow the
government's timetable.
my. We believe the government will be forced to
underwrite a large portion of the ownership share
for the capital-short Malay community.
the govern-
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A Shrinking Government Role?
We believe that Kuala Lumpur will achieve much
of its privatization agenda in the next few years,
but it is unlikely that this will substantially reduce
government budget expenditures because of plans
to extend loans to guarantee Malay participation.
Only over
the longer term will the government recover some
of its costs as Malay loans are repaid and conces-
sions to unions expire.
We believe that Kuala Lumpur will use any savings
accruing from privatization to increase financing of
a renewed industrialization program that it intends
to announce during the next few months. The
proposed industrial projects probably will be estab-
_lished in cooperation with private-sector participa-
tion, thus increasing public-sector investment. The
centerpiece of the current industrialization drive is
the much ballyhooed production of a Malaysian
car-the "Proton Saga"-even though it will be a
money-losing proposition. Mahathir recently an-
nounced that the auto industry would lose almost
$14,000 on each car manufactured during the first
year of production.' This suggests to us that govern-
ment plans for privatization will result largely in a
shift of government funds to such subsidized indus-
trialization projects. Thus the government's role in
the economy will continue and possibly increase
with little lasting effect on the public-sector budget
deficit.
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3 May 1985
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Mexico: Limited Impact of the
New Banking Laws
Mexico's recently published guidelines for the na-
tionalized banking system are designed to increase
the authority of the Central Bank to make mone-
tary policy, to stimulate the small private parallel
financial market, and to reaffirm the nationalized
banks' domination of the financial sector. The
reforms have been welcomed by local businessmen
and the international financial community
In part, the new legislation
was adopted to reassure the IMF that Mexico was
committed to controlling public spending and con-
taining growth in the money supply. We believe,
however, that Mexico will fall short of these goals.
The government retains significant veto power over
Central Bank policy. Moreover, growth of the
parallel financial market as a lower cost alternative
to bank credit for the private sector will be limited.
Wrangling Over the Guidelines
The nationalization of commercial banks by the
Lopez Portillo administration in September 1982
created'many uncertainties for the financial sys-
tem. After more than two years of debate over the
role of private financial institutions such as broker-
age firms and insurance companies; the govern-
ment published new banking laws on 1 January
1985. The President reportedly personally inter-
vened to break a deadlock between the Ministries
of Finance and Budget and Planning over allowing
the nationalized banks to own shares in nonbank
financial companies. De la Madrid sided with
Budget and Planning, which favored a prohibition
on ownership for bureaucratic reasons.
Central Bank Strengthened
The new bank regime increases the monetary au-
thority and political independence of the Bank of
Mexico but primarily on paper. The central govern-
ment can no longer borrow directly from the Bank
of Mexico by selling it securities. Instead, the
Central Bank sets its federal financing limit each
January. For 1985, for example, credit to the
federal government is to increase only 17 percent
over 1984, a cut in real terms of about 43 percent
at first-quarter inflation rates. In addition, the
Central Bank will extend to the government a
revolving credit equal to 1 percent of consolidated
federal income-an estimated $740 million for
1985. Meanwhile, sales of bonds to the public will
improve the ability of the Bank of Mexico to
control the money supply. Finally, to limit the
political factor in choosing the director general of
the Bank of Mexico, a person must have at least
five years of senior financial management experi-
ence to be appointed.
The autonomy of the Bank of Mexico, however,
remains quite limited. The President, who is reflat-
ing the economy because of political pressures,
retains broad discretion in appointing or forcing the
resignation of the Central Bank director. Moreover,
this official is not of Cabinet rank and reports to
the Finance Minister. Additionally, the government
can easily circumvent limitations on internal fi-
nancing because only congressional approval is
required to raise the ceiling.
Parallel Financing Gets Modest Boost
The President's decision to bolster the role of
private brokerage firms and insurance companies
has been widely applauded by businessmen. They
have little confidence in nationalized banks and
hope the reform will lower borrowing costs-real
interest rates jumped from strongly negative to
positive rates in 1982-84. Rather than borrow
exclusively from banks, the business community
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50
25 Al
0 V r v
-25
-50 I I
-125
-150
L
-175 Sept Jan Jan Nov
1982 1983 1984
a The real effective interest rate equals the difference between the effective
interest rate and the inflation rate. The effective interest rate includes
nominal interest rate plus additional costs such as loan fees and
compounding interest when loans mature in less than one year.
increasingly turned to the private parallel financial
market as bank interest charges rose. Parallel
market credit extensions leaped from virtually
nothing in 1982 to over $1 billion in late 1984,
Private stockbrokers are the backbone of the parallel
financial market. After divestiture by the nationalized
banks, the number of brokerage firms rose by six to
30. Stockbrokers obtain funds primarily through
trade in government and private securities. Moreover,
these firms' frequent contact with corporate treasur-
ers allows them to broker loans between companies in
surplus and deficit cash positions. In addition, broker-
age companies issue commercial paper directly to the
public at an interest rate that last year averaged an
estimated 8 percentage points under bank financing.
According to the financial press, for the first time
Chrysler's Mexican subsidiary raised peso financing
equal to $10.5 million in August 1984, and three
months later the Ford subsidiary in Mexico began
selling peso debentures also totaling some $10 million.
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3 May 1985
Mexico: A Glance at the Brokerage System
The brokerage system is gradually increasing in
importance. In the late 1970s the Mexican securi-
ties market began expanding as the oil boom and
introduction of new financial instruments encour-
aged diversification from traditional mining
stocks. Mexico's 30 licensed brokerage firms had
combined assets totaling $76 million in September
1984. Ten brokerage houses account for over 80
percent of this capital and its associated profits.
Only one of these brokerage houses was formerly
bank owned. By mid-1984 the brokerage system
was managing approximately 1.3 trillion pesos
(about $7 billion), which is equivalent to almost
one-fifth of bank saving deposits, according to the
Embassy.
At present, treasury bills (known as Cetes) account
for over 90 percent of the financial transactions
carried out by Mexican stockbrokers. Introduced
in 1978, Cetes are used by the central government
tofinance its budget deficit. These highly liquid
instruments carry interest rates slightly higher
than those on short-term time deposits, and can be
repurchased by the government when it wants to
restrict the money supply. Brokers trade in other
money market securities, including three-year pe-
trobonds issued by the state oil monopoly and
backed by oil. They carry a fixed interest coupon,
are protected from peso depreciation, and offer the
possibility of capital gains if the price of oil
increases. In 1980 commercial paper was intro-
duced to the securities market and a year later
brokers were allowed to start trading letters of
credit, or bankers' acceptances, issued by individ-
ual companies.
Stockbrokers also trade the stocks of over 200
companies registered on the Mexican stock ex-
change. Since 1982 no new stocks have been issued.
Most stocks traded represent steel, cement, chemi-
cals, mining, electronics, automobile products, and
retail companies; many are subsidiaries of foreign
companies. In 1975 the government mandated that
all registered securities be traded on the Mexican
stock exchange, thereby eliminating over-the-
counter transactions.
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The private long-term capital market, nevertheless,
remains relatively small. The capitalization of pri-
vately owned stockbrokers is still only about one-
tenth that of the banks, according to the Embassy.
Brokerage firms spun off from the nationalized
banks added little to total assets. The third-largest
stockbroker was not returned to private ownership
because its parastatal status, as part of SOMEX, a
state investment bank, predated the bank national-
ization.
The new bank laws reaffirm the nationalized
banks' domination of the financial sector. Only
nationalized banks are allowed to receive deposits
from the public. As multiservice institutions, they
also continue to extend mortgages and issue securi-
ties for long-term funding of priority projects.
Although the new laws reduced reserve require-
ments from 50 to 10 percent, the banks are also
required to increase the share of credits to priority
areas such as the budget deficits, housing, and
agriculture.
We believe the legislation will allow nationalized
banks to increase their financial role. For example,
the failure to make the SOMEX brokerage house a
private firm creates a legal precedent other state-
owned banks can follow, according to the Embassy.
The new laws also authorize banks to acquire up to
10 percent of the paid-in capital of industrial
companies; acquisitions up to 25 percent of a firm's
equity can be approved by the Finance Ministry. If
the banks take advantage of this provision, it could
reverse the government's recent return to private
ownership of the companies that had been held by
banks at nationalization.
The bank reforms may help the government in-
crease private-sector confidence in the financial
sector. In our judgment, return of bank brokerage
houses to private ownership will ease private-sector
concern that Mexico City is planning to expand its
Mexico: Leading Brokerage Million US $
Houses, September 1984
18.9
1.1
13.0
0.9
5.9
1.5
5.8
1.3
Stock development
4.2
2.2
Mexican stock exchange
2.9
1.3
Bancomer a
2.8
0.1
Invest-Mexico
2.6
0.5
Madero
2.4
0.3
Finamex
2.4
1.5
a Five other brokerage houses formerly bank owned are Atlantico,
Banpais, Bancreser, Comermex, and Cremi.
control over industry. Businessmen may also feel
more confident that the President prefers govern-
ment regulation, not public ownership, to control
the economy.
Serious obstacles remain to translating the bank
reforms into long-term economic gains; much will
depend on Mexico City's willingness to fully carry
out the laws. Recent electoral and drug-related
violence and high inflation already are constraining
parallel financing and spurring capital flight. At
the same time, the public sector is still squeezing
private business from bank credit markets. More-
over, the President's retention of a veto over mone-
tary policy and the potential for the banks to be
used for political patronage suggest to us that
inefficiencies in the banking system will be difficult
to reduce.
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Israel: Economic Development of
the Occupied Territories
Continued Israeli military occupation has held
back the economic development of the West Bank
and Gaza Strip, even though Arab residents of the
occupied territories have benefited somewhat. The
occupation regime-by Israeli design-discourages
economic ventures that might compete with those
in Israel or lay a foundation for an independent
state. Employment opportunities-the major bene-
fit for occupied territory residents-are declining in
Israel's slack economy. Meanwhile, the loss of
worker remittances as Palestinian guest workers in
other Arab countries return is adding to the re-
gions' economic malaise.
Minimizing expenditures extends to indirect costs.
Israeli governments have consistently thwarted
those West Bank and Gaza initiatives-such as the
production, processing, and marketing of citrus
fruit-which they perceive will harm Israeli eco-
nomic competitors. Defense Minister Rabin recent-
ly told some Knesset members that "no permits will
be given for expanding agriculture or industry that
may compete with the State of Israel." Political
factors also influence this policy. Control of West
Bank economic projects allows the Israelis to rein
in Palestinian activity that might provide financial
support to the PLO as well as establish an econom-
ic infrastructure for a future Palestinian state.
Occupation Economics
Israel has no "grand design" for the economic
development of the West Bank and Gaza but is
seeking to minimize the economic burden of the
occupation. To this end, Israeli authorities have
acted over the years to integrate the economic
activity. of the two territories with that of Israel
while avoiding formal annexation. Israel has made
use of relatively cheap Arab labor but has excluded
the occupied. territories from the extensive and
costly Israeli social welfare network.
Israel's success in minimizing its occupation costs is
reflected in West Bank/Gaza expenditure data.
Israeli statistics show that until the 1983/84 fiscal
year most municipal outlays in the West Bank and
Gaza were covered by revenues generated within
the territories. Those not covered were more than
offset by sizable trade surpluses Israel runs with
these two territories. Moreover, large expenditures
for developing the region's infrastructure, such as
expanding roads, communications lines, and power
supplies, improve the lot of the local residents but
are largely aimed at enhancing Israel's access to
the areas for security reasons and tightening links
between Jewish settlements and Israel proper.
Improved Living Standards
Israel's economic policies provide some benefits for
the Arab residents of the occupied territories. Israel
allows nearly 90,000 laborers from the West Bank
and Gaza to work in Israel, thus helping combat
disguised unemployment. In addition, West Bank
and Gaza farmers have adopted more productive
agricultural methods as a result of exposure to
highly developed farming techniques employed in
Israel and the Jewish settlements. Productivity has
advanced markedly since 1967, according to offi-
cial Israeli statistics, through the introduction of
chemical fertilizers, pesticides, improved seeds, and
mechanization. Israeli industrial investments have
been helpful but modest, focusing primarily on the
establishment of subsidiaries for industries based in
Israel proper or the improvement of subcontracting
arrangements.
The most highly visible result is improved living
standards in the West Bank and Gaza. Real in-
comes have grown and so has consumption. Not
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Economic Trends: Israel, the West Bank, and Gaza, 1983-84 a
Israel
6
West Bank c
0 1983 1984
a Source: Official Israeli Statistics.
b Fourth quarter 1982=100.
/ Gaza c
00
c Third and fourth quarters 1984 are CIA estimates for the West Bank and
Gaza.
only has the provision of basic necessities-espe-
cially housing-improved, but also per capita con-
sumption of most consumer durables has risen
dramatically. Indeed, the lot of the average West
Banker has improved markedly, probably at a
faster pace than it would have under Jordanian
benign neglect. Gaza's gains have been impressive,
but less so than the West Bank's, largely because
approximately one-third of the population still lives
in refugee camps.
Stagnant Domestic Economy
The problem with these economies is that, although
the populace is much better off, the improvement is
largely due to external trade and worker remit-
tances. Foreign economic relations-especially
those with Israel-are the linchpin of the econo-
mies of the West Bank and Gaza:
? Net imports of goods and services account for
over one-fourth of resource use in both of these
economies. Trade with Israel comprises about 80
Secret
3 May 1985
Israel
1,500 /K_West Bank C
/Gaza r
1,000 J
percent of West Bank trade and 90 percent of
Gaza trade.
? About half of the West Bank labor force is
employed in foreign countries. Of these, Israel
hires about half, with the rest employed in Jordan
and the Gulf states. Workers in Gaza have fewer
opportunities to work in Arab states, but roughly
one-third work in Israel.
? Wages remitted from those working abroad com-
prise nearly half of total hard currency earnings
for both territories, while other transfer pay-
ments-primarily external aid-provide an addi-
tional 15 percent.
This buoyant activity contrasts sharply with domes-
tic economic progress. Economic growth probably
has stagnated in the past few years in both areas,
due largely to little or no growth in the industrial
sector. Israeli occupation policies, the continued
uncertainty over the region's political future, and
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Gaza and the West Bank:
Balance of Payments, 1983
Gaza
West
Bank
Trade balance
-159.6
-255.4
Exports
170.2
212.6
Israeli
144.6
129.9
Imports
329.8
468.0
Israeli
302.6
415.8
e Excludes transactions with the Sinai and between the West Bank
and Gaza.
the inherent business conservatism of the local
inhabitants have stymied industrial initiatives.
Capital investment remains a small share of the
regions' economies and is dominated by residential
construction
Most growth has been in small cottage industries or
tourist-oriented enterprises. Well over 90 percent of
industrial enterprises in the West Bank and Gaza
employ less than 10 workers. Even agricultural
output probably has suffered despite its good record
because of occupation measures facilitating land
expropriation, the deprivation of water resources,
and the imposition of restrictions on sales of agri-
cultural products to Israel. or Israel's traditional
markets.
Prospects are poor for indigenous economic devel-
opment in the West Bank and Gaza as long as their
status remains in limbo. These areas are most likely
to suffer in the near term, given the unpromising
outlook for the economies of the countries upon
which they depend:
? Israel's austerity probably will continue for at
least another year. Construction, which employs
over half of the West Bankers and Gazans, is
slowing considerably.
? The poor oil market is hurting the Gulf state
economies, forcing many Palestinian workers,
especially the more highly skilled and educated,
to return home. A Bank of Israel study showed
.that the number of Palestinians leaving the West
Bank for jobs in the Gulf had dropped to a
handful by the end of 1984.
? The Jordanian economy cannot absorb many
workers; it also depends heavily on remittances
from its citizens working abroad. King Hussein
has limited the influx of Palestinians and, like the 25X1
Israelis, has discriminated against the import of
Palestinian goods. F___1 25X1
Other sources of outside revenue are few. The one
other significant inflow is the approximately $100
million annually assigned to the Jordan-PLO Joint
Fund for the Occupied Territories under the terms
of the Baghdad Accord of 1978. Few of the 25X1
signatories have kept current on their payments,
and it is uncertain whether the fund has been
adequately managed. The Consulate in Jerusalem
reports that what few funds remain are destined for
existing Joint Fund institutions and not new proj-
ects. In addition, the region faces the prospect.of
reduced funding from the UN Relief and Works
Agency (UNRWA). Although that agency is hop-
ing to avoid reducing its services the General
Commissioner recently told (that
such an event is likely if current deficits are not
covered. This would severely affect the'Gaza Strip,
not only because of the services UNRWA supplies
to the refugee camps there, but also because it is a
major employer. Finally, while funding from pri-
vate, voluntary organizations appears to be picking
up, it remains limited, disorganized, and subject to
Israeli controls.
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The impact of economic difficulties in Israel, Jor-
dan, and the Gulf already have generated growing
unemployment in the occupied territories. Israeli
statistics show some increase but understate the
problem. US Embassy reporting and press articles
attest to numerous signs of the worsening labor
market in the West Bank, such as fewer busloads of
workers heading westward each day as well as
informal surveys of the unemployed.
The nest egg that West Bank and Gaza workers
have acquired will not last long, and unemployment
compensation is nonexistent for many. In addition,
Israel's rapid inflation has not spared the West
Bank and Gaza, further eroding what incomes
remain. These Palestinians have few job options
open at home. Even if some chose to return to
agriculture, the US Embassy quotes agricultural
experts as saying that many fields vacated in the
West Bank would require at least two years to
become productive again. The West Bank and East
Jerusalem press report that numerous Palestinian
industrial concerns are closing because they cannot
compete with heavily subsidized Israeli goods.
In 'sum, attempts to "improve the quality of life" in
the occupied territories by laying the economic
foundations for such improvements are moving very
slowly, if at all. Despite signs of increased flexibili-
ty on the part of Prime Minister Peres and other
Labor Party figures in the National Unity govern-
ment, the philosophy remains one of reacting to
outside proposals rather than actively pursuing
developmental initiatives. The newly formed Jorda-
nian Government has stated its desire to boost its
role in the West Bank but also acknowledges that
financial constraints limit what it can do. Private
initiatives- occasionally emerge but are impeded by
the inertia of all involved parties.
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Cambodia:
1984/85 Rice Shortfall
We estimate that Cambodia's 1984/85 rice harvest
will decline for a second straight year. to 1.4-1.5
million metric tons-the smallest since 1979-80.
The entire shortfall is from the predominant rainy-
season rice crop heavily damaged by floods. Never-
theless, we believe that the crop was.not as severely
devastated as the Phnom Penh regime claimed late
last year when requesting food aid from the Food
and Agriculture Organization (FAO) of the United
Nations. Despite a smaller crop, we do not expect
widespread food shortages during the coming
months, because a substantial part of the rice
shortfall will be made up by other foods. In our
view, Cambodia's food problem will not result in a
further exodus of refugees to Thailand.
1984/85 Crop Shortfall
The Cambodian regime has claimed that drought
last July and August, followed by sudden, heavy
floods in August and September, would cut output
of the 1984/85 rainy-season rice crop to below
900,000 tons, some 40 percent less than a year ago.'
meteorological data, and other reporting
corroborates Cambodian claims of a rice shortfall,
but we believe that Phnom Penh's assessments of
weather problems overstated the amount of rice
destroyed. Although the regime reported a disas-
trous decline-463,000 hectares-in rainy-season
rice area, we estimate that about 56,000 hectares,
or less than 5 percent of the total rice area, was
destroyed. We believe that rainy-season rice pro-
duction will reach 1.2 million tons, about 20 per-
cent below the 1983/84 level.
' The Cambodian regime also made claims of a serious rice shortfall
during the 1983/84 crop season, citing drought and flood damage
similar to this year's reports. Provincial sowing totals, however,
reached planned levels, and some reports from Cambodia, Vietnam,
and the Soviet Union put rice output as high as 2 million tons as
Sowing and harvesting operations in Cambodia
extend through most of the year because the
country uses many rice varieties with different
length growing seasons. Rainy-season rice, ac-
counting for 90 percent of annual production, is
planted from June through November, and the
bulk of harvesting takes place from December
through February. Dry-season rice, grown mainly
in a few provinces, is planted from November
through March, for harvest from February
through April. Rainy-season rice yields average
1.1 metric tons per hectare, and dry-season rice
yields average 1.6 metric tons per hectare, because
of more sunlight, more controlled watering, and
less disease. Cambodia's rice yields have tradition-
ally been poor in relation to other countries'. A
labor force with low technical skills, shortages of
draft animals, fertilizer, seeds and equipment, and
a deteriorated irrigation network contribute to low
yields. Moreover, the collectivized system provides
little incentive for peasants to produce. Historical-
ly, flooding is the major factor behind annual
production variability.
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Because planting of the dry-season rice has only
recently been completed, the size of this crop
cannot yet be estimated accurately. This year's
plan of 190,000 hectares is, ambitious, but the
shortfall in rainy-season production should have
spurred sowings of 120,000 to 160,000 hectares.
Abundant water reserves combined with increased
availability of high-yield hybrid rice seeds could
boost yields, resulting in adry-season crop ranging 25X1
from 216,000 to 320,000 tons, up from last year's
output of 208,000 tons. 25X1
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Planned area (thousand hectares)
1,500
1,700
1,600
1,600
1,700
Harvested area (thousand hectares)
1,232
1,300
1,545
1,358
1,237
(percent of plan)
82
76
97
85
73
Yield (metric tons/hectare)
1.19
1.00
1.16
1.08
0.98
Production (thousand metric tons)
1,466
1,300
1,788
1,467
1,216
Dry-season rice
Planned area (thousand hectares)
123
150
165
155
190
Harvested area (thousand hectares)
88
149
135
105
120-160
(percent of plan)
72
99
82
68
63-84
Yield (metric tons/hectare)
1.30
1.72
1.60
1.79
1.8-2.0
Production (thousand metric tons)
115
256
216
208 b
216-320
Total rice
Planned area (thousand hectares)
1,623
1,850
1,765
1,755
1,890
Harvested area (thousand hectares)
1,320
1,449
1,680
1,463
1,357-1,397
(percent of plan)
81
78
95
83
72-74
Yield (metric tons/hectare)
1.20
1.07
1.19
1.14
1.06-1.10
Production (thousand metric tons)
1,581
1,556
2,004
1,675
1,432-1,536
a Area, yields, and production for 1980/81 are FAO estimates, and
the same data for 1984/85 are CIA estimates. All other data are
from Cambodian announcements. Total 1979/80 rice production
.was announced at 565,000 tons from an area of 771,000 hectares.
Numbers have been rounded.
b 1983/84 Cambodian data for its dry-season rice crop is inconsis-
tent. Using the area and yield shown, dry-season production would
be 188,000 tons instead of 208,000 tons reported.
Impact of the Rice Shortfall
Assessment of whether a total rice crop of 1.4-1.5
million tons will result in serious food shortages in
Cambodia is complicated by the lack of an exact
population figure-we believe that the total popula-
tion is 6-7 million-and by disagreement on the
size of an "adequate" ration.' Using a population of
6.5 million, and a milled rice ration of 13 kilograms
per month-midway between the FAO and Phnom
Penh estimates of an adequate ration-our project-
ed 1984/85 rice output would result in a milled
rice 3 deficit of roughly 200,000 to 250,000 tons.
' To calculate the amount of milled rice available from total rice
production, a 15-percent seed and loss factor is subtracted, and the
'The FAO uses, as a minimum emergency ration, an individual rice
requirement of 12 kilograms per month. Although such a ration will
sustain life, it is not sufficient for persons doing farm labor. Phnom
Penh has stated a minimum requirement of 14 kilograms per
month. An 18-kilogram monthly ration is considered the ideal
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Although milled rice availability seems likely to fall
below the estimated minimum needs, we believe
other food crops, fish, and game will partially offset
this shortfall. For example, using Phnom Penh's
1984/85 production estimates for corn, cassava,
and sweet potatoes, our estimated rice deficit could
be cut to approximately 135,000 to 190,000 tons.
Other crops, such as vegetables, bananas, sugar,
and coconut, will also alleviate some rice shortages.
In our view, the food problem in Cambodia will not
be a major cause of further exodus of refugees to
Thailand. Furthermore, the recent outflow of refu-
gees from camps along the Thai-Cambodian bor-
der-as a result of the heavy fighting-will not
alter the demand for food inside Cambodia because
international relief agencies have been providing
food assistance to most of these refugees for several
years.
21 Secret
3 May 1985
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secret
pot oil
Energy 25X1
Spot prices for most crudes and oil products-have edged lower in recent weeks.
The spot price for Arab Light crude declined about 20 cents per barrel during
April to $27.55-compared with pits: official price of $28 per barrel-while the
spot price for. UK Brent dropped 80 cents to $27.25 per barrel. Declining
prices reflect continued weak oil consumption. According to recent IEA data,
non-Communist consumption has averaged about 1 percent below year-earlier
levels so far this year. Rising production from several non-OPEC suppliers
including the North Sea, Oman, and Egypt also have kept spot prices soft.
25X1
Rgfinery Capacity A 180,000-barrel-per-day refinery. at Belford-Haven, United Kingdom, is
Australian
O' rices
being dissassembled and moved to the coast of Ajman in the UAE where it will
be reassembled by a Belgian firm. A $90 million financing package will be ap-25X1
proved once a contract-for the refinery's feedstock, most likely from Abu
Dhabi's Upper Zakum field, is finalized. the oil
purchase can be discounted-probably about $2 per barrel-since the sale is 25X1
between Emirates. This discount will enable sales of refined products below
market prices and provide Abu Dhabi, further opportunity to produce oil above
its OPEC allocation. This move is part of a trend toward further emphasis on
product marketing by OPEC countries that is putting additional downward
pressure on oil prices. 25X1
responsible for a firming of the Australian dollar at the end of last week.
Explaining the decision not to phase in the price increase or reduce excise
taxes, Energy Minister Evans said that Canberra must be seen as willing to
make politically tough decisions on the economy.. The decision on oil prices and
the simultaneous. announcement of a .US $650 million budget cut are probably
The Hawke government .announced last week that it would resist mounting
political pressure to change Australia's seven-year-old oil pricing system to
offset three months of rapid currency depreciation. Therefore, the domestic
price of oil will increase by about US $6.60 per barrel, which could raise
gasoline prices 13 percent. Harsh criticism has come from leftwing members of
the. ruling Labor Party-both in Parliament and in the state governments. .25X1
23 Secret
3 May 1985
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Breakthrough on the A key roadblock to Manila's long-delayed financial rescue package has been
Philippine Financial removed by the agreement this week between the commercial banks and a
Rescue Package major Saudi bank on conditions governing its participation in the new loan
package. An additional barrier was also removed by Manila's assurance that
foreign banks would receive overdue loan payments from a local fertilizer
company. Signing by Manila's commercial creditors is now scheduled in New
York later this month. Although the signing will pave the way for $925 million
in new bank loans, disbursements can be made only if Manila is in compliance
with its IMF progi am. Manila failed to meet the December and March
economic targets, and its next test of performance targets will come at the end
of May. Until a Fund decision on compliance-expected in June-the
Philippines will continue to husband its declining foreign exchange reserves by
restricting imports and postponing debt service payments.
West German
)tonornic. Forecast
Secret
3 May 1985
National Developments
Developed Countries
domestic economy moves on a slow track.
In their semiannual joint forecast, West Germany's five major economic
research institutes project 2.5-percent real GNP growth and a slight increase
in joblessness this year. The forecast is somewhat more pessimistic than most
other recent projections. The prediction of a 0.3-percentage-point increase in
unemployment, to 9.4 percent is-particularly at odds with the official
government forecast that unemployment will slip. under 9 percent. Foreign
demand will again be the main source of growth. West German economic
vitality seems increasingly dependent on the external sector, while the
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W,kst Germany Upping West German Government and business are stepping up R&D spending this
&D Spending
Spanish Social
Security Reform
1.2 percent, R&D funding will grow more than 8 percent.
year as part of what Economics Minister Bangemann is hailing as "a new
technology offensive." According to a Battelle. Institute study, real 1985 R&D
spending will rise at least 4 percent. Gains in the early 1980s averaged only 1.3
percent. This year's increase will about match the: expected US gain-both
countries already devote 2.8 percent of GNP.to R&D (public and private)
versus 2.6 percent for Japan. Bonn's emphasis on R&D is clearly reflected in
this year's budget-although overall federal spending is projected to rise only
unlikely
Union opposition may delay government efforts to overhaul Spain's social
security program-a source of escalating employer costs. Madrid has proposed
reducing expenditures by adjusting pension calculations and changing eligibil-
ity requirements for retirement and disability benefits. Government officials
.agree on the immediate need 'to curb the growth of social security expenditures
but have not settled on the size of the pension cuts: The gradually aging
population, sharp real wage gains after 1974, and layoffs have prompted a
rapid rise in pension benefits, and.a projected 30-percent jump in pensioners by
1990 threatens, the present system. Although the Socialist trade union has
rejected any benefit cuts. and threatened a demonstration, the government has:
offered to compromise only on eligibility changes. 'Elections next year make
further reforms to shift more of the social security burden onto workers
Portugal Attempts To Strong labor opposition and a potential break in party ranks may force the
Reform Labor Laws Soares government to weaken recently proposed legislation aimed at reducing
-labor market rigidities. The draft labor laws would allow companies to lay off-
workers made redundant by. better equipment and would provide fired workers
an indemnity-but not the.right to return-if the courts found they were 25X1
dismissed unjustly. This legislation would require an amendment of constitu-
tional guarantees of job security, which makes a revision of the bill likely. The
Socialist UGT trade union has threatened to join Communist workers in
demonstrations, stage a nationwide strike, and withhold support for Soares in
this December's presidential elections if the bill is' passed as written. If Lisbon
backs down, attempts to restructure will remain handicapped, and efforts to
increase productivity with labor-saving devices will continue to be discouraged.
Moreover, a heavily watered-down bill could actually make the labor market
more rigid with its new restrictions on temporary hiring-a practice increas-
ingly used to circumvent prohibitions on firing regular employees. 25X1
25 Secret
3 May 1985
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Less Developed Countries
ew Soviet- The USSR and Mozambique have signed a series of agreements on economic
JIozambican and technical cooperation, according to TASS. The accords cover assistance in
Economic Accords coal processing, ship repair, fishing, and reconstruction of railroads and
electric lines in southern Mozambique.
Moscow probably sees the extension of new
economic aid to the hard-pressed government as a means of limiting the
political aspects of President Machel's opening to the West for trade and aid.
The agreements are modest, however, especially in comparison with the level
of Moscow's military aid to Maputo.
Ind sias Slow Jakarta's ambitious tax reform program is off to a rough start.
S art on Tax Reform President Soeharto has declared assets of only $800,000,
and Mrs. Soeharto has made no declaration under the amnesty program for
declaring previously undisclosed assets.
The-new value-added tax is 25X1
causing confusion among business firms in addition to increasing prices.
Moreover, there are delays in rebates to exporters and some major loopholes in
the regulations, according to the US Embassy. Tax reform, in our view, will
succeed only if the government can win the cooperation of a public and
business sector not accustomed to paying taxes honestly-a questionable
prospect.
Wghanistan's Crop Widespread rains since late March have replenished Afghanistan's critically
is exhausted.
low irrigation reserves, averting a crop disaster. Afghanistan produces some 85
percent of its food and industrial crops on irrigated land. There probably now
is enough water to sustain the crop of winter wheat-Afghanistan's principal
food grain-until harvesting begins in late May. Prospects are less favorable
for summer crops such as corn, rice, and cotton because irrigation reserves are
expected to-run dry before the plants mature in late summer. The amount of
damage will depend on what stage of growth the plants are in when the water
25X1
25X1
25X1
Venezu a's Foreign \/ Caracas hopes to liberalize some restrictions on foreign investment, but the
Inves ment Reforms Y Cabinet is still stalling in face of domestic political resistance. Foreign
H g Up investment inflows have stagnated in the 1980s as Venezuela-in accord with 25X1
the Andean Pact investment code-enforced stringent profit restrictions and
limits on foreign ownership and management. The US Embassy reports that
the Lusinchi administration is developing new rules guaranteeing dollar
repatriation. Caracas is receiving some criticism on its plans to expand foreign
ownership rights and allow private-sector participation in the oil industry from
domestic firms fearing increased competition and from nationalistic groups
resisting changes in the oil nationalization laws. 25X1
Secret 26
3 May 1985
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Secret
Structural Adjustment VLast month's IMF standby agreement provides San Jose with $54 million,
Begins in Costa Rica primarily to reduce the current account deficit and replenish foreign exchange
major role in solving Venezuela's deepening recession.
The US Embassy believes achieving political support for the revisions will be
difficult, despite widespread recognition of the need for new investment.
Moreover, foreign investors are still waiting for clear signals on the adminis-
tration's willingness to ease price, import, and foreign exchange controls for
new ventures. Consequently, we believe new direct investment gains will
remain modest, dashing Lusinchi's hopes that renewed inflows will play a
reserves. On 16 April the World Bank approved an $80 million structural
adjustment loan, which is aimed at expanding nontraditional exports to new
markets outside the Central America region. To secure the loan, San Jose
promised to continue its gradual reduction in export taxes and to reduce.-the
public sector's role in the economy. In a third accord, Paris Club members'
agreed on 22 April to reschedule Costa Rica's $190 million debt due in 1984,
1985, and mid-1986. The generous terms of this agreement will considerably
ease the debt service burden-currently about 40 percent of total exports-
and reduce austerity pressures as the general election approaches early next
year.
Poland's Poor.,
Fjrst-Quarter Results
The Polish economy has started 1985 with its worst economic performance in
three years due mainly to the effects of a cold winter. Hard currency exports
declined 12.8 percent and imports 3.4 percent, resulting in a first-quarter trade
surplus of only $250 million compared with $360 million for the same period
last year. Industrial production stagnated, with output in the extractive
industries 5 percent below that in the comparable 1984 period. Cold weather
also led to declines in construction and transportation of 9 and 15 percent, re-
spectively. Although some weather-related losses can be made up, Poland
already has lowered its 1985 hard currency export targets. As a result, likely
cuts in industrial imports may depress output in some sectors later this year.
Ili
rowth Prospects
the effects of large-energy shortfalls-brought on by a severe winter and a
virtual lack of energy stockpiles-are still reverberating through the economy.
We estimate that industrial production in the first quarter may have dropped 25X1
by as much as 7 percent compared with first quarter 1984. Steel production
has been particularly hard hit, and shortages of steel, in turn, are-hampering
other industrial sectors, including those concentrating on exports. Although a
"catch-up" program may succeed in making up the first-quarter losses, overall
prospects for economic growth this year are slim. Nevertheless, by continuing
27 Secret
3 May 1985
Romanian Economic Despite Bucharest's energy conservation program announced in mid-January, I I
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Secret
P ans for 1985
hinese Grain
Production
to give priority to hard currency exports, Romania may still be able to match
last year's successful export performance. The leadership's determination is
evidenced by its willingness to inflict more austerity on the population, which
has just endured the most severe winter and the worst food and energy
shortages since the immediate postwar period.
China's 1985 grain production
target is 405 million metric tons, 2 million tons less than the recond 1984 har-
vest. The area planted to grain is expected to decrease by 2.5 million hectares,
but officials hope higher yields will offset the potential 15-million-ton loss.
planting schedule.
Under newly adopted agricultural policies, farmers may plan their own crop
mix, and many farmers are shifting from grain to more profitable cash crops.
Although the media have exhorted peasants not to reduce grain production,
the agriculture official insists the state will not interfere with the farmers'
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3 May 1985
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