WESTERN EUROPE: FOREIGN DEBT PROBLEMS

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP85S00316R000200050004-1
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 29
• Document Creation Date: December 22, 2016
• Document Release Date: August 31, 2010
• Sequence Number: 4
• Publication Date: July 1, 1984
• Content Type: REPORT

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Directorate of
Intelligence
Western Europe:
Foreign Debt Problems
EUR 84-10145
July 1984
377
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Directorate of Secret
Intelligence
Western Europe:
Foreign Debt Problems
Economic Issues Branch, EURA
Office of European Analysis. Comments and queries
are welcome and may be directed to the Chief,
This paper was prepared by
Secret
EUR 84-10145
July 1984
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Western Europe:
Foreign Debt Problems) 25X1
Key Judgments Twelve West European countries (WE-12) 1 currently face foreign debt
Information available problems of varying degrees of severity. Collectively they impose an
as of 29 June 1984 additional burden on an international financial system already severely
was used in this report.
strained by troubled LDC and East European debtors, and several of them
will need official assistance during the next two to three years. Total
foreign debt for the WE-12 increased approximately $14 billion during
1983, to an estimated $383 billion-more than half the total debt for 100
LDCs and almost five times the level for Eastern Europe. Since the end of
1978, WE-12 debt has increased by 88 percent, about the same as the
increase in LDC debt and more than twice the rate for the East European
countries. Today, not a single country among the WE-12 has a prime credit
rating for both short-term and long-term borrowing.
The debt problems facing most of the Twelve will limit their ability to re-
spond to their number-one domestic economic problem-unemployment-
without creating a balance-of-payments crisis. As governments attempt to
reduce their debt burden, the effects on unemployment could contribute to:
? A greater turnover in West European governments as austerity programs
in many of the WE- 12 continue to worsen unemployment and weaken the
political base of incumbent governments.
? An increase in protectionist measures as West European governments
seek to limit imports in order to ease foreign borrowing requirements.
? A greater willingness on the part of these countries to expand trade with
the Soviet Union and Eastern Europe.
? An increase in demands on the financially beleaguered EC to raise funds
on the Euromarket for relending to member countries-demands that
will only highlight the limits on the EC's ability to respond to member
countries' problems
These tendencies will affect the United States and its relations with West
European governments. Specifically, trade disputes-symptoms of the debt
and unemployment problems-will continue to plague relations. Recent
problems with steel and agricultural trade may intensify. Because about 80
percent of the WE-12 debt is denominated in dollars and carries variable
rates of interest, West European leaders will continue to pressure US
officials to reduce the budget deficit, the major factor they believe is
behind high US interest rates. In addition, the debt problems within the
WE-12 are likely to result in greater support by these countries for
additional resource allocations for the IMF and other multilateral groups.
' The 12 countries are Belgium, Denmark, Finland, France, Greece, Iceland, Ireland,
Norway, Portugal, Spain, Sweden, and Turkey
Secret
EUR 84-10145
July 1984
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Secret
We believe the debt situation in six of the 12 countries constitutes a serious
problem and will worsen at least through 1985:
? Portugal and Turkey currently have IMF programs but will need
additional financial help this year and next.
? Greece and Ireland will soon need IMF programs.
? Denmark and Sweden will likely face debt service problems in the future
if current policies persist; no IMF programs are on the horizon
In four countries-Belgium, Finland, Iceland, and Spain-we believe the
debt situation is troublesome but improving. These countries generally are
following restrictive policies that will tend to curb their debt problems.
There is still a possibility, however, that high levels of unemployment in
Belgium and Spain may force a shift in government policies for political
reasons that would quickly worsen the debt outlook.
France's austerity program has forestalled a serious debt problem. Presi-
dent Mitterrand is not likely to make any major changes to the economic
program prior to the National Assembly elections in 1986. Nevertheless,
public dissatisfaction with the austerity program is likely to force some
moderation of economic policies. Under such a circumstance France would
remain a net borrower, though the increase in debt would not pose serious
problems. Norway is using oil earnings to reduce its large foreign debt and
is not likely to run into difficulties unless there is a substantial drop in oil
prices.
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Composition of the Debt
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West European Debt Situation
7- 1.11
Greenland I'a
(Denmark) .;,,~., `:..
Greenland
Sea
North
Atlantic
Ocean
Irpliind 0!#~
North
Sea
Large debt and deteriorating
Large debt and improving
Relatively small debt
Svalbard
t (Nor)
Nova a~'
Zemlya
The United States Government has not recognized
the incorporation of Estonia. Latvia, and Lithuania
innto the Soviet Union. Boundary representatwn
not necessarily authoritative
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Western Europe:
Foreign Debt Problems
The Debt Problem in Perspective
The foreign debt position of many West European
countries has deteriorated markedly since 1978. Alto-
gether we have identified 12 countries (WE- 12) that
show one or more indications of debt problems (see
tables 1 through 7). While not all of these countries
face a major payments crisis, we believe that collec-
tively their increased credit risk creates additional
strains on an international financial system that is still
reeling from the LDC debt problem. During the last
few years, the ability to repay foreign debts has
diminished in most of the 12 countries, and two-
Portugal and Turkey-have needed major debt res-
chedulings backed by IMF assistance and have imple-
mented IMF austerity programs. Most of the others
have independently instituted government-sponsored
austerity measures.
The rapid growth of debt in the WE-12 was faster
than the growth in both LDC and East European
debt. From 1978 to the end of 1982, the WE-12 saw
their combined foreign debt jump 81 percent to $370
billion; during the same period, debt for 100 LDCs
advanced 80 percent to $596 billion, and debt for the
seven East European countries rose by 38 percent to
$81 billion. By the end of 1983, we calculate the WE-
12 countries owed $383 billion, assuming they bor-
rowed just enough money to cover their current
account deficits. The actual figure may be even
higher, however, because countries such as Belgium,
Denmark, France, and Sweden sought to rebuild their
foreign exchange holdings in addition to covering
their current account deficits.
The debt profile of some in the WE- 12 rivals that of
the most-debt-troubled LDCs and in many cases
exceeds the ratios for the East European countries.
For example, the debt-to-export ratio for Portugal and
Turkey in 1982 exceeded Mexico's 252 percent and
the East European average of 221 percent; Portugal's
314 percent approached Brazil's 356 percent.' Interest
and all amortization payments as a share of Portu-
guese exports in 1982 were 129 percent, equal to
Mexico's 1981 debt service ratio. Most of the WE-12
countries had debt service ratios exceeding those of
the East European countries, except Poland. Ratios
for the other East European countries ranged between
37 and 73 percent while the WE-12 ranged between
29 and 129 percent.
Sporadic debt problems existed in Western Europe
during the early and mid-1970s, but it was not until
late in the decade that widespread debt difficulties
began to develop. As late as 1978, external debt as a
share of GNP was only about 20 percent for the WE-
12-reasonable by international standards and not
much higher than the share for the other West
European countries. The ratio of debt to GNP grew
steadily from 1978 onward, however, and by 1983
reached 34 percent for the WE-12. While only five
countries in 1978 had debt-to-GNP ratios of 40
percent or more, by 1983 the number had jumped to
eight.
Reflecting rising debt problems in the region, bank-
ers' confidence in a number of West European coun-
tries has slipped. Influenced by lessons learned from
LDC problems, many banks are encouraging France,
Greece, and Ireland to restructure their debt now
before repayments become a serious problem. In the
meantime they are lowering credit ratings on some
countries, pricing credits with bigger spreads or
shorter terms to reflect increased risks, and limiting
exposures. Standard and Poor's has reduced Den-
mark's credit rating, and several banks have internal-
ly listed the other 11 countries on our list below the
prime credit risk category for medium-term borrow-
ings as well as for short-term loans (except in the case
of Norway). A number of large banks have reduced
their exposure to high-risk West European countries
by selling off their share of syndicated loans to
' If worker remittances are included with exports, Portugal's 1982
debt-to-export ratio drops from 314 to 216 and Turkey's falls from
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Table 1
Western Europe: Total External Debt
Billion US $
1978
1979
1980
1981
1982a
Total Western Europe
410.9
506.9
594.7
626.8
681.9
WE-12
204.1
254.3
302.3
334.7
369.5
Belgium
8.0
14.1
19.2
26.0
31.0
Denmark
25.8
30.4
30.4
31.8
33.4
Finland
13.0
14.2
17.1
17.6
19.1
France
50.3
65.8
81.1
91.1
106.1
Greece
5.8
6.5
8.6
10.0
11.2
Iceland
0.9
1.0
1.1
1.2
1.4
Ireland
8.1
12.0
15.0
16.5
18.9
Norway
28.3
32.6
33.9
32.1
31.0
Portugal
7.8
9.9
12.3
15.6
18.5
Spain
19.7
24.1
29.9
34.4
37.4
Sweden
20.9
26.9
34.3
36.8
38.9
Turkey
15.5
16.8
19.4
21.6
22.6
Other WE
206.8
252.6
292.4
292.1
312.4
Austria
9.7
11.7
14.3
14.7
13.3
Italy
36.3
39.5
52.8
61.3
66.0
Netherlands
12.2
16.2
20.0
15.9
16.8
Switzerland
15.8
21.6
26.0
25.3
28.6
United Kingdom
53.6
66.0
71.8
61.8
68.3
West Germany
79.2
97.6
107.5
113.1
119.4
Table 3
Western Europe:
External Debt as a Share of GDP
Table 2
Western Europe:
Change in Total External Debt
Percent change
1979
1980
1981
1982-
1978-82
23.4
17.3
5.4
8.8
66.0
24.7
18.9
10.7
10.4
81.0
Belgium
76.3
36.2
35.4
19.2
287.5
Denmark
17.8
0
4.6
5.0
29.5
Finland
9.2
20.4
2.8
8.5
46.9
France
30.8
23.3
12.3
16.5
110.9
Greece
12.1
32.3
16.3
12.0
93.1
Iceland
11.1
10.0
9.6
16.7
55.6
Ireland
48.1
25.0
10.0
14.5
133.3
Norway
15.3
3.9
-5.3
-3.3
9.5
Portugal
27.1
24.2
26.8
18.6
137.2
Spain
22.2
24.1
15.1
8.7
89.9
Sweden
28.6
27.4
7.3
5.7
86.1
Turkey
8.4
15.5
11.4
4.5
45.8
Other WE
22.2
15.8
-0.1
7.0
51.1
Austria
20.5
22.1
2.8
-9.4
37.1
Italy
8.8
33.7
16.1
7.7
81.8
Netherlands
32.8
23.5
-20.5
5.7
37.7
Switzerland
36.8
20.3
-2.7
13.0
81.0
United Kingdom
23.1
8.8
-13.9
10.5
27.4
West Germany
23.3
10.1
5.2
5.6
50.8
1978
1979
1980
1981
1982 a
Total Western Europe
16
16
17
20
23
WE-12
19
20
21
26
31
Belgium
8
13
16
27
37
Denmark
46
46
46
55
59
Finland
38
34
34
36
39
France
11
11
12
16
20
Greece
18
17
21
27
30
Iceland
41
40
38
40
54
Ireland
66
69
84
99
111
Norway
70
69
59
56
55
Portugal
44
49
50
66
79
Spain
13
12
14
18
21
Sweden
23
25
28
33
40
Turkey
30
24
34
37
43
Other WE
14
14
14
16
18
Austria
17
17
19
22
20
Italy
14
12
13
18
19
Netherlands
9
10
12
11
12
Switzerland
19
22
26
27
30
United Kingdom
17
16
14
12
15
West Germany
12
13
13
17
18
Table 4
Western Europe:
External Debt Service Ratio a
Total Western Europe
26
26
29
35
38
WE-12
26
30
32
40
43
Belgium
6
9
12
17
29
Denmark
51
49
59
60
66
Finland
35
30
44
61
67
France
23
24
30
41
44
Greece
34
29
23
33
41
Iceland
28
25
29
36
43
Ireland
30
37
67
86
84
Norway
46
45
32
38
39
Portugal
46
43
62
93
129
Spain
31
29
32
40
43
Sweden
29
29
30
42
49
Turkey
155
163
106
73
77
Other WE
25
23
26
32
35
Austria
36
34
31
39
42
Italy
31
26
27
40
42
Netherlands
7
7
8
9
9
Switzerland
15
18
22
27
28
United Kingdom
18
17
23
28
26
West Germany
35
35
36
42
44
a Interest plus payments on long- and short-term debt, as a percent
of exports of goods and services.
b Based on oreliminary debt data.
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Table 5 Table 7
Western Europe: Total Debt as a Percent Western Europe:
of Exports of Goods and Services Current Account Balances
1978 1979 1980
1981
1982 a
Total Western Europe 55 53 54
59
66
72 70 70
78
85
14 19 22
30
37
151 143 126
138
150
Finland 123 104 98
100
117
France 44 45 47
54
67
Greece 98 84 102
109
142
Iceland 100 91 92
100
128
117 141 146
172
208
166 152 120
112
113
88 80 88
102
108
77 77 87
99
111
535 560 524
365
286
44 43 43
46
53
Italy 50 42 50
61
67
Netherlands 19 20 21
17
19
Switzerland 46 56 60
61
71
United Kingdom 53 49 43
39
47
West Germany 45 47 46
51
54
Table 6
WE-12: Months of Imports Covered by
Foreign Exchange Holdings
WE-12 1.2 1.6 2.5
1.4
1.1
Belgium 0.6 0.7 0.9
0.5
0.4
Denmark 1.8 1.5 1.4
1.1
1.0
Ireland 3.7 2.2 2.5
2.4
2.3
Norway 1.6 2.1 2.5
2.7
2.9
Portugal 1.8 1.5 0.8
0.5
0.4
Spain 5.4 5.0 3.2
3.0
2.2
Sweden 1.7 1.0 0.8
1.0
1.0
Turkey 2.0 1.5 1.7
1.5
1.1
Other WE 2.6 2.5 2.0
1.9
1.8
Austria 3.0 1.6 1.7
1.9
2.1
Italy 1.9 2.3 2.2
2.0
1.4
Netherlands 0.7 1.0 1.3
1.1
1.3
Switzerland 7.2 5.5 4.4
4.3
5.0
United Kingdom 1.9 1.7 1.5
1.1
0.9
West Germany 3.3 3.7 2.2
2.2
2.3
1974-83
1974-78
1979-83
1982 1983
Total Western Europe
-139.7
-28.7
-111.0
-21.5 2.3
WE-12
-176.2
-62.1
-114.1
-33.4-14.3
Belgium
-16.1
0.0
-16.1
-2.7 -0.5
Denmark
-17.7
-6.9
-10.8
-2.2 -1.2
Finland
-8.0
-4.1
-3.9
-1.0 -1.0
France
-19.0
2.0
-21.0
-12.1 -4.0
Greece
-15.6
-5.2
-10.4
-1.9 -1.9
Iceland
-0.8
-0.4
-0.4
-0.3 -0.1
Ireland
-9.5
-2.0
-7.5
-1.3 -1.1
Norway
-9.4
-14.3
4.9
0.5 2.5
Spain
-27.6
-11.3
-16.3
-4.2 -2.4
Sweden
-19.1
-5.0
-14.1
-3.5 -1.1
Turkey
-19.0
-9.8
-9.2
-1.2 -2.0
Other WE
36.5
33.4
3.1
11.9 16.6
-7.7
-4.5
-3.2
0.7 -0.1
Italy
-19.0
-2.7
-16.3
-5.5 0.1
Netherlands
11.8
6.0
5.8
3.2 4.5
Switzerland
25.3
14.1
11.2
3.6 3.0
United Kingdom
14.6
-10.8
25.4
9.4 3.1
West Germany
11.6
31.3
-19.7
3.6 3.9
(banks seeking to limit their
exposure in a country have also resorted to withdraw-
ing interbank deposits.
Portugal and Turkey now have the most serious debt
problems in Western Europe, and both are in the
midst of IMF programs. These countries are the
poorest in Western Europe, and their economies ex-
hibit many LDC characteristics: low GNP per capita,
basic infrastructure inadequacies, structural bias to-
ward balance-of-payments deficits, a relatively small
or narrowly based export sector, high propensity to
import, a large percentage of the population in the
rural sector producing a relatively small share of
GNP, government protection of and involvement in a
large share of the business sector, and inadequate
capital markets.
The debt problems of Greece and Ireland are also
serious and getting worse, although borrowing in
international capital markets has been somewhat easi-
er for them than for Turkey or Portugal. The growth
in debt for both countries has been exceptional: 141
percent for Ireland and 124 percent for Greece over
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Following the definition used by the International
Monetary Fund (IMF), external debt is the total
stock of obligations residents of one country owe to
the rest of the world. It comprises all short-,
medium-, and long-term liabilities of the private and
public sectors, including bonds, bank loans, bank
deposits, trade credits, letters of credit, and bankers'
acceptances. Liabilities to a country's own citizens
living abroad and liabilities to nonresidents that are
denominated in the country's own currency are part
of foreign debt under this geographic approach, al-
though these two categories are a very small part of
the total.
Because of data and reporting problems, country debt
compilations cannot be completely accurate. Ironical-
ly, West European debt data are generally more
difficult to compile than data on LDCs, which are
published by the World Bank. Although the IMF, the
Bank for International Settlements (BIS), and the
Organization for, Economic Cooperation and Develop-
ment (OECD) are improving their collection systems,
comprehensive disaggregated data are not available
on a timely basis. Moreover, countries experiencing
debt problems often hide or delay publication of data
so that creditor confidence is not jeopardized. This is
done by including borrowing activity in vague catego-
ries such as "other capital flow" or by increasing the
relative amount of short-term debt-liabilities with a
maturity of one year or less. Accurate figures for
short-term debt do not usually exist until well after
the end of a calendar year. As a result, short-term
the last five years. Ireland is the only West European
country whose foreign debt exceeded its GNP in
1982. Like Portugal and Turkey, these countries
cannot readily cope with a large debt burden when
export revenues and capital inflows are weak, as was
the case during the recent economic recession. In our
view, neither Greece nor Ireland has an effective
economic program to deal with its growing foreign
debt problems and neither has an immediate financ-
ing alternative to borrowing
Belgium, Denmark, Finland, France, Iceland, Spain,
and Sweden have also experienced rapid debt growth
over the last five years. Belgium's debt has increased
nearly fourfold, and the debt for the seven countries
debt can swing greatly during the course of a year
and may or may not surface as a problem depending
on other financial flows. Portugal and France, for
example, have used short-term debt extensively with-
out the market's becomin full aware of the extent
of the borrowing activity.
Conceptual and reporting problems also require mak-
ing judgmental adjustments to the data. In countries
where the banks are significant international finan-
cial intermediaries-Austria, Belgium, France, Italy,
the Netherlands, Spain, Switzerland, the United
Kingdom, and West Germany-short-term foreign
currency liabilities are included only to the extent
they exceed short-term foreign currency assets. We
have made this adjustment because the amounts
owed by banks in these countries are to a large extent
deposit liabilities-a good portion of which are inter-
bank deposits-used to finance lending as well as
redeposit activity. Intercompany indebtedness be-
tween the nonresident parent and local subsidiary is
technically a part of total debt but often not reported
as such. Instead, in most countries this credit is
reported, if at all, as a component of direct invest-
ment- and is generally not separately identified. Final-
ly, it is also common practice among countries not to
report nonbank trade credits. These intercompany
obligations skirt the normal letter-of-credit paper
trail through banks and simply do not make it into
the reporting system: these figures are relatively
as a whole has doubled. Except for Belgium and
France, in 1982 debt as a share of exports for these
countries exceeded 100 percent and ranged between
108 percent (Spain) and 150 percent (Denmark).
Moreover, all except Iceland tend to have large
international capital flows that can exacerbate bor-
rowing requirements during an economic or political
crisis when capital flight creates a drain on central
bank resources. Such a confidence problem occurred
in France during 1981-83 following the election of
Socialist leader Francois Mitterrand.
Norway is the only country among the WE-12 whose
debt position stabilized during 1978-82. Following a
period of heavy investment in the oil sector during the
1970s, oil revenues are now sufficient to reduce the
still relatively large amount of debt
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(2)
(3)
(4)
(5)
Determining a Country's Credit Risk
banks to assess credit risk
No set formula exists for assessing a country's credit
risk. As a result, we initially used a set of five
indicators to help identify potential problem debtors
in Western Europe. Though somewhat arbitrary,
these indicators are frequently used by international
Risk Indicators
(1) External debt grew by at least 100 percent during
1978-82.
External debt was equal to or greater than 40
percent of 1982 GNP.
The debt servic%xports ratio in 1982 (interest
plus amortization on long-term debt plus short-
term debt as share of exports of goods and
services) is equal to or exceeds 50 percent.
Total debt as a share of 1982 exports of goods
and services equals or exceeds 100 percent.
Foreign exchange holdings at the end of 1982
were equivalent to less than one month's imports.
The indicators are not weighted equally and vary in
importance from country to country. Nevertheless, we
believe any country facing a serious debt problem is
Table 8
Debt Profile Indicators
Debt Up Debt/GNP
100 Percent Over 40 Percent
(1978-82) (1982)
likely to trip at least one indicator. In general, the
greater the number of indicators tripped, the more
likely the country will experience difficulty in servic-
ing its foreign debt.
Other less easily quantified factors are also extreme-
ly important in assessing debt problems. These in-
clude particularly the government's policies to deal
with the debt and the uses to which the borrowed
funds are put. Norway, for example, had a rapid
buildup in debt in the 1970s but used the funds to
develop its oil and gas resources-which led to
increased export earnings that are now being used to
pay off the foreign debt. For the most part, determin-
ing the risk status of a country thus comes down to a
subjective judgment about how well the country is
utilizing the funds it has borrowed.
A total of 12 countries tripped at least one of the
indicators, making their debt situation worthy of
further study (see table 8). Portugal led the list,
tripping all five indicators, while Ireland was in
second place with four. France and Spain, on the
other hand, tripped only one
Debt Service Debt/Exports Foreign
Over 50 Percent Over 100 Percent Exchange Less
(1982) (1982) Than One
Month's
Imports
(1982)
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Causes of the Problem
The large increases in oil prices in the 1970s were the
driving force behind the rapid runup in foreign debt
for the WE-12, but domestic economic policies have
been the decisive factor in determining the seriousness
of their problems. Expansionary fiscal and accommo-
dating monetary policies aimed at offsetting the de-
pressive effects of higher oil prices on economic
growth and employment pushed current accounts
further in the red than otherwise would have oc-
curred. Moreover, heavy government regulation and
involvement in the economies, often combined with
policies that kept exchange rates overvalued, impeded
adjustment to the changing economic environment.
Compared with the WE-12, the six West European
countries (WE-6) that did not trip any debt problem
indicators all followed more moderate monetary and
fiscal policies, relied more extensively on market
forces to adjust to higher oil prices, and exported more
to OPEC countries because of their closer trade ties
with the oil producers.
During the 1979-83 period, we calculate that higher
oil prices added $153 billion to the import bill of the
WE-12-86 percent of the increase in foreign debt.
Over these five years the cumulative current account
deficit for the WE-12 totaled about $114 billion,
roughly double the amount piled up during the pre-
ceding five-year period.
Stimulative demand management policies-particu-
larly in Denmark, Greece, Ireland, Portugal, Sweden,
and Turkey-tended to make the external deficit
situation worse by keeping the demand for imports
relatively high while choking off export potential.
Fiscal policy in the WE-12 after the first oil shock
moved from a slightly restrictive stance to a strongly
expansionary mode. Government spending for the
WE-12 mushroomed from 35 percent of GDP in 1973
to 50 percent by 1982, and the governments' budget
balances as a share of GDP moved from a 1.4-percent
surplus in 1973 to an estimated 5.0-percent deficit in
1983. Most of the expenditure increase occurred in
government transfer payments:
? The sharp rise in unemployment and the expansion
of benefits since 1973 boosted unemployment bene-
fit payments.
? Health care, pension, and social security benefits
rose considerably.
? The growth of inefficient nationalized enterprises
The WE-6 also increased government spending but
did so at a slower pace and were able to keep the
deficit relative to GNP at slightly lower levels. During
1973-82 government spending for this group rose
from 40 percent of GNP to 50 percent, and their
budget deficit as a share of GNP rose from 2.2
percent to 4.4 percent.
Monetary policy was also highly stimulative in the
WE-12 as government deficits tended to be financed
by money creation. The WE-6, on the other hand,
financed a greater part of their deficits by borrowing
in domestic financial markets. Changes in the money
supply reflect these differences in approach. In the
1973-82 period, the average annual growth in the
money supply reached 13.3 percent in the WE-12
compared with 10.2 percent in the WE-6.
Foreign borrowing requirements for the WE-12 also
grew when governments failed to let their exchange
rates adjust in response to widening inflation differen-
tials. During the 1973-82 period, inflation in the WE-
12 group averaged 13.7 percent in contrast to 9.9
percent in the WE-6. Authorities in several coun-
tries-Belgium, Denmark, France, Greece, Portugal,
Spain, and Turkey-acted at different times to main-
tain overvalued exchange rates primarily in an at-
tempt to hold down domestic price increases. As a
result, current account balances deteriorated as im-
port demand surged while export competitiveness
declined. Artificially high exchange rates also ad-
versely affected capital flows in several countries.
The international competitiveness of the WE-12-and
hence their current accounts-also has been detri-
mentally affected by the high degree of government
involvement in these economies. Although difficult to
quantify, we believe the governments of most of the
WE-12 have interfered with the operation of their
economies to a greater extent than the other West
European countries. Many of the Twelve have adopt-
ed measures that have inhibited adjustment to the
changing world trade environment, including:
? Controls on prices.
? Direct subsidization of industry.
? Regulations on interest rates and credit allocation.
? Nationalization of industry.
added to government spending.
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Price controls implemented at various times in Bel-
gium, France, Iceland, Finland, Greece, Norway,
Portugal, Spain, and Turkey have interfered with
resource allocation; controls on energy prices in many
countries, for example, kept the demand for imported
oil high. Subsidies to industry in France, Greece,
Portugal, Spain, and Turkey have kept alive many
uncompetitive firms. Regulated interest rates in
France, Greece, Ireland, Portugal, Spain, and Turkey
have had similar effects by artificially providing
credit. Nationalization of industries in several coun-
tries also has made economies less flexible and effi-
cient. Greece, Portugal, Spain, and Turkey have for
many years relied heavily on foreign debt to finance
government-owned industries. While Portugal, Spain,
and Turkey are attempting to reduce the role of
government in the economy, Greece and France have
expanded the number of nationalized sectors in recent
years.
Composition of the Debt
The composition of medium- and long-term WE- 12
debt is fairly well balanced between bank credits and
international bonds. Bank loans now account for
about an estimated 60 percent of the WE-12 debt and
bonds, an estimated 40 percent. The trend over the
past several years, however, has been toward in-
creased use of bonds. New bond issues fulfilled 46
percent of WE- 12 international financing needs in
1982, 53 percent in 1983, and 58 percent during the
first quarter of 1984. The rise in the share of bonds is
primarily the result of increased use of floating rate
notes (FRNs), a debt instrument with a variable
interest rate; regular bonds carry a fixed rate of
interest over the life of issue. Investors have found
FRNs attractive to hold because the variable rate
protects them against inflation. In 1983 FRNs ac-
counted for 26 percent of all new bond issues, com-
pared with only 10 percent in 1978.
The interest rate charged on roughly 75 percent of the
WE-12's foreign debt fluctuates with current market
rates. We estimate that for every 1-percentage-point
increase in rates, the cost of servicing the WE- 12 debt
goes up by about $2.5 billion. The variation in cost is
particularly sensitive to rates in the United States and
the Eurodollar market because about 80 percent of
WE-12 obligations are denominated in dollars. The
interest rate on syndicated credits is tied to the
London interbank offer rate (LIBOR)-usually by a
spread over LIBOR-or the US prime rate. Short-
term debt, which accounts for about 35 percent of the
$370 billion in outstanding WE-12 debt at the end of
1982, usually has a fixed rate of interest, but, because
the maturities are very short-30 to 120 days usual-
ly-the cost of the credits can vary quickly. F_
Six Will Worsen
We believe the foreign debt situation will be a serious
problem for half of the WE- 12 over the next few years
(see table 9). Specifically:
? Portugal and Turkey almost certainly will need
additional assistance in 1984. Turkey in particular
faces a hump in its debt service obligations begin-
ning later this year.
? Greece and Ireland are likely candidates for an IMF
bailout in the next year or two.
? Denmark and Sweden, while not likely to require
IMF assistance, probably will continue to see their
debt expand and their credit ratings remain below
prime.
Despite Portugal's IMF program aimed at improving
the economy and debt situation, Lisbon probably will
need additional IMF and other official assistance in
the near future. Lisbon should meet the $1.25 billion
1984 current account target set in the June agreement
with the IMF, but Portuguese officials are worried
that financing the deficit by borrowing from commer-
cial banks could be difficult. To help matters, they
have opened loan sources in Japan and plan to make
new overtures in West European capitals. Portuguese
officials have also asked the United States for help in
meeting any external financing shortfall. Portugal has
sold about $1 billion worth of gold through the Bank
for International Settlements (BIS) and still holds
nearly $8 billion worth at current prices. Finance
Minister Lopes has indicated, however, that for now
further gold sales are politically unacceptable; the
new government believes that additional sales would
be viewed by the public as sacrificing Portugal's
national heritage.
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Table 9
WE-12: Foreign Debt and Current Account Estimates
Current Account
Balances b
1983
1984
1985
1983
1984
1985
1983
1984
1985
Total WE-12
383.0
390.5
390.5
34
33
33
-14.3
-7.9
-0.9
Belgium
31.5
32.0
30.5
39
37
34
-0.5
-0.3
1.5
Denmark
34.5
36.0
37.0
61
61
60
-1.2
-1.5
-1.0
Finland
20.0
21.0
22.0
42
41
40
-1.0
-1.0
-0.8
France
110.0
112.0
111.5
21
21
20
-4.0
-2.0
0.5
Greece
13.0
15.0
17.5
38
44
48
-1.9
-2.0
-2.3
Iceland
1.5
1.5
1.5
61
61
61
-0.1
0
0
Ireland c
19.5
20.0
20.5
107
108
108
-1.1
-1.1
-0.5
Norway
28.5
26.0
24.0
53
50
47
2.5
2.3
2.0
Portugal
20.0
21.0
21.5
101
110
116
-1.5
-0.8
-0.8
Spain
40.0
40.5
40.5
26
26
24
-2.4
-0.5
0
Sweden d
40.0
39.5
38.0
44
111
38
-1.1
0.5
1.5
Turkey
24.5
26.0
26.0
51
48
48
-2.0
-1.5
-1.0
a Projected. Based on current account balances and rounded to the
nearest one-half billion dollars.
b OECD data for 1983 and estimates for 1984 and 1985; assumes
no major shifts in government policies.
Although Turkey is generally meeting the economic
targets set by the IMF, it probably will need addition-
al official assistance to get over a hump in debt service
that begins later this year. Turkey must begin repay-
ing debts that were rescheduled earlier as well as
money borrowed from OECD governments as part of
the 1980 relief package. These principal repayments
plus those to commercial banks will amount to $1.3
billion in 1984 and jump to $1.9 billion in 1985. In
addition, Turkey must begin repaying its $1.6 billion
IMF loan; $366 million is due this year and $385
million in 1985. At the same time, Turkey will have to
finance a current account deficit of about $1.5 billion
in 1984. The recent liberalization of foreign exchange
regulations could also strain the central bank's re-
sources in the short term if businessmen take advan-
tage of the opportunity to divert funds to foreign bank
accounts.
c Ireland's current account figures for 1983 and 1984 are official
Irish numbers reported by the US Embassy in Dublin and were not
available to the OECD for publication in the July Outlook.
d The OECD 1985 current account forecast for Sweden, we believe,
is overly optimistic and should be closer to $0.5 billion.
Greece's debt problem is accelerating the most rapidly
within the WE- 12, and we believe the country soon
will be forced to seek IMF assistance. Current trends
clearly indicate a deteriorating situation:
? Negative real interest rates are discouraging savings
and encouraging consumption and imports.
? The $1.9 billion current account deficit in 1983 will
edge even higher in 1984 and in 1985 we expect the
deficit to approach the record level of $2.4 billion
recorded in 1981.
? Repayments on previous loans will accelerate in
1984 as a result of the large amount of borrowing
during 1980 and early 1981.
? Foreign exchange reserves have already dwindled to
less than one month's worth of imports.
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Figure 1
Western Europe: Total Foreign Debt
Although the pickup already under way in world
trade will give a boost to Greek exports, we believe the
increase will be moderate because of poor price
competitiveness and a decline in import demand in the
Middle East, an important market for Greece. On the
import side, Greece will have to spend to rebuild oil
inventories because of destocking last year, and pay-
ments on debt service will also rise as a result of the
increased debt. Beyond 1984 only a significant in-
crease in investment to improve international compet-
itiveness can help Greece expand its export sector. But
private direct investment inflows-particularly pur-
chases of Greek real estate, a traditional source of
capital inflows-have dropped from $1.5 billion annu-
ally during 1980-81 to $850 million annually during
1982-83. Bankers' attitudes toward Greece are also
souring,
many banks have sold out their shares on recent loan
syndications to Greece because they believed the
terms were too generous for the risk involved.
In our view, the Papandreou government's interven-
tionist economic policies are primarily responsible for
Figure 2
Western Europe: Current Account Balances
25X1
25X1
the continuing deterioration. Papandreou has relaxed
the moderately restrictive income policy for 1984.
Moreover, make-work unemployment programs are
being discussed within the government as restive labor
unions challenge the Socialist government's lack of
attention to its prolabor platform. Political pressure
from Papandreou's leftist supporters make it unlikely,
therefore, that he will adopt the austerity measures
needed to reduce the external deficit.
Ireland almost certainly will not be able to improve its
foreign debt position this year; there is a good chance
it will deteriorate further. Any major increase in
borrowing requirements would quickly trigger the
need for an IMF-type debt restructuring program.
Although Irish exports are doing better as a result of
the upturn in world trade, we believe the Irish current
account deficit of $1.1 billion in 1983 will be repeated
this year. We also believe there is a strong possibility
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that the government will soon reverse its restrictive
economic policies, thus leading to an even greater
deterioration in the current account than currently
forecast by the OECD.
Pressures to relax economic policy are building be-
cause the unemployment rate has soared 5 percentage
points since 1982 to almost 16 percent. Although the
current coalition government-made up of the Labor
Party and the United Ireland Party (Fine Gael)-
continues to emphasize the need for restrictive poli-
cies, a split is beginning to develop. While the Labor
Party is having second thoughts about austerity, Fine
Gael is advocating new tax increases and spending
cuts as part of its five-year plan to balance the budget
by 1986. We believe the mounting unemployment
problem could drive a wedge between the coalition
partners, causing the government to fall. Under such
circumstances, the opposition Republican Party
(Fianna Fail) probably would win a national election
and adopt more stimulative economic policies.
International bankers are anticipating that Ireland
will need an IMF restructuring program. As a result,
some of them have suggested that Ireland should seek
an IMF program now while foreign reserves are
relatively strong and before a crisis atmosphere devel-
ops. the structural changes in
the economy necessary to reduce unemployment will
take time to implement and to become effective. F_
Denmark and Sweden will continue to experience
increasing debt difficulties, but neither is likely to
need IMF assistance during the next year or so. Both
countries' capacity to export has been hurt in recent
years by the small amount of productive investment in
the economies; disinvestment has actually occurred in
the Danish manufacturing sector. Until bankers are
convinced that their investments will go toward pro-
ductive ends instead of funding welfare policies, credit
ratings will remain unchanged or drop further.F_
The Danish economy will have to continue to borrow
abroad in order to finance its external deficit, as it has
for the past 20 years. The OECD forecasts a slight
deterioration in the deficit this year to $1.5 billion.
The figure is likely to be higher if the government
retreats from its effort to cut the public deficit to 8 to
9 percent of GNP-down from 9.6 percent in 1983.
Pressures on the Schluter government to provide some
stimulation will probably intensify, however, because
we believe its program to reduce public-sector jobs
will lead to an increase in the country's unemploy-
ment rate. External performance will also be weak in
1984 as Danish goods have suffered a loss of price
competitiveness during the last year.
Sweden's debt situation continues to benefit tempo-
rarily from a competitive devaluation in 1982. We
believe the current account deficit will fall again in
1984 and new foreign borrowings, therefore, will be
less than in the last two years. In our view, however,
current policies cannot be sustained; thus the outlook
for 1985, or until there is a policy shift, is for an
increase in foreign borrowing. The OECD's recent
forecast of a $1.5 billion current account surplus for
1985 appears to us as unsubstantiated and overly
optimistic. We believe the price effects of the devalua-
tion will have played themselves out by then and
further export capacity utilization will not be possible
without substantial investment; a surplus of only $0.5
billion is more likely. Also, Prime Minister Palme's
commitment to the welfare system will keep budget
financing requirements and demand high, both of
which will work to keep the current account in the
red.
Six Will Improve
The remaining six countries in the WE-12-Belgium,
Finland, France, Iceland, Norway, and Spain-prob-
ably will see an improvement in their debt profile over
the next few years. The governments of these coun-
tries have already taken economic measures to reduce
the debt burden, and we believe these programs will
be successful. Nonetheless, potential problems re-
main, and in the cases of Belgium, France, Iceland,
and Spain any relaxation of current restrictive policies
would quickly create renewed debt problems.
Four countries-Belgium, Finland, Iceland, and
Spain-are all implementing generally tight economic
policies in conjunction with some structural changes
that will help improve their current account outlooks:
? Belgium implemented an economic reform program
in 1982 that tightened fiscal and monetary policies,
adjusted the exchange rate, and suspended wage
indexation for two years.
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? Finland tightened monetary policy beginning in late
1982, devalued the markka, and is planning to
tighten fiscal policy during 1984.
? Iceland has strongly tightened monetary and fiscal
policies, devalued the kronur, and suspended wage-
price indexation until mid-1985.
? Spain has tightened monetary and fiscal policies,
devalued its currency, and reduced norms for wage
increases; it also is attempting to restructure the
economy primarily by opening up previously pro-
tected sectors to domestic and external competition.
All these countries will improve their current account
positions during 1984, a trend which began after 1980
for Belgium and Spain. Belgium, we believe, will be
only $0.3 billion in deficit this year, and Spain's
deficit will be reduced further to about $0.5 billion.
Improved price competitiveness and the expected
pickup in world trade should boost export volume this
year by 4 to 4.5 percent for Belgium and 7.5 percent
for Spain
A number of potential problems remain, however,
which could slow further progress in containing the
increase in foreign debt:
? Continuing high unemployment in Belgium (14.5
percent) and Spain (19.5 percent) could lead both
governments to ease up on fiscal and monetary
policy restraints, which in turn could boost imports.
? Belgium has restored wage indexation for 1984,
which could affect international competitiveness
later this year and beyond.
? Major wage negotiations in Finland this year could
lead to wage and price increases that would hurt
Finnish sales to Western markets-a development
Helsinki particularly wants to avoid given an ex-
pected decline in exports to the Soviet Union.
France's foreign debt outlook is improving as well:
? Austerity measures introduced in 1982 and 1983
have slowed domestic economic growth, which has
reduced the growth of imports.
? Recovery in the other major countries is promoting
French exports.
? Exchange rate changes in the past have more than
compensated for still relatively high inflation in
France, thereby improving international
competitiveness.
As a result of these factors, we expect France's
current account to be in small surplus this year,
reducing the need to borrow foreign funds.
The outlook for trends in French foreign debt during
1985 and 1986 is clouded by the possibility that
President Mitterrand will ease up on austerity before
the 1986 National Assembly elections. We do not 25X1
expect Mitterrand to make any major shift in policy
given the economic problems his 1981 reflation policy
created. Still, a strict adherence to the austerity
program would probably add to the Socialist Party's
problems as the election drew close, and we thus
believe that a moderate relaxation of policies is likely.
We estimate that such a moderate relaxation of
policies would push the current account balance into a
small deficit, as opposed to the small surplus that the
OECD is now predicting for 1985.
Oil and gas revenues have helped reduce Norway's
debt since 1980. The 1984 current account surplus
will be only slightly smaller than last year's $2.5
billion figure and will permit another reduction in
foreign debt. Barring a sharp drop in world oil prices,
Oslo should be able to continue trimming the debt
over the next few years. Oslo has also taken steps to
improve its foreign credit rating as well as the terms
on loans taken out to finance new oil and gas develop-
ment. Previously, major borrowings were done in the
name of the Kingdom so that the debt was heavily
concentrated in the public sector. A change in the law
now permits Norwegian banks to invest in the oil
sector. As a result, the public sector is reducing its
share of the foreign debt as the banks raise funds on
the Euromarket in their own names instead of the
Kingdom's name. The strategy has helped to spread
the risk on Norwegian borrowings and at the same 25X1
time has incorporated a higher degree of commercial
decision making for investment in the oil sector. 25X1
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Implications
Growing foreign debt service requirements in Western
Europe, in conjunction with slow economic growth
and continuing high unemployment, are likely to add
to pressures for protectionist measures to aid domestic
markets and improve current account earnings. De-
fensive West European policies-particularly with
respect to agriculture, steel, textiles, and consumer
electronics and watches-have already hurt the ex-
port earnings of some LDCs and newly industrializing
countries. The combination of debt and unemploy-
ment problems will also tend to increase West Euro-
pean interest in trade with the Soviet Union and
Eastern Europe, possibly leading to further differ-
ences with the United States over trade restrictions.
We also believe West European countries are likely to
maintain pressure on the United States to further
lower interest rates and the budget deficit, which is
viewed as the cause of high US rates. Concern is
particularly acute in the WE-12 because their debt
servicing obligations will remain high and so much of
their debt fluctuates with current market rates. There
is a widespread perception in Western Europe that
high US rates are forcing up interest rates around the
world, thus increasing the burden of servicing foreign
debt. The West Europeans also claim that high US
rates of interest are affecting business investment in
Western Europe because firms there traditionally
have relied heavily on debt instead of equity to
finance growth.
The likelihood that a number of West European
countries could require some form of official external
financial assistance will tend to boost West European
support for increasing the resources of the IMF and
other multilateral facilities. The special IMF quota
increase in 1982, though it came three years earlier
than specified in IMF rules, was felt by many LDCs
and West Europeans to be too little, and the issue will
be raised again at this year's IMF/World Bank
meetings in September. We also believe West Europe-
an countries in financial difficulty will find common
ground with the LDCs in the idea of a new SDR
allocation; French Finance Minister Jacques Delors
has already said publicly he is supporting a proposal
for a new issue of the special drawing rights. If a
major increase in IMF quotas or SDRs is not ap-
proved, we believe that France and many of the other
WE-12 countries would support a new IMF borrow-
ing facility-like the 1974 oil facility-that would
raise a country's IMF borrowing limitation above the
current maximum of 600 percent of quota.
Debt problems among current and prospective mem-
bers will present the EC with problems that it will be
able to deal with in only a limited way. This is
probably just as well as far as the more financially
sound EC countries are concerned. West Germany
and the United Kingdom, for example, would proba-
bly feel more comfortable if IMF programs are
adopted by Greece and Ireland. Recently, in fact,
Greece approached the EC for a loan and apparently
was turned down because it did not have a compre-
hensive economic program. The Community has its
own financial problems, and EC syndications on the
Euromarket to be used to relend to member coun-
tries-such as the $3.7 billion 1983 EC loan to
France-will probably be used only on a very selective
basis. Any new loans for member countries, in fact,
would require the express consent of West Germany,
the ultimate financial guarantor for EC borrowings.
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Appendix
WE-12: Debt Situation in
Individual Countries
parity in the European Monetary System (EMS) and hold down inflation.
Causes
Belgium's fiscal, exchange rate, and wage policies encouraged heavy foreign
borrowing during 1979-82. As as result, foreign debt increased by 288 percent-
the largest increase of any West European country-and rose from 8 percent of
GDP to 37 percent. Government spending as a share of GNP rose to 58 percent by
1982-up from 39 percent 10 years earlier-primarily because of increases in
transfer payments that in turn impacted heavily on consumption and imports.
Export competitiveness declined during the 1970s as real wage increases out-
stripped increases in Belgium's trading partners by 16 percent while the value of
the Belgian franc was kept artificially high at different times in order to maintain
restored in 1984 and may again threaten foreign competitiveness.
Responses
The government launched an economic reform plan in 1982 aimed at restraining
demand by cutting the public-sector deficit and restoring the profitability and
foreign competitiveness of firms. Some progress has been made in reducing real
government expenditures, and in 1984 the government is projecting a decline of
0.2 percent; the deficit, however, will still equal 11.5 percent of GNP. Depreciation
of the franc by 8.5 percent and real wage declines of 2.5 percent in 1982 and 3.5
percent in 1983 have helped firms boost exports. Wage indexation, however, was
and improve employment
Outlook
Net foreign borrowing requirements will continue to diminish in 1984 paralleling
the projected improvement in the current account. The OECD estimates that the
deficit this year will be about $0.3 billion, down from $4.9 billion in 1980. Brussels
faces a strong challenge in the next two years, however, as it attempts to further
reduce the public-sector deficit and contain wage increases while at the same time
the unemployment rate continues to inch upward. A sustained recovery in trade
with West Germany, its main trading partner, will help most to reduce debt levels
investment.
Causes
Increases in government spending, wage indexation, and foreign exchange regula-
tions drove Denmark's current account heavily into the red during 1979-83 and in-
creased Danish reliance on foreign debt. Government spending now accounts for
about 60 percent of GNP and the tax burden is 45 percent; there is currently a
large structural component to the budget deficit that has contributed to foreign
borrowing requirements. The growth of the public sector has contributed to a
downward trend in private domestic investment since 1974, a cut in savings, a
smaller manufacturing sector, and a shift in the work force out of the private
sector-all factors that reduce Denmark's export potential. Automatic wage
indexation and high minimum wages also hurt Denmark's price competitiveness in
foreign markets, while restrictions on capital inflows limited foreign direct
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Responses
The Danish Government is implementing a budget that is aimed at reducing the
huge public-sector deficit and holding down demand. Some cuts in transfer
payments were accomplished in 1983. Wage restraint and a national incomes
policy are being used instead of devaluations to improve and maintain the
competitiveness of Danish firms; wage indexation has been suspended until 1985.
Outlook
Denmark will continue to run current account deficits that will have to be financed
with more borrowing in the years to come. This year's deficit will be slightly higher
than last year's $1.2 billion if the government can effectively implement its new
tightened budget, a prospect we consider likely at this time. Several factors,
however, point toward a worsening in the foreign accounts over the medium term:
the Danish export sector is in a depressed state and requires net new investment;
the public sector is releasing workers faster than the private sector can absorb
them; and wage indexation will be restored next year, threatening Danish
competitiveness. Copenhagen will continue to rely on an incomes policy instead of
devaluations to maintain foreign competitiveness, a more difficult policy option.
Causes
International competitiveness deteriorated during most of the 1970s and through
1982 as wage costs per unit of output increased at a greater rate than in partner
countries. These increases were not completely offset by exchange rate changes,
and, as a result, export performance-Finnish export growth relative to market
growth-has lagged behind partner countries since 1979. Because of the lack of a
broad domestic capital market, government deficits have been financed largely by
foreign borrowing.
labor negotiations.
Responses
The Finnish Government tightened monetary policy during 1982-83 and is
planning to tighten fiscal policy in 1984 in order to mildly restrict demand and pre-
vent any worsening of the current account deficit. A 1982 devaluation helped
improve foreign competitiveness despite continued and relatively rapid wage
increases. Helsinki plans to maintain its share in foreign markets by selectively
devaluing the markka when necessary. The government also hopes to contain any
potential setback for the foreign sector by limiting increases in wages at this year's
tage of the pickup in world trade.
Outlook
The current account deficit this year will improve because Finnish policies are
sound and the outlook for exports is good. The tighter monetary and fiscal policies
should slow the rate of inflation. Unemployment will decline in 1984 to about 5.7
percent, helped primarily by a strong pickup in exports to industrial countries.
Helsinki's policy of selective devaluation should help to maintain international
competitiveness because there is still sufficient industrial capacity to take advan-
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deficits.
Causes
The highly expansionary Socialist economic plan implemented in 1981 increased
foreign borrowing requirements significantly. Even before that, however, unbal-
anced economic policies were forcing Paris to rely heavily on foreign funds to
finance large current account deficits. Government spending rose to over 50
percent of GNP in 1982 from 39 percent 10 years earlier, while export
competitiveness declined during the 1970s as wage costs rose sharply. France's
foreign market share declined by 1.2 percentage points during 1975-80, while the
share of imports in the domestic market increased from 22 percent to 28 percent in
the same period. The Socialist government's expansionary economic stance in
1981-82 strongly stimulated demand and put France out of phase with the other
major countries, worsening the current account deficit. The Socialist victory also
resulted in a decline in net new foreign investment in France, increasing the
economy's dependence on borrowing as the source of foreign exchange to cover
gotiations.
Responses
President Mitterrand, reacting to his failed attempt to spend France's way out of
the recession and finding the Socialist platform expensive to implement, tightened
the 1982 austerity program with broader and harsher measures in 1983. The focus
of the new package was to reduce inflation and improve the balance of payments.
Higher taxes, forced savings, and slower wage growth-designed to reduce
consumption and imports-were coupled with foreign exchange controls to reduce
the foreign borrowing requirement. Money supply growth was also reduced
somewhat to slow inflation and ease pressure on the franc within the EMS. These
measures were implemented following the March 1983 devaluation of the franc
within the EMS and in part at least came about as a result of the realignment ne-
current economic regimen, France is still a relatively good credit risk.
but a continuation of current policies could restore their confidence. Under the
Outlook
We expect the debt situation to improve in the short term, but there is some
possibility that it will deteriorate in the medium term. For 1984 the OECD expects
the current account to drop from a $4 billion deficit in 1983 to $2.0 billion. The
improvement is due to the fact that the French austerity program is having its in-
tended impact and depressing demand and imports, while at the same time
recovery elsewhere is strongly boosting French exports. For the longer term,
however, it is possible that Mitterrand will alter the course of economic policy to
maintain the Socialist majority in the 1986 elections for the National Assembly.
Some changes in the current program can be expected as unemployment and wage
restraint stir the ire of the French labor force; the new budget, scheduled to be vot-
ed on in Parliament this fall, may give an indication as to how far the government
is willing to go. A major shift in economic policy would quickly drive the current
account deep into the red and significantly increase French foreign borrowing
requirements. International bankers are concerned about a shift by Mitterrand,
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estate rather than productive investments in the domestic and export sectors.
Causes
Greek governments since the mid-1970s have relied on expansionary economic
policies in an attempt to gain short-term political advantage but at the cost of
thwarting economic adjustment. This overspending was financed by a fully
accommodating monetary policy and foreign borrowing. Real wage increases were
not matched by gains in productivity, and foreign competitiveness was made worse
by maintaining the value of the drachma when inflation in Greece was higher than
elsewhere. Domestic investment has slumped badly since 1980, impeding Greece's
ability to expand production and exports. Foreign investment in Greece, which has
helped to offset current account deficits in the past, has been concentrated in real
further alienating the business community.
Responses
Athens has avoided implementing an economic program to deal with its serious
debt problem. The 1983 decision to devaluate the drachma and break its link to
the dollar was a good move, but the government followed this up by deciding to
maintain the value of the drachma. The government also tightened fiscal and
credit policies somewhat in 1983 to restrict demand but at the same time kept alive
plans for an employment program. In addition, Papandreou relaxed his moderately
restrictive incomes policy for 1984 and tightened price, profit, and import controls,
program will be needed sooner rather than later.
Outlook
The foreign debt situation is deteriorating rapidly. The current account deficit will
not improve this year, according to the OECD, and could get worse at a time when
foreign private capital inflows have been declining. Net new borrowings as a result
will have to increase by 15 to 20 percent in 1984, and banker confidence is low as
Papandreou fails to take effective action to deal with the debt problem. The US
Embassy in Athens has said that IMF help probably will be needed in the next two
years. If corrective economic measures are not implemented, we believe such a
policy during the 1970s kept demand for foreign goods high.
Causes
Foreign borrowing was necessary to cover chronic current account deficits during
the last decade. These deficits resulted from a sharp deterioration in the terms of
trade because of increased oil prices and a drop in the price of fish-Iceland's
main export. Iceland's export earnings have also been strongly affected by
fluctuations in the volume of fish catches, while a highly expansionary monetary
wage-price indexation, and devalued the kronur.
it has reduced real government consumption, cut monetary growth, suspended
Responses
Reykjavik has taken a number of steps to cut foreign borrowing and slow
inflation-which last year dropped from 130 percent to 30 percent. In particular,
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Ireland
factors which are out of Reykjavik's control
Outlook
Tightened fiscal and monetary policies are continuing to depress demand and
improve the current account outlook. The current account will be in rough balance
in 1984 as imports will actually decline again and exports will be the only sector
providing positive growth to the economy. Iceland's borrowing requirements in
part remain hostage to the fluctuations in fish catches and world fish prices,
Causes
Large increases in government spending unmatched by tax increases and an
industrial policy that has made unemployment worse have forced the government
to borrow large sums from abroad to finance its huge budget imbalance and cover
current account deficits. Total government spending as a share of GNP soared
from 39 percent in 1973 to 57 percent in 1982, pushing the Exchequer's borrowing
requirement to over an average of 15 percent of GNP in 1981 and 1982. This stim-
ulus to demand boosted imports while foreign sales were hurt because large wage
increases were often not fully offset by exchange rate adjustments. Also, produc-
tivity gains have come mainly in the capital-intensive export industries. This has
helped reduce the current account deficit but has had little impact on halting the
rise in unemployment and the additional cost to government in unemployment
benefits. Unexplained capital outflows rose to nearly $1 billion in 1982-about a
tenfold increase over 1981-because of exchange rate uncertainties.
EMS.
Responses
The government is currently relying heavily on fiscal and monetary restraints to
hold down demand-despite a serious and growing unemployment problem-and
is hoping for a boost to exports as recovery picks up in the United Kingdom and
Western Europe. Interest rates and taxes were raised to stimulate savings and cut
the government deficit-which fell to 13 percent of GNP in 1983. Exchange rate
adjustments have not figured strongly in Dublin's policies since Ireland joined the
reserves are still adequate.
Outlook
Ireland's debt profile is dangerously high and the government's economic strategy
needs better balance if a debt crisis is ultimately to be avoided. Even under the
present austere economic program, the $1.1 billion current account deficit in 1983
will be repeated again this year. The near-l6-percent jobless rate reflects the
lopsided industrial policy that has strongly favored capital-intensive investment.
We believe this to be an unhealthy situation and one that is likely to trigger a polit-
ical crisis. The current coalition government-made up of the Labor Party and the
more conservative United Ireland Party (Fine Gael)-would verly likely fall if a
new economic program stressing economic stimulus and employment were popu-
larly demanded. The current opposition Republican Party (Fianna Fail) probably
would win a national election but would not be able to loosen the fiscal reins for
very long before an IMF- type program would be necessary. Bankers are
anticipating that Ireland will need a debt restructuring program at some point in
the next couple of years and are encouraging Dublin to seek one now while foreign
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petitiveness.
Causes
Large capital equipment imports to develop oil and gas reserves, along with a 30-
percent reduction in market share of traditional exports, kept Norway's external
balance in deficit throughout the 1970s. Traditional exports were hurt by a
combination of poor commodity mix (largely intermediate goods that did not fare
well after the first oil crisis), a poor country mix (buyers of Norwegian goods
tended to be hard hit by the two recessions of the last decade), and poor price com-
better in recent years.
Responses
Norway's oil revenues pushed the current account balance into the black during
the 1980s, precluding the need for a policy shift to deal with the foreign debt. Fis-
cal policy in fact is relatively expansionary, emphasizing labor market support
measures, and tax cuts have been announced. Traditional exports have also fared
determining the future price competitiveness of traditional exports.
Outlook
Oil revenues are now making it possible for Norway to reduce its foreign debt. The
short-term outlook is favorable, and bankers have raised their internal rating for
short-term lending to Norway back up to the prime category. The current account
will still be in surplus this year, though down somewhat from 1983 because of ris-
ing imports. Wage negotiations this spring will play an important part in
government reflated again, precipitating another IMF program in 1983.
Causes
Foreign borrowing requirements have been kept high by economic policies that
have stimulated demand and imports and distorted the value of the currency.
Lisbon followed a strong expansionary fiscal policy during most of the 1970s
backed by a generally accommodating monetary policy. These policies, coupled
with generous wage settlements, stimulated demand and pushed inflation up
beyond most of its major trading partners, yet the government refused to let the
exchange rate adjust to the changing price level. As a result, trade competitiveness
was hurt, and since 1980 the trade deficit was made worse by the second oil shock
and a drought that hurt agricultural production. Moreover, the overvalued escudo
also adversely affected capital flows at various times, increasing the borrowing
requirement. An IMF program was in effect during 1977-79 and relied on
temporary demand restraint measures to reduce inflation and improve the foreign
account. Moderate policies fell by the wayside during the second oil crisis as the
Fund.
Responses
The 1983 austerity measures associated with the IMF program targeted a
moderate reduction in money growth, raised interest rates, projected a reduction in
the deficit from 12.5 percent of GNP in 1982 to 6 percent this year, incorporated a
12-percent devaluation, reduced subsidies, and outlined structural adjustments-
primarily in the public enterprises. The government was able to meet all the 1983
targets in the program. The recession has kept credit limits well within IMF
ceilings and has dampened import demand, helping Lisbon to reduce the current
account deficit. The Soares government, however, is apprehensive about the
political repercussions of the recession and has sought easier targets from the
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Outlook
Portugal may have to seek increased financial assistance to finance its 1984
current account deficit and has already informally approached the United States
for financial help. Portugal's long-term debt outlook depends upon structural
reform of the economy: reducing government's role in the public enterprises,
utilizing more of the work force with less emphasis on capital-intensive projects,
and increasing reliance on market forces to determine resource allocation. The
IMF is stressing these objectives for the new program.
markets. Also, both increases in labor costs and an overvalued peseta have
adversely affected trade at different times and increased foreign borrowing.
Causes
The increase in foreign debt has been the result of the increase in oil prices and the
inward orientation of the Spanish economy. Franco's policies produced an
industrial sector that was accustomed to subsidies and protection from foreign
competition and thus was not well positioned to compete effectively in world
form of higher unemployment.
Responses
Spain has taken a medium-term approach in dealing with its foreign debt and
other economic problems. Madrid has effectively implemented a tight monetary
and fiscal stance to curb demand, while a devaluation in late 1982 and a reduction
in wage norms have also helped to reduce the current account deficit. At the same
time the government is pressing ahead on structural reforms to improve market
forces and make Spanish firms more efficient and competitive. Structural reforms
in the financial and manufacturing sectors, however, are taking their toll in the
foreign debt, we also believe that the unemployment problem is somewhat less
than the statistics currently indicate because of the large underground economy.F_
Outlook
Foreign debt will continue to grow this year but by a reduced amount as the
current account deficit continues to decrease for the fourth straight year; we
concur with the OECD estimate that the deficit will be $0.5 billion. Spanish
exports continue to benefit strongly from the recovery abroad and the devaluation
of the peseta while tight monetary and fiscal policy hold down the growth in
imports. Shedding Franco's protectionist legacy has been costly and the unemploy-
ment rate has soared to 18.4 percent, second only to Turkey among. OECD
countries. While this is a serious problem that could eventually cause an
unraveling of the economic program and a ballooning in the current account and
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caused foreign competitiveness to wither, hurting exports.
Causes
Government policies oriented toward improving employment and raising workers'
incomes-policies such as public jobs programs, subsidies, and minimum wage
rate increases-reduced foreign competitiveness. The increase in government
spending to 69 percent of GNP in 1982 has resulted in one of the heaviest tax bur-
dens in Western Europe and a government borrowing requirement equivalent to 12
percent of GNP. Although subsidies to industries increased from 3.4 percent of
GNP in 1970 to almost 10 percent in 1980, industrial output did not increase dur-
ing 1970-82. The heavy emphasis on demand stimulation and transfers to
industries impacted heavily on the current account through increased imports.
Devaluations offset the increases in wage costs, but the decline in productivity still
Responses
Stockholm has relied on a 16-percent devaluation in late 1982 to expand exports
and improve its foreign accounts. Plans to tighten fiscal policy to reduce demand
have not materialized, although monetary policy was tightened-which helped to
slow inflation somewhat in 1983. Plans to hold real wage increases to zero this year
will be difficult for the government to sell, given record profits in the export sector
Outlook
The current account improvement this year is estimated by the OECD to continue
in 1985, resulting in a $1.5 billion surplus. We believe this is overly optimistic for
several reasons. Future devaluations to improve competitiveness will not stimulate
exports to the extent the last one did because the Swedish export sector is
approaching full capacity and will need more productive investment to take
advantage of any price change. Prime Minister Palme's commitment to the
welfare system will keep the budget deficit and financing requirement high, which
along with the cyclical pickup in demand will help to keep the current account in
25X1
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source of foreign exchange, were also reduced because of the overvalued lira
Causes
Turkish foreign debt soared during the 1970s, mainly as a result of the
government's inappropriate response to the 1973 oil price hikes. Always jockeying
to stay in power, a succession of weak coalition governments found it impossible to
take the needed steps. By holding down the domestic price of oil and other goods,
maintaining an overvalued exchange rate, and pursuing sharply expansionary
policies, Ankara pushed the current account-which had recorded a $0.5 billion
surplus in 1973-deep into deficit. In addition, a long history of direct government
involvement in the economy through State Economic Enterprises created ineffi-
ciencies and a protected domestic sector that has increasingly discouraged both
domestic and foreign private investment in Turkey. Worker remittances, a major
transactions.
Responses
The 1980 stabilization plan along with direct economic assistance from OECD
countries and the IMF has helped to slow the growth in debt. Inflation and the
government deficit have been reduced, relative prices have been made more
flexible, and the exchange rate consistently has been maintained at a realistic
level. Recently elected Prime Minister Turgut Ozal has forged ahead in the same
market-oriented direction and has removed more restrictions on foreign exchange
repayment to the IMF.
Outlook
Turkey faces a hump in its debt service obligations beginning later this year when
principal repayments on rescheduled debt begin falling due. Meanwhile, exports
are being hurt by the financial problems of OPEC-which now accounts for two-
fifths of foreign sales. In this situation we believe Turkey will not be able to cover
all of its financing needs in 1984 and 1985 without additional official assistance
from the IMF or other OECD governments. We estimate total financing needs for
these two years at about $6.5 billion. Current account deficits for both years will
total about $2.5 billion in addition to which principal repayments on previous loans
and reschedulings worth $3.9 billion will fall due, including a $0.7 billion
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