INTERNATIONAL ECONOMIC & ENERGY WEEKLY

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP97-00771R000807750001-5
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 40
• Document Creation Date: December 22, 2016
• Document Release Date: October 20, 2010
• Sequence Number: 1
• Publication Date: October 25, 1985
• Content Type: REPORT

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Directorate of
Intelligence
Weekly
International
Economic & Energy
Secret
-Secret-
DIIENW85-043
25 October 1985
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Secret
International
Economic & Energy Weekly
iii SS/nopsis
LZ
1 / Pyrspective-International Commodity Programs Foundering
3 / Sanctions Against South Africa: Bark Worse Than Bite
9 / Eastern Europe: Boom Market for Syndicated Lending
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15 /Malaysia: The Push for Economic Parity Falls Short
19 nth Yemen: Banking on Newfound Oil
23 / Tanzania: Nyerere's Legacy of Economic Decline
27 Briefs
28
29
32
Energy
International Finance
Global and Regional Developments
National Developments
Comments and queries regarding this publication are welcome. They may be
directed to Directorate of Intelligence
Secret
DI IEEW 85-043
25 October 1985
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Secret
International
Economic & Energy Weekly
Synopsis
1 Perspective-International Commodity Programs Foundering
International programs such as the UNCTAD international commodity
agreements and the EC's Lome Convention are failing to soften the blow of
low prices on LDC export earnings.
3 Sanctions Against South Africa: Bark Worse Than Bite
In the past six months, most industrialized nations have responded to political
developments in South Africa with economic sanctions against Pretoria-
primarily symbolic measures aimed at sending a political message. Taken as a
whole, however, sanctions and the threat of additional actions have added to
eroding banker and foreign investor confidence in South Africa.
9 Eastern Europe: Boom Market for Syndicated Lending
East European borrowing from Western banks has rebounded sharply this
year. Borrowers have taken advantage of favorable loan terms to restructure
debt, build reserves, and cover shortfalls in hard currency earnings.
15 Malaysia: The Push for Economic Parity Falls Short
Since 1971 Malaysia's economic strategy has been governed by the New
Economic Policy (NEP), an ambitious social restructuring program directed at
boosting Malay participation in the Chinese-dominated economy. Declining
economic growth in recent years has slowed the NEP's progress and, in our
judgment, makes it likely that its 1990 goals will not be met.
19 North Yemen: Banking on Newfound Oil
Last year's discovery of oil by a US firm has significantly enhanced the long-
range prospects for North Yemen' economy. The government, however, faces
the challenge of keeping the country afloat until oil revenues start flowing.
23 Tanzania: Nyerere's Legacy of Economic Decline
President Julius Nyerere, who steps down as President of Tanzania on 4
November leaves behind a moribund economy operating near subsistence
levels. Restoration of economic growth is unlikely in the near term because the
country has depleted its foreign exchange reserves, relies heavily on foreign
assistance, and remains far from an agreement with the IMF.
iii Secret
DI /EEW 85-043
25 October 1985
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International
Economic & Energy Weekly
Perspective International Commodity Programs Foundering
Intergovernmental programs such as the UNCTAD international commodity
agreements and the EC's Lome Convention are failing to soften the blow of
low commodity prices on LDC export earnings. Furthermore, few, if any,
officials in the international commodity community foresee a significant
turnaround in commodity prices before 1990.
Having been largely overpowered by the magnitude of the commodity price
decline, progress within UNCTAD on commodity issues is at a near standstill.
The few international commodity agreements that contain price provisions all
have uncertain futures. The tin, rubber, and cocoa agreements face difficult
renegotiations over the next couple of years, and the coffee agreement is
plagued with disputes between various factions-not just between producers
and consumers. The sugar agreement now exists only on paper after prices
collapsed last year. Other proposed UNCTAD programs, such as the Common
Fund to boost prices or compensatory financing to aid exporters, are
languishing.
The new five-year Lome agreement between the EC and the African,
Caribbean, and Pacific (ACP) states-primarily Western Europe's former
colonies-does little to attack the earnings problem. EC aid for proposed LDC
mineral investment projects will be put to more rigorous tests, and benefits to
EC industry will be given higher priority. The ACP commodity earnings
stabilization program has been reworked, and EC control over funds will be
stricter. Moreover, the level of funds available to offset ACP earnings
shortfalls remains almost the same as the previous Lome agreement-despite
lower ACP earnings and the temporary depletion of funds for the program in
LDC exporters' special access to protected Western commodity markets also is
eroding. Mediterranean exporters of fruits and vegetables are in danger of
losing their preferential access to EC markets when Spain and Portugal-also
major producers join the Community next year. Moreover, while the EC is
likely to continue to allow ACP sugar to enter its protected market, it will con-
tinue to dump massive amounts of cheap sugar on the world markets,
depressing earnings for those LDCs without special arrangements. Sugar
exporters with special access to the US market have also faced reductions in
their quotas over the last several years.
Market forces are likely to play a greater role in commodity markets as the in-
ternational commodity programs wither. Indeed, most changes being proposed
within the commodity organizations reflect a growing recognition of the
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importance of underlying supply and demand factors. In this more market-
dominated environment, the large, efficient commodity producers-such as
Brazil-could thrive. In contrast, the earnings of many smaller LDCs will be
more at the mercy of commodity price swings. Realization of this fact by the
LDCs has itself undermined intergovernmental programs. As a result, LDC
unity on commodity issues shown prior to the 1980s is now being buffeted by
the "every man for himself" attitude. While this will mean better balanced
markets in the 1990s, the shakeout will be painful for commodity-dependent
LDCs.
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Sanctions Against South Africa:
Bark Worse Than Bite
In the past six months, most industrialized nations
have responded to political developments in South
Africa with economic sanctions against Pretoria.
These have been primarily symbolic measures
aimed at sending a political message rather than
inflicting real economic hardship. Nonetheless, the
sanctions will have some impact:
? Pretoria is likely to lose some revenue earned
from Krugerrand exports in the short term, but
has alternatives it can implement, if need be, to
shore up reserves.
? South Africa will find it more difficult to obtain
computers and other sensitive imports for the
nation's security forces.
Taken as a whole, however, sanctions and the
threat of additional actions have added to eroding
banker and foreign investor confidence in South
Africa. Major clashes between demonstrators and
South African police or the arrest of another black
antiapartheid leader will likely prompt a number of
countries to impose stiffer measures.
Most of the sanctions have been symbolic, with
little direct economic cost to either party. For
example, South Africa sells only about $67,000
worth of Krugerrands to Australia annually. Like-
wise, the EC's ban on oil exports to South Africa
amounts to a loss of only $30 million, in 1984. In
the short run, even bans on new investment, some
of the toughest sanctions yet imposed, are probably
negligible because little new foreign investment
would have been forthcoming in the face of South
Africa's deep economic recession.
Direct Impacts
Krugerrand Exports. Sales of Krugerrands earn
Pretoria about $500-600 million annually. Over
time, gold coins minted in other countries probably
would replace Krugerrand sales. To circumvent
these bans, South Africa probably will either sell
bullion or increase its gold collateralized borrow-
ings from international banks to shore up reserves.
Sanctions and Their Impact on South Africa
At last count, some 68 countries have attempted to
pressure South Africa by imposing a wide range of
sanctions. Such measures include restricting ex-
ports and imports, halting government programs
that promote bilateral trade, banning new invest-
ment, and reducing cultural, scientific, and mili-
tary contacts. A few of the sanctions have been
specifically directed against apartheid. For exam-
ple, the sale of computers and other goods to South
African security forces has been banned by Austra-
lia, Austria, Canada, the European Community
(EC), Finland, Japan, and the United States. Some
governments have established codes of conduct
intended to promote equal employment opportuni-
ties within their country's South African subsidiar-
ies. Bans on Krugerrand imports are aimed at
crimping South Africa's export earnings while hav-
ing a minimal economic impact on the black popu-
Imports of Sensitive Products. Most Western na-
tions have restricted sales of so-called sensitive
products-for example, computers and military-
related items-to South Africa's security forces.
Although these restrictions will make importing
such products more difficult and costly, we believe
Pretoria will be successful in obtaining needed
equipment either through purchasing goods from
countries without bans, or by circumventing these
restrictions-in the past Pretoria has weathered oil
and arms embargoes through illegal acquisitions
and domestic production. Many Western countries
have also restricted new nuclear contracts, but new
regulations limiting nuclear sales are likely to have
a minimal short-run effect because most countries
have been restricting new sales for the past couple
Secret
DI IEEW 85-043
25 October 1985
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Import Export Investment Loan Export Other Comment
Restrictions Restrictions Restrictions Restrictions Finance or
Insurance
United States Ban or Krugerrands and arma- Ban on nuclear goods or tech- Ban on loans, ex- Require US com-
ments imports. nology and computers for secu- cept those used to panics in South
rity forces and agencies enforc- "improve lives of Africa to adhere
ing apartheid. black South to code of
Africans." conduct.
Australia Ban on Krugerrands. Embargo Ban on petroleum and petro- Suspension of Gov- Voluntary Export fi- Voluntary code of Sanctions expected
on government contracts over leum products, computer hard- ernment of Austra- nancing ban. conduct for firms. to have little ef-
$13,000 with South African ware, and other products used lia investment in fect petroleum
companies. by South African security South Africa, and and computer ex-
forces. South African Gov- ports negligible and
ernment investment Krugerrand imports
in Australia. less than $67,000
annually.
Austria Voluntary bank restrictions on Ban on computer exports and Ban on new invest- No government Minimal effect-to-
Krugerrand imports. assistance by state enterprises in ment by state loans gurantees for tal Austrian trade
nuclear projects. Ban on weapon enterprises. exports to South with South Africa
exports. Africa. was only $142 mil-
lion in 1984.
Canada Krugerrand sales "discoura- Voluntary for crude oil and re- Voluntary on new Termination Voluntary code of Canada sells virtu-
ged." Acceptance of UN embar- fined products. Mandatory for loans. of export conduct for firms. ally no crude oil or
go on South African arm sales. computer sales to security forces insurance. Mandatory ban refined products to
and agencies enforcing on air traffic to South Africa
apartheid. and from South Krugerrand com-
Africa. Abroga- petes with the Ca-
tion of double- nadian Maple Leaf.
taxation
agreement.
Japan Government guidance against Ban on computer sales which (See comment.) "Guidance" against Insurance Japan has banned
Krugerrand sales. might assist South African mili- extension of com- fees raised 20 direct investment in
tary or police. mercial loans. percent. South Africa for 30
years. Japan
imports about $50
million worth of
Krugerrands
annually.
Nordic countries' Importers urged to find other Ban on new nuclear sales and Ban on new Ban on new loans No govern- Cessation of com-
suppliers. Ban on weapon and computer equipment. Nordic ex- investment. and any participa- ment support mercial flights to
Krugerrand imports. porters urged to find other tion in international of trade with and from South
markets. loans. South Africa. Africa.
Sweden Krugerrands, fruits, and vegeta- Recommendation: exporters 1979 freeze on in- Cessation of cam- Import and export
bles banned. Government "dis- seek alternative markets. vestments mercial flights to restrictions still re-
couraging" imports of other tightened. and from South quire approval by
goods. Africa. Parliament. Since
1979 all new invest-
ments and loans
banned.
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South Africa: Sanctions Scoreboard (continued)
Norway Fruits and vegetables. All im- Licensing of all trade, ban on (See comment.) Cessation of com-
ports from South Africa subject crude oil exports. mercial flights to
to licensing. and from South
Africa. Registra-
tion of all Norwe-
gian ships calling
on South Africa.
Compulsory regis-
tration is designed
to stem the flow of
oil to South Afri-
ca-Norwegian
tankers carry be-
tween one-third and
one-half of Pre-
toria's oil imports.
Investment in South
Africa has been
blocked since 1976.
Finland Ban on government purchases Ban on leasing, trade in patents Ban on investment. Ban on new loans. All measures still
from South Africa and recom- and licenses, computers, and nu- require approval by
mendation that municipalities clear exports. Parliament, which
also refrain from buying South will debate the issue
African products. this week. Volun-
tary restrictions
have eliminated
80% of imports
from S. Africa.
European Arms and paramilitary Oil, new nuclear collaboration, Voluntary code of
Community b equipment. and equipment for police and conduct for firms
armed forces. with subsidiaries
in South Africa.
EC Gradual phase out of coal im- Ban on new invest- Limits on ex- Cessation of com-
members ports by 1990 (Denmark). ment (France and port insur- mercial flights to
Denmark). Suspen- ance (West and from South
sion of official sup- Germany and Africa
port for investment the (Denmark).
in South Africa Netherlands).
(Belgium).
Actions symbolic
since no crude oil
exported by the
Community to
South Africa-
France barred new
nuclear supply con-
tracts in 1983. The
United Kingdom
initially withheld
approval of EC
sanctions.
France prohibited
Krogerrand imports
since late 1960s.
Commonwealth Voluntary ban on Krugerrands Voluntary ban on computer Voluntary ban on Voluntary ban on If no progress is vis-
Countries c and arms. sales to South African security government loans. government fund- ible toward disman-
forces, new nuclear equipment ing of trade mis- tling apartheid
and technology, and oil exports. sions to South within six months,
Africa. additional measures
will be considered.
London probably
agreeded to the ban
on Krugerrands in
exchange for mild
sanctions by the
Commonwealth
similar to the EC's
measures.
Nordic countries: Norway, Sweden, Denmark, Finland, and Iceland. C The United Kingdom plus 48 former colonies and territories.
b European Community countries: Belgium, Denmark, France, Italy, Luxem-
bourg, the Netherlands, Ireland, Greece, United Kingdom, West Germany,
Spain, and Portugal.
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South Africa: Million US $
Top Five Trading Partners, 1984 a
Total
16,942
Total
Of which:
Of which:
West Germany
2,343
United States
2,626
United States
2,299
Japan
1,579
Japan
1,850
West Germany
1,455
United Kingdom
1,640
United Kingdom
1,317
Italy
525
France
653
of years. The nuclear restrictions applied by the EC
in mid-September are largely symbolic because
France-the only significant EC supplier of nucle-
ar technology to South Africa-has barred new
nuclear contracts with South Africa since 1983.
Continuation of the nuclear-sales ban may hamper
Pretoria's plans to build a second nuclear power
plant in the 1990s, however.
Broader Implications
Although the bans on new loans and investments
that have been imposed so far will have little direct
impact, sanctions have contributed to the erosion of
foreign investor confidence in South Africa that
triggered the exodus of some foreign companies
and spawned the recent financial crisis. In the past
year, 18 US companies-three times the number a
year earlier-have halted all or part of their South
African operations and others have scaled down
their operation
South Africa's three-month moratorium on debt
principal repayments damaged the country's credit
reputation and, as a result, Pretoria will find it
more costly to secure foreign loans and trade
financing. Higher cost foreign credit probably will
contribute to keeping domestic interest rates high
and-compounded by corporate disinvestment-
tions.
The imposition of sanctions by Western countries,
however, will not prompt the white regime to
accelerate its program of limited reform. The go-
vernment's longtime "stand firm" approach to ex-
ternal pressure has always been viewed favorably
by most white voters. President Botha probably
believes, justifiably, that his strong support from
whites would erode quickly if they thought he was
weakening under pressure from foreign countries
and restive nonwhites. In fact, the right wing,
which has become increasingly anti-US, may be
able to exploit the sanctions issue to gain new
support. Although many blacks have applauded the
limited measures as a sign of growing Western
awareness of their plight, they believe the sanctions
are inadequate to pressure the white government
and may delay or preclude stronger Western ac-
We believe that Australia, France, and the Nordic
countries will impose additional sanctions unless
Pretoria takes significant steps toward dismantling
apartheid. Australia is calling for further action,
according to US Embassy reporting, and-along
with Afro-Asian members of the Commonwealth-
pressed the issue during last week's Commonwealth
Conference. The French, the driving force behind
EC sanctions, are likely to support calls for UN
sanctions and additional measures by the EC, as
well as take action on their own. Norway, Sweden,
and Denmark are calling for comprehensive sanc-
tions by the United Nations, but may adopt some
new measures independently.
Barring heightened violence or government repres-
sion within South Africa, the British and West
Germans probably will be able to prevent any
additional sanctions by the European Community.
London's opposition stems from its significant eco-
nomic ties, which the Thatcher government does
not want to endanger at a time of high domestic
unemployment. London's initial reservation to EC
will slow economic growth.
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Secret
sanctions was probably dropped only in an effort to
forestall more extreme actions by the United Na-
tions or at the Commonwealth Conference. The
Commonwealth's mild voluntary sanctions proba-
bly represent a victory for Prime Minister Thatcher
who resisted stronger mandatory measures at the
conference. Traditional West German resistance to
future sanctions has hardened following Bavarian
leader Strauss's denouncement of Bonn's agree-
ment to the EC measures. Swiss refusal to use
economic sanctions to achieve political goals, com-
bined with their important trade relationship with
South Africa, is likely to ensure that Switzerland
remains the only major industrialized nation not to
impose sanctions.
Japan, Canada, Spain, Belgium, Italy, and the
Netherlands appear to be pursuing a wait-and-
follow strategy. These countries almost certainly
will not advocate additional sanctions, but may
adopt measures to avoid the appearance of support-
ing the white-minority regime. Japan's recent ac-
tions came considerably after other Western na-
tions enacted measures. Similarly, Spain, Belgium,
Italy, and the Netherlands are likely to take further
action only if a consensus forms within the EC.
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Eastern Europe: Boom Market
for Syndicated Lending
East European borrowing from Western banks has
rebounded sharply this year. The region raised $2.8
billion in syndicated loans on increasingly favorable
terms in the first 10 months of 1985-a sharp
turnaround from the early 1980s when bankers
slashed lending to the East. Japanese and Arab
banks have played a leading role in new lending,
while the importance of US and West European
banks has fallen. Lenders have become more in-
clined toward Eastern Europe because of improved
hard currency trade performance in the region over
the past two years and a lack of comparably
attractive investments elsewhere. Borrowers have
taken advantage of favorable loan terms to restruc-
ture debt, build reserves, and cover shortfalls in
hard currency earnings this year.
Widening Circle of Borrowers
The number of East European countries returning
to the syndicated market has grown quickly this
year, and many of the loans have been
oversubscribed.'
? East Germany secured a $500 million loan in
March; in June it obtained a consortium loan for
$600 million.
bridge loan to Romania in May
Only Yugoslavia and Poland, which still require
debt reschedulings, remain shut out of the syndicat-
ed loan market.
Japanese and, to a lesser extent, Arab banks have
played a prominent role in the upswing in new
lending. Japanese banks, looking to diversify their
loan portfolios, have taken the lead or jointly
managed 41 percent of the loans to Eastern Europe
this year, as compared with 18 percent in 1979.
increased
competition from Japanese banks in the lending
market has pushed down interest rates on loans to
Eastern Europe. In contrast, US banks have man-
aged 15 percent of this year's loans to the East,
down from 20 percent in 1979. This parallels the
decline in overall US exposure to Eastern Europe.
Many US banks that have managed recent loans to
the region have been mainly interested in earning
the management fees and have tried to sell off their
portions of the loans quickly to limit exposure.
? Hungary in June tapped Western banks for the
bulk of an $800 million World Bank cofinanced
loan and Japanese banks for an additional $400
million since January.
? Bulgaria borrowed $200 million in July and $120
million in October.
? Czechoslovakia borrowed $100 million from a
Western bank consortium in July.
The lack of comparably attractive lending opportu-
nities elsewhere largely explains the willingness,
and, in some cases, even eagerness of Western
banks to resume lending to Eastern Europe. The
financial positions of East Germany, Hungary,
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Management of Syndicated Loans to Eastern Europe, 1979 and 1985
Bulgaria, and Czechoslovakia seem relatively more
secure than those of many LDCs, especially in
Latin America, where bankers feel overexposed. As
a result, not only has the absolute amount of East-
ern Europe's borrowing increased, but also its share
of bank lending to countries outside the OECD-
13 percent so far this year, as compared with 6
percent in 1976 and 10.5 percent in 1979.
Eastern Europe's hard currency trade surpluses in
1983-84 and some easing of East-West tensions
have been the major factors encouraging bankers to
look more favorably on the region. The East Euro-
pean borrowers have also substantially cut their
debt since 1980, and, except for Romania, they
have avoided rescheduling. Having made deep cuts
in their East European exposure in 1981-83, banks
now feel they have elbowroom to respond to loan
requests from the more creditworthy countries.
Some bankers-particularly in Western Europe
and Japan-believe East European imports from
the West will rise with the launching of new five-
year economic plans for 1986-90, and they want to
reestablish ties to the better credit risks.
Western banks have been particularly receptive to
loan requests from East Germany and Hungary for
additional reasons. East Germany, besides running
sizable trade surpluses, boasts the strongest record
of economic growth in Eastern Europe since 1982.
Banks also value the West German umbrella for
East Berlin, which Bonn demonstrated by guaran-
teeing two large West German bank loans during
East Germany's liquidity squeeze. Finally, banks
have found East Berlin a lucrative loan market
because of the regime's acceptance of relatively
high interest rates-recent loans have carried high-
er spreads over LIBOR than those for most other
Bloc countries. The East Germans apparently pre-
fer to have their loans oversubscribed at higher
interest rates than to obtain the most favorable
terms.
In Hungary's case, bankers are counting strongly
on Budapest's reform program to improve the
efficiency and competitiveness of the economy.
Hungary's good relationship with the IMF-which
lent it nearly $1 billion in 1982-84-has added to
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Syndicated Loans to Eastern Europe, 1978-85
Billion US S
7
0 1978 79
t
81 82 83 84 85
Jan-Oct
banker confidence. Moreover, banks have been
eager to participate in World Bank cofinancing
loans because they believe that Bank involvement
guarantees that the loans are exempt from resched-
uling should Budapest run into repayment prob-
lems. Japanese banks have been particularly at-
tracted by the apparent security of these deals.
In Romania's case, however, new lending has been
less than voluntary. Recent loans have stemmed
largely from the bankers' desire to avoid another
round of reschedulings. Disappointing export per-
formance earlier this year seriously reduced Ro-
mania's foreign exchange reserves. Leading credi-
tor banks concluded that Bucharest needed a major
loan to cover large payments due in October under
its rescheduling agreements.
Reasons for Borrowings
The East Europeans initially used the borrowings
to repair some of the damage to their financial
positions caused by the credit crunch. They took
advantage of the longer maturities and lower inter-
est rates to replace more expensive short-term debt
accumulated in 1982-83. Borrowers also used the
funds to boost reserves and build financial cushions
against another cutback in lending to the region.
East Germany and Czechoslovakia returned to the
loan market to reestablish their credit ratings. For
example, East Germany continued to raise new
credits even though it had not drawn down all its
previous borrowings and sought oversubscribed
loans as proof of its financial strength. In contrast,
the more recent borrowing initiatives by Hungary,
Bulgaria, and Romania have resulted from short-
falls in hard currency earnings caused by poor
trade performance this year.
The borrowing trend is likely to continue, at least in
the short run. Even countries with no immediate
plans to draw down the funds will probably contin-
ue to exploit the continued shortage of lower risk
LDC borrowers. In addition, some East European
countries may plan more borrowings to finance an
increase in Western imports as they enter the new
cycle of five-year plans. Some countries may see
the need to import more capital goods to redress
import cutbacks in the early 1980s and meet
modernization requirements resulting from Soviet
pressure to improve the quality of exports to the
USSR.
Still, an extended downturn in the region's econom-
ic health or deterioration in East-West relations
could reverse the trend. While this year's slump
apparently has not alarmed banks, lenders-and
even borrowers-may become reluctant if trade
performance continues to slide. The current enthu-
siasm among bankers for Eastern Europe may cool
when it becomes apparent that these countries have
done little to produce the sustained growth in
exports needed to pay for more imports. Failures by
Poland, Romania, and Yugoslavia to meet obliga-
tions under rescheduling agreements might sour
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some bankers on the entire region, but such a
spillover seems much less likely than in 1981. A
more serious threat to Eastern Europe's ability to
obtain new loans might result from a reemergence
of severe payments problems in the LDCs.
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Malaysia: The Push for
Economic Parity Falls Short '
Since 1971 Malaysia's economic strategy has been
governed by the New Economic Policy (NEP), an
ambitious social restructuring program directed at
boosting Malay participation in the Chinese-
dominated economy. Declining economic growth in
recent years has slowed the NEP's progress and, in
our judgment, makes it likely that its 1990 goals
will not be met. Ironically, Prime Minister Ma-
hathir, once considered a Malay chauvinist, could
become the scapegoat for the NEP's failure to
deliver if he is still in office because his concept of
affirmative action for Malays is the philosophical
underpinning of the NEP.
A Strong Start Weakens
By 1980, the NEP had made impressive strides in
achieving greater economic balance largely because
a buoyant economy, growing 8 percent annually
through the 1970s, financed the restructuring. Gov-
ernment expenditures-underpinned by trade reve-
nues and oil exports-rose nearly 20 percent annu-
ally during the period and funded increases in
numerous NEP-oriented programs. Kuala Lumpur
used a large portion of this spending increase to
acquire equity capital for establishing a Malay
commercial and industrial base. Large investments
in development programs to benefit rural Malays
were also made.
Global recession, however, dampened Malaysia's
economy in the early 1980s, slowing economic
growth to just over 6 percent annually through
1984-compared with the 7.8-percent average an-
nual rate that government officials said was neces-
sary to keep the NEP on track. Growth in 1985 is
expected to slip to 5 to 5.5 percent, according to the
US Embassy.
The New Economic Policy
Kuala Lumpur embarked on the New Economic
Policy (NEP) in 1971, following racial rioting
between Malaysia's main ethnic groups-the Ma-
lays who constitute 50 percent of the population
and the Chinese who account for 35 percent. Set
for 20 years, its objectives were to eradicate pover-
ty and restructure employment and corporate equi-
ty in favor of the economically backward Malays.
The ambitious social restructuring objectives of
the NEP essentially call for the advance of rural
and urban Malays into modern activities at all
levels of employment and ownership. In order to
achieve the stipulated shifts in economic roles,
Kuala Lumpur at the outset decided to use quasi-
government-agencies as proxies for the capital-
short Malay community. In this role, the govern-
ment has established commercial and industrial
enterprises and acquired corporate equity in trust
for the Malays.
To minimize non-Malay resistance to this policy,
the goals of the NEP are not pursued through
outright redistribution but as an outgrowth of a
rapidly expanding economy. On paper at least,
Malay economic advance occurs as the Malays are
granted the lion's share of the opportunities gener-
ated by economic growth. Preferential treatment
for the Malays increases their share of the econo-
my, but does not necessarily reduce the absolute
size of non-Malay wealth.
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Malaysia: Development Spending and Debt, 1975-85
Debt Service/ Exports b
Percent
Foreign Debte
Billion US $
lam` .14 ,_1, t 1 1 k I I f t' 1 t t t 1 ~'I I t t t I t i Id"? .1 , "9' 1 F I' i
0 1975 80 85 0 1975 80 85 0 1975 80 85 0 1975 80 85
a Expenditures on Malaysia's 19 off-budget agencies (Petronas, MAS, b 1975-78 excludes short-term debt.
Hicom, and so forth) are excluded. In 1984 these agencies represented an 1975-78 excludes short-term debt,
additional $1.6 billion in public authority spending.
Depressed international commodity prices-espe-
cially for oil, tin, and rubber-substantially re-
duced both export earnings and the government's
trade-based revenues. By 1982 the current account
deficit had risen to $3.4 billion-13 percent of
GNP-a drastic downturn from a surplus of nearly
program of fiscal austerity. Mahathir also intro-
duced more radical policies to ease budget deficits
and foreign payments strains. Because these poli-
cies relax strictures on non-Malay employment and
ownership, they have been controversial:
Privatization. Mahathir's ambitious privatization
agenda is certain to conflict with the goals for
increased Malay participation in the economy
because the capital-short Malays, unlike Chinese
and foreign interests, are unable to purchase a
substantial share of newly privatized enterprises.
Moreover, government agencies established to
promote Malay ownership will also be
constrained.
$1 billion just three years earlier.
1 ?
Mahathir's first reaction to these strains was to
boost foreign borrowing to maintain the pace of the
NEP's progress. As a result, Malaysia-which
entered the 1980s with one of the smallest foreign
debts in Asia-turned into one of the most aggres-
sive foreign borrowers among developing countries.
Its foreign debt doubled between 1979 and 1982 to
$12 billion.
Austerity and the NEP Clash
Confronted with rising federal budget deficits in
the early 1980s, Mahathir reversed the upward
trend in development spending and implemented a
? Foreign Equity Revisions. Last July, Kuala Lum-
pur announced changes in the foreign equity
regulations to encourage more foreign invest-
ment. The new rules link the foreign partner's
equity ceiling-previously limited to 30
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percent-with the export level of the project.'
These more lenient guidelines will allow in-
creased foreign investor participation, but at the
risk of crowding out Malays.
? Amending the Industrial Coordination Act. Kua-
la Lumpur has also announced a reexamination
of one of the cornerstones of the NEP-the
Industrial Coordination Act (ICA). Under the
ICA, the Ministry of Trade and Industry is
empowered to impose conditions-including equi-
ty and employment structure, location, and the
use of Malay distributors-on firms which em-
ploy more than 25 persons and exceed $100,000
in capital. A recent World Bank/United Nations
study, however, proposed that Malay employment
and equity participation goals would be best
accomplished through financial incentives. We
believe any such move would incur substantial
opposition within the Malay community and
among organized labor.
We believe Mahathir's alterations in the frame-
work of the NEP reflect not only the need for fiscal
restraint and increased private investment, but also
indicate a fundamental shift in his attitude toward
it. He deplores the "welfare mentality" the NEP
has generated among Malays and has privately
expressed disappointment with their failure to ex-
ploit the opportunities available under the NEP. To
counter this attitude, he seems intent on pushing
his Look East policy, which is an attempt to
inculcate a Japanese-style work ethic into the
Malay community.
Disillusion with the NEP he so strongly advocated
is a dilemma for Mahathir as he faces a major
decision concerning its future. Despite his belief
that the Malays themselves are largely responsible
for the failure of the NEP to reach its targets, the
shortfall will be politically damaging to the Ma-
hathir administration. We believe Mahathir will
have to choose among three policy options to limit
adverse repercussions.
Extend the Deadline. His most likely response is
simply to extend the NEP into the Sixth Malaysia
Plan (1991-95) by pushing back the target dates
and continuing preferential treatment for the Ma-
lays. This is probably the most politically accept-
able solution for Mahathir and the rest of the
Malay leadership. In addition, we believe this
option would create only minimal opposition among
the Chinese.
Mahathir is not yet committed to an extension,
maintaining that it would be premature at this
point. Even if the NEP is extended, we believe its
role will diminish in the longer term as Mahathir
works to wean the Malays from the "handout
mentality."
Let the NEP Expire. Although it is unlikely, in our
view, this option cannot be discounted if Mahathir
is still in office. According to the US Embassy,
Mahathir is much less content than his predeces-
sors with the mechanical focus on increasing per-
centages of Malay ownership in quasi-governmen-
tal companies. We believe the prospects for
expiration would increase in the event of a drastic
downturn in the international economy during the
next few years. If the NEP were to expire, however,
we believe Mahathir would leave in place certain
structural aspects-such as university quotas for
Malay students and preferential treatment in gov-
ernment contracts-which enterprising Malays
could exploit.
Go For Broke. As its least likely choice, the Ma-
hathir government could attempt to achieve the
NEP agenda on schedule by a "go for broke"
strategy in the 1986-90 plan. Such an effort,
however, would require massive government fi-
nancing and lead to worsening budget deficits and
accelerated foreign borrowing. The financial im-
pact, in our view, would probably undermine Ma-
laysia's good international credit standing and risk
leaving its external accounts vulnerable to an inter-
national economic downturn. It would, moreover,
directly conflict with Mahathir's austerity policies
of the past three years.
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Potential Fissures in the Malay Community
A diminished role for the NEP could provoke new
communal tensions, in our judgment. The emer-
gence of a Malay middle class since 1971 has
brought many Malays into the economic main-
stream but, according to the US Embassy, left
many more behind. With the current leadership
more closely identified with the new class of urban,
well-educated Malays, we believe rural Malays
probably would seek a political voice more closely
aligned with their own interests. Such a realign-
ment would reduce the traditionally strong rural
support for Mahathir's party, the United Malays
National Organization, and strengthen the attrac-
tion of its main-but thus far ineffective-rival for
the Malay vote, the fundamentalist Islamic party.
The Malay community now believes that, under the
NEP, two important aspects of culture-Islam and
Malaysian as the national language-are accorded
the status they deserve. Under a watered down
version, however, perceptions of increasing secular
influences within Malaysian society might precipi-
tate calls-from both the newly prosperous urban
Malays as well as the more traditional rural Ma-
lays-for stricter adherence to Islamic principles.
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North Yemen:
Banking on Newfound Oil
Last year's discovery of oil by a US firm has
significantly enhanced the long-range prospects for
North Yemen's economy. The government, how-
ever, faces the challenge of keeping the country
afloat until oil revenues start flowing. We believe
that President Salih will be able to guide the
economy through the tough times it will face over
the next three years, in part by relying on the
private sector that maintains large cash holdings.
In addition, Salih probably will implement further
austerity measures and try to arrange advanced
payment from Western firms for future oil produc-
tion. His most difficult task, and one at which most
leaders of new oil exporting countries have failed,
will be offering the Yemeni people some early
benefits of the oil find without raising popular
expectations too high.
Developing the Oil Find
The Hunt Oil Company first struck oil in July
1984,-the only find to date-and initial estimates
from this find put North Yemen's production po-
tential at 200,000 b/d. Since then, Sanaa has
launched an aggressive campaign to discover other
oil resources. It has awarded or is preparing to give
concessions-both onshore and offshore-to Hunt,
BP, Exxon, the French National Petroleum Oil
Company Total, and Amoco. Only three small
areas remain to be leased. BP is just beginning
exploratory drilling operations and the others are
still involved with preliminary arrangements.
Sanaa's initial goal is to meet domestic energy
needs. To reduce its $300-million annual import
bill for petroleum products, Sanaa has awarded a
contract for a 10,000 b/d refinery project to Hunt.
The refinery-expected to be operational by next
October-will satisfy almost one-half of North
Yemen's domestic requirements
Exports of crude will require pipeline and terminal
facilities-initial oil exports probably will not begin
until 1988. In June, Bechtel made a formal propos-
al to build the 400-kilometer Ma'rib to Salif pipe-
line, with an initial capacity of 100,000 b/d and a
potential capacity of 400,000 b/d. In addition,
various West European, Japanese, and South Kore-
an firms are interested in subcontracts for the
terminal and pipeline. The participation of these
firms would enhance the possibility of obtaining
project financing.
To facilitate North Yemen's oil development, San-
aa elevated the state-owned Yemen Oil and Miner-
al Corporation (Yominco) to ministerial status last
August. Ahmed al-Mohani, current North Yemen
Ambassador to Saudi Arabia, will reportedly be the
new Minister of Petroleum. The appointment of
Mohani-who was educated in the United States-
probably will work to the advantage of Western oil
firms in North Yemen. It also is likely to help ease
the tensions between Saudi Arabia and North
Yemen that developed after the Hunt oil discovery
near their disputed border.
Worsening Economic Straits
Although oil-related activity has not provided im-
mediate relief to the troubled economy, expecta-
tions of North Yemenis have begun to rise. The
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Saudi Arabia
Ethiopia
GoHe de. I
Tadp,a,
EXXON NUN
*Sana I !.r
Perim Island
(P.D.R.Y.)
no defined
boundary
People's Democratic
Republic of Yemen
(South Yemen)
HUNT Lease holding company
Lease limit
- - - Approximate lease limit
0 50 100 Kilometers
0 50 100 Miles
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economy faces continued current account and bud-
get deficits, as well as an average inflation rate of
20 percent per year. Sanaa is dependent on foreign
aid to cover the trade gap, but aid funds are less
than one-third of their 1982 levels and are not
likely to rebound in the near future because of the
impact of declining oil revenues on North Yemen's
Persian Gulf benefactors. In addition, foreign ex-
change reserves have fallen to $290 million and are
now sufficient to cover only two months of imports.
Worker remittances, which provide much of the
country's foreign exchange, are likely to decline.
Yemeni workers have
begun to return from Saudi Arabia because of the
contraction of the Saudi economy. Although many
returning workers hope to find lucrative jobs in
North Yemen's oil sector, opportunities in this field
are not yet widely available. While North Yemen's
private sector still maintains a surplus of capital,
Yemenis hold a major share of their assets in cash
outside the banking system. This continues to be a
source of frustration to economic policy makers
who are unable to mobilize these resources for
economic development.
Sanaa has implemented a series of austerity mea-
sures over the past year to deal with the deteriorat-
ing economic situation. Despite the government's
fears of fueling inflation and public discontent,
Sanaa floated the riyal last April. It hoped to
encourage a drop in imports that would enable it to
ease the politically unpopular import restrictions
imposed in 1983. The new measures have not been
in place long enough to determine whether they will
prove successful.
In August, the government moved to attack infla-
tion. It closed six of Sanaa's larger grocers for
violating government retail price guidelines. It also
directed all "mixed-sector" businesses to move
their bank accounts-5 percent of all commercial
bank deposits-from private commercial banks to
the government-controlled Yemen Bank for Recon-
struction and Development (YBRD). The goal is to
restrict the lending base of the commercial banks,
thereby cutting growth in the money supply.
Sanaa has begun considering additional measures
to deal with the budget deficit-$400 million this
year. Although the government has expanded reve-
nue collection in recent years, the US Embassy
estimates that it collects only about half the reve-
nues owed it. Sanaa will try to tighten tax compli-
ance, especially the payment of customs duties that
comprise half of all government revenues. Sanaa is
also considering increased taxes and user's fees for
government services. On the expenditure side, the
government will cut capital spending programs and
public-sector employment, and closely audit expen-
ditures. The poor administrative capabilities of
North Yemen's civil service and the decentraliza-
tion of tax collection, however, will constrain San-
aa's ability to use tax increases as a means of
increasing revenues. Moreover, further budget cuts,
while easier to implement, are likely to be political-
ly unpopular.
Until oil revenues begin to flow, President Salih
will have to grapple with the challenges created by
continuing economic problems and rising popular
expectations. Because most of the initial returns
from oil production will be used to make payments
on debts incurred for oil development projects,
Salih will be unable-at least initially-to bolster
his power base by distributing the benefits of
economic growth to a broad spectrum of the popu-
lation. Limited public discontent, sporadic strikes,
and complaints about government inefficiency
probably will continue.
Still, there are economic and societal factors that
will help the government muddle through this
period of stress. The "mattress money" of the
private sector will serve as a buffer to Yemeni
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families and probably will help mitigate their frus-
trations over economic difficulties. In addition, the
Yemeni business community-which has contrib-
uted about half of the resources for the country's
development plans-generally supports the govern-
ment, and probably will continue to do so because
of the stability Salih's regime has brought the
country.
The Hunt oil discovery and the activity of other US
oil firms has improved US-North Yemeni rela-
tions. The oil discovery has enhanced Salih's power,
and we believe that the political stability that his
regime has brought advances US interests. Over
the next five years, Salih probably will increasingly
look to the United States for financial aid to
support the economy until oil revenues are realized.
North Yemen's satisfaction with the developing
relationship with the United States, the oil find,
and the presence of US military equipment in
North Yemen's inventory-as well as Sanaa's
growing dissatisfaction with Soviet military equip-
ment-creates possibilities for further military pur-
chases from the United States. Moreover, the
success of Western firms in finding oil in North
Yemen will not be lost on South Yemen where the
Soviets have long been unsuccessfully exploring for
oil. The contrast between Western success in the
north and Soviet failure in the south may move
Aden to open additional oil concessions to Western
firms.
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Tanzania: Nyerere's Legacy of
Economic Decline
President Julius Nyerere, who steps down as Presi-
dent of Tanzania on 4 November, leaves behind a
moribund economy operating near subsistence lev-
els. Although Nyerere's successor, Vice President
Mwinyi, is likely to try to initiate domestic policy
reforms as he did while President of Zanzibar, he
will be hampered by the near total breakdown of
the country's infrastructure, a thriving unofficial
economy, low productivity, and 25- to 30-percent
inflation. All of these have been firmly ingrained by
chronic currency overvaluation, mismanagement of
state-run enterprises, and negative real producer
returns. Restoration of economic growth is unlikely
in the near term because the country has depleted
its foreign exchange reserves, relies heavily on
foreign assistance, and remains far from an agree-
ment with the IMF.
Government interventionist policies have also put a
damper on production. Artificially low producer
prices-set periodically by the government-pro-
vide negative real returns to farmers, discouraging
production for both the domestic market and ex-
port. Real GDP fell during 1981-83 and posted
only minimal gains last year. Shortages of goods in
state-run stores, particularly in urban areas, has
encouraged black-market activity. The 90 percent
of the population that is engaged in agricultural
production is increasingly turning to subsistance
farming.
The government-owned enterprises, which control
almost all legal trade, have long been one of the
biggest drains on the economy. Their ever-spiraling
operating costs have absorbed rising percentages of
profit.
Nyerere's Policy Failures
In our view, however, Nyerere's socialist domestic
policies, starting with the self-sufficiency concept
of Ujamaa, have been the primary cause of the
country's economic decay. In addition, Tanzania,
which began independence with a diversified agri-
cultural export economy, has suffered reverses from
its military intervention in Uganda from 1978-82,
droughts in the 1970s that made it a net food
importer, and the two oil price shocks.
We believe the Ujamaa village development pro-
gram, launched in 1967, .set in motion the decline
in agricultural production. Peasants were relocated
to unfamiliar and underdeveloped areas, but the
government failed to support the program ade-
quately. From the beginning, the government was
unable to provide the transportation to ship crops to
market and to provide necessary agricultural equip-
ment, pesticides, and fertilizers. Moreover, Tanzan-
ia's four-year involvement in Uganda diverted
manpower and money from the program. The
experiment was abandoned in the early 1980s.
t ie Tanzani-
an Sisal Authority, according to US Embassy
reporting, has failed to purchase and market goods
adequately and has provided little incentive to
workers; at the same time, it has allowed produc-
tion and maintenance to decline sharply. These
businesses have frequently not paid farmers at all
for their crops.
An overvalued currency has made Tanzanian com-
modities considerably less competitive on the world
market. Thus, Tanzania finds it difficult to earn
hard currency for purchases of oil, chemicals, seed,
and machinery and is unable to pay debts to oil
suppliers and international lenders. Debt service
last year was equal to about 75 percent of exports
of goods and services. Nyerere's continued resis-
tance to devaluation was the major obstacle to an
IMF standby agreement last spring, and further
negotiations are not likely to resume any time soon,
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Tanzania: Selected Economic Indicators, 1980-84
Note scale change
Real GDP Growth
Percent
4
Debt Service Ratio
Percent
Government Spendinga Foreign Trade
Billion Tanzanian shillings Billion US $
Impact on Society
The economic downturn has severely damaged the
country's fragile infrastructure. Even the much
vaunted socialist medical and health care services
have deteriorated, according to US Embassy re-
porting, and malaria and other endemic diseases
are again on the rise. The transportation sector
operates erratically; schedules of the Chinese-built
Tazara railroad linking Tanzania and Zambia are
determined by available fuel supplies, according to
press reporting. Road repair and maintenance of
the congested facilities at the port of Dar es Salaam
are neglected, and potential revenue from port
activity is often lost because of theft of goods
waiting transshipment or spoilage in warehouses
and on wharves, according to press reports.
The economic slide has fostered a subculture of
corruption. The military loses thousands of dollars
yearly from stolen payrolls, weapons, clothing, and
food. Peasants smuggle food across the Kenyan
border to sell or to barter for soap or cooking oil.
According to press reports, in Dar es Salaam and
other larger cities, meals in restaurants are ob-
tained faster and cheaper by bribing the waiter to
steal from the kitchen.
Mwinyi's Prospects
Pragmatists in the government already are pressing
Mwinyi to institute economic reforms when he
takes over the presidency. Mwinyi, a lackluster
party stalwart who was a compromise choice of the
country's sole political party, favors the current
Chinese development model and trade liberaliza-
tion measures he enacted on Zanzibar. He lacks a
solid base of support on the mainland, however, and
we believe he will proceed with caution for the first
six to 12 mon
cynical attitui
probably will
for economic
Is he is in office. Moreover, the
le that permeates the lower classes
make it difficult to gain their support
?eform.
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While no cabinet changes will be made until after
the inauguration on 4 November, Minister of Fi-
nance Msuya, will likely be retained in the new
government. He has been a supporter of such
policies as an IMF agreement, devaluation, trade
liberalization, producer price increases, and reorga-
nization or privatization of some state-run enter-
prises.
i Defeated
presidential contender Salim may also prove to be a
valuable ally if Mwinyi chooses to press ahead with
reforms. Salim has been Prime Minister since 1984
and was previously Foreign Minister, but his role in
the new government is unclear.
The success of any new public policies will hinge to
a great extent on the degree of Nyerere's influence
over the new President and the political strength of
senior party members, who still cling to Nyerere's
tenets of African socialism. Nyerere will continue
as party chairman, with de jure authority over the
President until 1987, when that position will again
be combined with the presidency, as under
Nyerere.
Meanwhile, Mwinyi will be dealing with party and
government bureaucracies formed under his pred-
ecessor's long tutelage. Although Nyerere's social-
ist policies have been disastrous, we believe his
philosophy and charisma have earned him many
followers who remain loyal to his inspiring, if naive,
economic rhetoric.
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Energy
OPEC Production OPEC crude oil output in September averaged 15.1 million b/d, a 300,000-
Update b/d increase from August levels. Continued weak oil demand, however, kept
production about 1 million b/d below the organization's self-imposed ceiling.
Iraqi attacks on Khark Island reduced Iranian exports, but Saudi Arabian and
Nigerian production increases more than offset the decline.
Quota First Third August September
Half Quarter
Saudi Arabia a 4.35 3.4 2.7 2.4 2.8
Less share of Neutral Zone 3.2 2.5 2.3 2.6
United Arab Emirates 0.95 1.1 1.1 1.1 1.1
a Neutral Zone has no production quota; output is divided between
Saudi Arabia and Kuwait and included in their country quotas.
27 Secret
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r
l Spot Oil Market
f Trends
prices from falling sharply.
'Romanian Energy
Emergency Declare
schedules. The move reflects Ceausescu's desperation over the effect of energy
shortages on the economy this year, but it will probably do little to augment
the supply of electricity. Coal production is far below planned targets and
snarls in traffic have interrupted coal deliveries. Ceausescu's coercive style has
become more pronounced as the economy has deteriorated this year.
Latin ,American
Rea ion to Debt
Initiative
The spot oil market has been calm since some crude prices rose sharply in early
October in response to the last effective Iraqi attack on Khark Island, the
slowdown in Soviet exports to the West, and falling US oil inventories. North
Sea Brent crude prices, which jumped to $29.05 per barrel in early October,
have dropped in recent weeks and now stand at $28.15. Arab light and
Nigerian Bonny Light are now selling at $27.80 and $28.75 per barrel, 20
cents below and 10 cents above respective official prices. Rising oil production
in October will likely cause spot prices for key OPEC crudes to weaken. Saudi
exports are up, reflecting the first sales through new product pricing arrange-
ments, and Iraqi sales have also increased since the opening of the new spur to
the Saudi East-West pipeline. In the absence of further supply increases,
however, higher consumption during the winter heating season should keep
President Ceausescu last week imposed a state of emergency in the energy
sector, fired the minister and deputy premier responsible for electrical power
production, and put the military in charge of running the entire power system.
Military command teams are to take control of thermal power plants and
punish civilian employees for any failure to obey orders to maintain production
Latin American debtors generally have welcomed the US initiative on debt
presented in Seoul, but they doubt that it will be enough to solve the region's
financial problems. High-ranking officials in Brazil, Mexico, and Argentina
view the proposal as a sign that the United States recognizes the need of debtor
countries to restore economic growth and to obtain more foreign capital. They
are particularly encouraged by US intentions to promote substantially in-
creased lending by multilateral institutions and by commercial banks. None of
the region's debtors have voiced opposition to the initiative, although Peruvian
Finance Minister Alva Castro reaffirmed Lima's position that the debt-related
functions of the IMF should be eliminated. Considerable Latin skepticism
exists, however, about the initiative's potential to ease the region's financial
burden. Most Latin American debtors probably will await firm commitments
from the multilateral institutions or commercial banks before offering stronger
endorsements. They also will seek further information about the prospects for
increased donor contributions to the World Bank, World Bank guarantees for
commercial lending, and cofinancing between the World Bank and commer-
cial banks. Meanwhile, the concern that the initiative leaves the issue of
interest payment burdens unresolved may prompt the debtor countries to
increase pressure on creditors to defer interest or place a cap on interest
payments.
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Japanese Financial The Finance Ministry publicly announced Monday it is canceling plans to
Liberalization Setback issue its first short-term bonds-similar to US treasury bills-this year. The
recent decline of interest rates for long-term bonds to below that of three-
month bills makes it advantageous for the Finance Ministry to stick with
traditional instruments when it refinances 2.3 trillion yen ($9 billion) worth of
national bonds next month. We believe the announcement indicates that,
despite earlier fears of a debt-refunding crunch beginning in 1985, Tokyo will
have little trouble rolling over bonds in the near future,
isappointing
Yugoslav
Trade Performance
Yugoslavia is falling short of IMF targets for hard currency balance of
payments performance this year. Despite improvements in recent months, poor
trade results early this year and smaller-than-expected growth in tourism
saddled Belgrade with a current account deficit of $77 million for the first sev-
en months of 1985, as compared with a surplus of $225 million for the same
period last year. The Yugoslavs also suffered a $393 million drain on the
capital account. To cover shortfalls, Belgrade has had to draw down its hard
currency reserves to a level comparable with that during its liquidity crisis in
1982. Although its performance apparently improved in August, Belgrade is
unlikely to meet the IMF targets of an $880 million current account surplus
and a $200 million increase in reserves for this year. Belgrade may try to cut
back imports, but this would probably depress industrial performance. Failure
to achieve the IMF goal will hurt prospects for both the multiyear reschedul-
ing agreement from Western governments and an end to close IMF supervi-
sion, which Belgrade hopes to negotiate next year.
Global and Regional Developments
J anese Exporters Japanese firms have begun to allow Cuba two years to pay for goods,
iberalize Credit according to the US mission in Havana-a decision that has already helped in-
/ to Cuba crease Japanese exports. Although MITI only provides export credit insurance
for six months on shipments to Cuba, the mission reports many exporters are
assuming the risk for longer-term financing themselves or arranging for
private export insurance. Last month, a Japanese corn an won an $800,000
contract to sell steel conveyor belting to Cuba
We believe Japanese firms will continue their extended credit policy as
long as Havana maintains an acceptable payment record. In our view, the
advantage Japanese firms now enjoy will increase over the next year as
Havana must begin to repay their rescheduled Western debt.
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EC-US Dispute Over The EC intends to file a complaint with the GATT against the US export sup-
Wh~t Trade port program for wheat in response to the US decision to begin an action
against EC wheat export subsidies. The EC contends that US subsidies have
undercut world prices, whereas EC subsidies only close the gap between
international and domestic prices. Bilateral consultations are unlikely to
produce a solution, and the dispute probably will be referred to a GATT panel
by the end of the year. The dispute almost certainly will complicate EC-US
negotiations on other agricultural trade problems, including the EC's pre-
ferential treatment for imports of Mediterranean citrus and its production
subsidies for Community fruit canners. The US complaint will increase EC
fears about the way agricultural subsidies will be treated in the new GATT
round. It also is likely to intensify debate within the EC on reform of the
Common Agricultural Policy and on how to cut cereal production.
EC-US Citrus Dispute EC member states have failed to come up with proposals to resolve the dispute
Deadline Nears with the United States over EC trade preferences for citrus fruit, despite a US
imposed deadline of 31 October. According to Embassy reporting, the EC
Commissioner for External Relations may suggest on his own initiative that
the deadline be dropped and discussions on citrus continue in exchange for
meeting US demands on a separate dispute involving canned fruit. Washing-
ton is seeking EC compliance with a GATT panel finding that EC preferences
for citrus imports from Mediterranean countries have hurt US exporters. The
EC, however, is politically committed to protect the interests of key Mediterra-
nean trading partners-such as Morocco, Tunisia, and Israel-after Spain and
Portugal join the Community in January. As a result, the Commission
probably will be unable to deal with US demands directly until spring 1986
when negotiations to amend the current Mediterranean preference agreements
are completed. Italy and Greece-concerned about protecting their own citrus
growers-are delaying agreement on EC Commission proposals to guarantee
the current Mediterranean share of the EC citrus market. In order to try to
satisfy US demands, the EC is likely to offer the United States largely
symbolic concessions-such as a reduction in grapefruit tariffs or expansion of
the reduced-tariff season for US oranges-or may propose concessions on
other products, such as almonds. Should the United States increase tariffs on
EC pasta as a result of EC failure to meet the October deadline, the
Community almost certainly would retaliate against imports of US lemons and
walnuts.
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Mixed Preliminary The Caribbean Basin Initiative (CBI) so far has been unable to stem the
Results for the CBI region's decline in export earnings, but has made a promising start in
ritish Push Exports
o Latin America
countries. Embassy reporting indicates that during 1984, the first year of the
program, 268 export-oriented investments worth about $200 million and more
than 31,000 jobs were created. The region's larger economies-the Dominican
Republic, El Salvador, Jamaica, Honduras, and Panama-reaped the most
benefits. US imports of products under the CBI increased 6 percent during this 25X1
period. Nevertheless, total US imports from these countries dropped 18
percent during the first half of 1985 largely because the region's exports
remain dominated by petroleum, sugar, coffee, and bauxite/ alumina-
products that have experienced sluggish world demand, low prices, and, since
diversifying the production and export bases of the 21 CBI-designated
1984, sizable US disinvestment in the.region.
Largely because of the precipitous drop in exports, a number of Caribbean and
South American leaders have openly criticized progress under the CBI.
Leaders of the Caribbean Community, during their annual summit meeting
this summer, complained that the CBI is insufficient to meet the needs of the
region, especially the smallest islands. According to Embassy reporting,
Jamaica's Prime Minister Seaga has privately stated that he cannot continue
to publicly support the Initiative unless faster progress is made soon. The
Secretary General of the Latin American Economic System also recently
complained that the CBI has failed to promote development and sets too many
military and political preconditions for designation as a beneficiary.
Middle East and hopes to eventually double exports to the region.
To boost exports and prolong the life of the current economic expansion, the
Department of Trade and Industry (DTI) has begun a marketing campaign
designed to help British manufacturers find export markets, particularly in
Latin America. The DTI in conjunction with two business groups will help
exporters find potential Latin American buyers. DTI has identified six sectors
in which British firms should do well-chemicals, machinery for special
industries, non-electrical machinery, electrical power and switchgear, other
electrical equipment, and scientific instruments. British trade offices in Latin
America have already identified chemical buyers and put them in touch with
British exporters. A preliminary version of the program last year contributed
to a 16-percent increase in exports to Latin America in the first half of 1985 as
compared to the same period last year. While the $2 billion worth of annual
exports to Latin America account for only about 2 percent of total British
exports, London is eager to develop this market to offset shrinking sales to the
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Ina -Bangladesh Prime Minister Gandhi and President Ershad agreed on a formula to settle
A ree on Sharing Water problems on sharing water at the recent Commonwealth summit in The
Bahamas. The US Embassies in New Delhi and Dhaka report the two leaders
decided to extend for three years a 1982 agreement on sharing water from the
Ganges River and to set up a joint commission to study ways to increase the
flow of the river. The study is to be completed in a year, after which Gandhi
and Ershad will meet again to work out a new agreement. The two sides have
conflicting ideas on how to increase the river's flow, however, and negotiations
within the joint commission probably will take longer than a year.
New Japanese
Study Group on
Trade Imbalance
Developed Countries
The Japanese Government last week established a high-level committee of
government, business, and labor representatives to study structural remedies
for Japan's growing trade surplus. We believe Tokyo has decided to supple-
ment its current strategy-gradual market opening combined with modest
expansion of domestic demand and limited exchange rate intervention-in an
attempt to head off eventual US and EC trade restrictions. Although the
committee's role is not yet clear, it will probably review ways to alter the
export orientation of the country's industrial structure, according to the US
Embassy, as well as examine methods of international cooperation to ease the
trade imbalance. The Embassy believes Prime Minister Nakasone may use the
new committee's report at the Tokyo summit in May to argue for more
formalized currency market intervention and possibly some macroeconomic
policy coordination among summit partners.
Impact of Yen
Appreciation on
Autos and Steel
Tokyo press reports indicate that Toyota, Nissan, Honda, and possibly others
are watching the exchange rate very closely, while the chairman of Nissan is
quoted as stating that Japanese automakers will need to raise prices because of
the stronger yen. In yen terms, the value of auto exports to the United States
have fallen about 10 percent over the past month, and profits have been cut
even more. Because of cutthroat competition at home, the United States is the
automakers major source of profits needed to finance large-scale capital
investment and R&D programs. A similar profit squeeze is also affecting
Japanese steel producers who already have informed customers of price
increases of about 10 percent on steel exports to the United States beginning in
January 1986. Such a move would aid US steel producers' efforts to raise
prices. The large integrated US producers have announced significant in-
creases on certain products for next January while some minimills are already
putting somewhat smaller raises into effect for part of their product line.
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Japanese-US Talks on The second round of bilateral discussions on allowing foreign lawyers to act as
Legal Services legal consultants in Japan, scheduled for 28 October in Tokyo, will probably
not make much progress. Japan's demand for legal services has grown with its
position as a major trading and financial center and, because there are only
13,000 Japanese lawyers, US attorneys are eager to participate. September
talks bogged down because the Japanese Federation of Bar Associations
(JFBA) proposed itself as monitor of all qualified foreign lawyers to assure
"quality control." The federation also requested reciprocal treatment for
Japanese attorneys, although JFBA is undecided whether a majority of state
bars or merely "significant" states must permit access to Japanese lawyers.
According to the US Embassy, however, there is actually little interest within
the Japanese legal community in attaining US access. We believe the Justice
Ministry and the JFBA will hold their hardline position until pressured by the
Prime Minister or senior Japanese officials to make concessions for the sake of
overall Washington-Tokyo relations.
Canadian Banking Canada's banking system is undergoing difficulties that will almost certainly
D culties Continue set back plans to deregulate financial services or include them in trade talks
with the United States. Problems became apparent last month when bad
management practices and a large number of poor loans forced the closure of
two small regional banks-the first failures in 62 years. Ottawa moved quickly
to insure all deposits-at a cost to the federal treasury of some $730 million-
and to push through legislation to enhance federal regulatory powers over
banking. Meanwhile, a third regional bank neared collapse, and only a merger
with one of Canada's largest banks kept the smaller bank open. Ottawa claims
the country's banking system is sound, but the questions raised by the recent
bank failures will almost certainly slow the government's plans to ease
restrictions on bank ownership.
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trench Aerospace a Firm Messier Hispano Bugatti (MHB) is looking for a US partner
Seeks US Partner MHB is a subsidiary of the government-owned Snecma engine
combine and the sole supplier of landing gear for Airbus aircraft. The move
aims at gaining access to US advanced technology and to US markets,
especially those of the big jet aircraft manufacturers.
MHB's founder and Snecma are willing to go as far as offering a substantial
minority stock position to a US company. The US company would benefit by
gaining access to European sales especially to Airbus Industrie, which are
being closed to US companies as rapidly as European suppliers can be
qualified.
creek Government
,, kesponse to
Labor Unrest
olicies this month 50,000 farmers rallied in Maharashtra State to hear a powerful
of the national interest
rural leader decry Prime Minister Gandhi's economic policies as "pro rich."
Farm leaders from other states, some opposition politicians, and a key militant
union organizer supported the attack on textile, cotton, and sugar price
policies. Backed by opposition parties, the farm leader has launched a "civil
disobedience" campaign. Over the past five years, rising production costs and
sagging farm prices have spawned successful "middle-class" farm protest
movements for higher crop prices and subsidies. If a sustained campaign
develops, with labor union and opposition party support, New Delhi may well
be forced to reexamine some of its recent efforts to liberalize the economy.
Prime Minister Papandreou has expelled eight labor leaders from his PASOK
party, according to press reports. The eight had joined the Communists in
calling for a nationwide strike in opposition to the economic austerity program
announced last week which will reduce the real income of workers. In Athens,
only about 20,000 workers responded to the call. The expulsions reflect
Papandreou's determination to maintain tight control over the party and to
stifle leftwing criticism of his economic policies. At a party Central Committee
meeting last month, Papandreou laid the groundwork for the expulsions by
accusing dissident unionists of pursuing narrow economic ends at the expense
Less Developed Countries
Inn Farmers Protest The Gandhi administration's economic liberalization moves have drawn their
G dhi's Economic first major public protest from farmers. The US Embassy reports that early
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/
Pakistani Price Rises The US Consulate in Karachi reports that consumer prices in that area show a
h 135 t A .1 d 2
0
l
s alp . -percen increase since pri an a
-percent rise over
ast year.
Prices normally tend to decline during the autumn. Led by rises in essential
commodities-cereals, vegetables, meat, kerosene, and sugar-the higher
inflation, in part, reflects administered price increases, local government wage
indexation, and a 5-percent surcharge on imports. Although price movements 25X1
in Pakistan's major city are insufficient to establish a national trend, we expect
that Islamabad's massive domestic bank borrowing, deregulation of edible-oil
trade, increased support prices for cereals, and higher energy prices will likely
fuel nationwide inflationary pressures over the next year.
/Soviet Task Force A Soviet task force on economic reform is reportedly considering measures to
on Economic Reform promote competition among industrial firms, increase labor productivity, and
legalize private activity in consumer services. This advisory group agrees that
some type of business mechanism-other than market pricing-is needed to
make Soviet industry more efficient. It also agrees that enterprise managers
should have more control over staffing and payroll. One member contends that
tolerating a 2-percent unemployment rate would advance both these goals. He
also suggests that industrial firms be allowed to choose their own suppliers and
that noncompetitive enterprises be reorganized. He says the task force is
studying ways to legalize a large number of consumer services currently
available only on the black market. The decision to establish a task force to
prepare recommendations on such politically sensitive subjects is significant
and indicates that Gorbachev is looking for specific ways to back up his calls to
improve economic performance. Although the task force is reportedly under
pressure to come up with recommendations, the leadership probably will not
take quick action on permitting unemployment, expanding the private sector,
or other controversial issues. It is more likely to initiate small-scale experi-
ments while assessing the economic gains from measures already put into
place.
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Pravda Discussion of A recent article on modernization commenting favorably on the technological
Capitalist Incentives benefits of Western-style competition suggests a broadening of the current
discussion on economic reform. The author, a member of the Soviet Academy
of Sciences, argues that the "law of the jungle"-even though exploitative-is
a powerful force for technological advancement and improved product quality.
He states that Western enterprises, which operate under the principle of
"survival of the fittest," are forced to produce quality products efficiently or
run the risk of being overtaken by their competitors. He claims that because
Soviet defense industry-confronted by the competitive threat of US defense
programs-works on this principle, its level of technological development and
the quality of output are superior to that on the civilian side. He also asserts
that the military exerts "powerful influence" over the quality of the products it
receives and that the civilian economy could benefit from this type of
consumer-producer relationship.
The article generally elaborates on the strategy outlined in General Secretary
Gorbachev's major policy address of 11 June, but its acknowledgment that
capitalist competition spurs technology and improves quality is new. The
benefits of Western-style competition for the Soviet economy probably would
be considerable, but the relative success of the defense industry is better
explained by benefits not easily shared with the civilian sector.
Soviet Foreign Trade TASS announced Saturday that Deputy Minister of Foreign Affairs Boris
Minister Replaced Aristov had replaced 77-year-old Minister of Foreign Trade Nikolay Patoli-
chev, the third high-level personnel change in the economic sphere in a week.
Patolichev, who retired for health reasons, held the post for 27 years. Aristov
has no formal background in foreign trade and is primarily a longtime party
official, but he has-like new Gosplan Chairman Talyzin-extensive experi-
ence in East European affairs. This appointment thus supports recent Soviet
policy statements emphasizing increased trade and economic integration
within CEMA. This continues General Secretary Gorbachev's pattern of
bringing outsiders into key ministerial positions. Gorbachev's economic agenda
requires a more aggressive approach to management than Patolichev probably
was willing or able to provide. Heightened rumors of corruption within the
Ministry of Foreign Trade probably portend further personnel and policy
changes in the Ministry.
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USSR Reorganizing Last week the Politburo approved the creation of a bureau within the Council
Machine-Building of Ministers to coordinate the work of the various machine-building industries.
Industry The new bureau reportedly is to have the power to issue binding decisions and
Bulgarian Ministerial
/ Changes
reallocate resources among the ministries. There are currently 11 machine-
building ministries in the civilian sector and another nine engaged primarily in
military production. It is unclear which ministries will be affected or whether
the powers given to the new bureau will enable it to function more successfully
than did a similar unit set up for the agro-industrial sector in 1982. General
Secretary Gorbachev had earlier called for a major shakeup of the ministerial
bureaucracy to reduce its size, eliminate overlap, and remove superfluous
layers. The creation of the new bureau may be a move designed to prepare the
way for bolder steps later, but if Gorbachev stops here it will only worsen
problems.
The Bulgarian State Council decreed changes in the Cabinet last Friday, three
days before General Secretary Gorbachev's visit. All involved the economy.
Ivan Iliev, an aide to party leader Zhivkov, replaced Stanish Bonev as
chairman of the State Planning Committee and as deputy prime minister.
Reflecting growing concern about the economy, First Deputy Prime Minister
Aleksandrov, a fast-rising Zhivkov protege and close friend of the Soviet
Ambassador, was named to head a new party-state Committee on Energy
Problems. The new appointments are in part a response to repeated Soviet
criticism this year of Bulgarian economic inefficiency and corruption. Other
changes may be in the works.
eijing Tightens Up Beijing's new Capital Helicopter Corporation (CHC) will centralize foreign
Helicopter Procurement helicopter procurement in a single corporation responsible for military and
civilian helicopter acquisition throughout China.
Capital
Helicopter, a subsidiary of the Civil Aviation Administration of China, reports
directly to the State Council-the highest level of China's central government.
The new company recently bought 17 civilian Westland helicopters from the
United Kingdom andl I plans 25X1
to acquire an equal n
umber of the military version.
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