INTERNATIONAL ECONOMIC & ENERGY WEEKLY

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP97-00770R000100320001-7
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 37
• Document Creation Date: December 22, 2016
• Document Release Date: June 10, 2011
• Sequence Number: 1
• Publication Date: May 3, 1986
• Content Type: REPORT

Declassified in Part - Sanitized Copy Approved for Release 2011/12/29: CIA-RDP97-00770R000100320001-7
Directorate of Secret
Intelligence
International
Economic & Energy
Weekly
30 May 1986
gok-711--
5ke?Lt
?Seeret?
DI IEEW 86-022 V
30 May 1986
Copy
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International
Economic & Energy Weekly
30 May 1986
Secret
iii Synopsis
1 Perspective?Tokyo Summit: Tenuous Progress
3 International Financial Situation: Chile's Creditors Pushing for Political
Liberalization
7 Kuwait: Weathering the Drop in Oil Revenues
11 LDC State Trading Organizations: Stunting Development and Obstructing
Trade
15 LDC Domestic Deficits: The Other Debt Problem
19 Briefs Energy
International Finance
International Trade
Global and Regional Developments
National Developments
Comments and queries regarding this publication are welcome. They may be
directed to Directorate of Intelligence,
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DI IEEW 86-022
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International
Economic & Energy Weekly
Synopsis
Secret
1 Perspective?Tokyo Summit: Tenuous Progress
For the Big Six leaders, the Tokyo Summit achieved the goal of outward unity
by the statement condemning terrorism and a declaration aimed at improving
the interndtional monetary system. They will have difficulty building on these
accomplishments because of domestic political pressure and conflicting eco-
nomic interests.
3 International Financial Situation: Chile's Creditors Pushing for Political
Liberalization
We believe Chile will be able to obtain sufficient foreign lending this year to
cover its financing requirements and support Santiago's export promotion
program. Creditor countries, however, are already threatening to vote against
needed development bank lending unless President Pinochet agrees to political
liberalization measures that would ensure a transition to democracy
7 Kuwait: Weathering the Drop in Oil Revenues
Kuwait faces a number of economic challenges?the decline in oil prices, the
Iran-Iraq war, and the lingering effects of the stock market crash in 1982?
that are hampering government efforts to revitalize the economy. Nonetheless,
with a foreign asset cushion of $80 billion and a small population, the
government probably will be able to shield most Kuwaitis from serious
economic hardships
11 LDC State Trading Organizations: Stunting Development and Obstructing
Trade
State trading organizations play a significant role in many developing country
economies and are important actors in world trade. In our judgment, these
organizations create numerous distortions in LDC domestic economies that
hamper the development process and obstruct international trade.
15 LDC Domestic Deficits: The Other Debt Problem
While much attention has focused on the LDC external debt situation, many
LDC governments are also struggling with a growing internal debt. Although
the LDCs have made some progress, prospects for further substantial reduc-
tions are limited because cuts would increasingly hit politically sensitive areas
such as public-sector wages and consumer subsidies
Hi
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DI IEEW 86-022
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Perspective
International
Economic & Energy Weekly
30 May 1986
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Tokyo Summit: Tenuous Progres 25X1
For the Big Six leaders, the Tokyo Summit achieved the goal of outward unity
by the statement condemning terrorism and a declaration aimed at improving
the international monetary system. West European leaders also generally
regard the summit as a domestic political plus because each came away able to
claim at least some success. Prime Minister Nakasone, on the other hand, has
come under fire from his political opponents, who claim that the summit was a
failure for Japan. His chances for staying in office beyond October, undoubt-
edly hurt by the outcome of the summit, remain tenuous despite the recent an-
nouncement of joint lower and upper house Diet elections for July.
The declaration on terrorism formalizes a generally harder line that began
emerging before the summit. Although the Big Six governments remain
opposed to economic sanctions, they are focusing on promoting international
cooperation, improving security, and expelling possible terrorists. The power-
sharing arrangement between Prime Minister Chirac and President Mitter-
rand probably will bring an even tougher French stance because neither wants
to appear soft on the issue. Paris, however, may still resist some forms of
cooperation if it believes they would compromise its independence on foreign
policy. Rome is trying to reduce its vulnerability to Libyan moves by loosening
economic links now that most Italians have left Libya. Nakasone, however,
was sharply criticized by both his Foreign Ministry and the ruling party for
agreeing to single out Libya in the summit statement. As a result, Tokyo is
sending a delegation to the Middle East in an effort to assuage domestic
concerns, limit damage to its relations with Arab countries, and protect its oil
supplies-70 percent of which come from the Middle East.
While the summit made progress on terrorism, Big Six governments will have
difficulty building on this accomplishment. Another successful terrorist attack
on US interests, for example, almost certainly would renew strains among
summit countries. West European and Japanese officials do not believe the
statement on terrorism approves the US raid on Libya and probably hope that
the stated commitment to cooperate will help them head off a similar US
response to future terrorist acts.
Most summit leaders are publicly expressing satisfaction at what they portray
as good progress on monetary cooperation despite their uncertainty as to when
and how they can follow it up. Prime Minister Craxi, in particular, is
attempting to benefit domestically from Italy's admission, along with Canada,
to a newly formed Group of Seven (G-7). The Italians?next year's summit
host?are likely to try to solidify their position on monetary affairs by pushing
for a strong role in enacting the multilateral economic surveillance plan agreed
to at Tokyo.
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West Germany and Japan reject the notion that multilateral surveillance
should force them to change their policies in response to the economic
indicators listed in the summit declaration. Bonn remains concerned that the
surveillance scheme could compromise its control over its economic policies
and eventually fuel inflation, while Tokyo fears that indicators might be used
by other countries to argue for a further appreciation of the yen. Both still wor-
ry that other summit countries may try to push cooperation further. They also
are disappointed that the United States gave no pledge to shore up the dollar.
Nakasone's domestic critics continue to snipe at his failure to arrange joint in-
tervention against the yen's rise.
Monetary cooperation is likely to be modest until summit countries establish
the type of consensus on exchange rate policy that was reached at the Group of
Five meeting last September. If the dollar begins to drop again, Bonn and
Tokyo almost certainly will press hard for the United States to intervene. Italy
and Canada, meanwhile, are likely to bristle if the continuing Group of Five
makes the major decisions on monetary matters and they remain shut out
despite membership in the G-7.
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International Financial Situation:
Chile's Creditors Pushing for
Political Liberalization
We believe Chile will be able to obtain sufficient
foreign lending this year to cover its financing
requirements and support Santiago's export promo-
tion program. Nonetheless, it will be another year
of tight budgets and restricted imports that could
keep economic growth under 3 percent. Santiago's
economic plan for 1987 calls for economic growth
of more than 4 percent and will probably require
additional foreign lending. Creditor countries, how-
ever, are already threatening to vote against needed
development bank lending unless President Pino-
chet agrees to political liberalization measures that
would ensure a transition to democracy. Should
creditor countries threaten only to veto new project
lending, Pinochet could probably defer?or can-
cel?lending requests until late 1986 or early 1987
without hurting the economy. Delays or cancella-
tions in Santiago's World Bank structural adjust-
ment loan program could undermine Chile's eco-
nomic growth this year and further erode
Pinochet's domestic support.
1985 Economic Performance
Chilean data indicates that the economy achieved
more than 2-percent growth in 1985 despite de-
pressed commodity prices and tight economic poli-
cies. According to the US Embassy, Chile's main
exports?copper and agricultural products?re-
mained even with 1984 levels because of increased
export volume. Moreover, Santiago cut its current
account deficit through a 13-percent reduction in
imports. Additionally, Santiago met its IMF-sup-
ported program targets by maintaining relatively
tight fiscal and monetary policies. Even with these
austerity measures, Santiago still claims to have
reduced unemployment by two percentage points to
11.9 percent and increased real wages in 1985 by
almost 2 percent.
The Chilean press and private economic studies
paint a grimmer picture of the economy. For
instance, they reveal that, although unemployment
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Chile's Foreign Financing Program
Chile concluded a three-year foreign financing
package last year to support an export expansion
program designed to encourage economic growth
and provide foreign exchange to service its debt.
The main features of this program include:
? An IMF Extended Fund Facility providing $750
million over three years for balance-of-payments
support. Repayment, however, of past IMF draw-
ings will reduce the net benefit of these funds.
? A World Bank structural adjustment lending
program that provides for three consecutive loan
years of $250 million each, with disbursement
each year contingent upon successful completion
of the previous year's program and formal ap-
proval by the executive board for the next year's
loan.
? A World Bank cofinanced loan of $300 million
with commercial banks.
? A collection of project loans from the World
Bank and the Inter-American Development
Bank?some already approved and others yet to
be requested?to cover Chile's remaining finan-
cial gaps.
? A commercial bank rescheduling of more than $6
billion in 1985-87 loan maturities and $700
million in loans to be disbursed in 1985 and
1986.
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Chile: Balance of Payments,
1984-87
Million US $
1984
1985
1986b
1987b
Current account
?2,060
?1,329
?1,377
?1,288
Trade balance
293
713
723
907
Exports, f.o.b.
3,650
3,647
3,900
4,273
Imports, c.i.f.
3,357
2,934
3,177
3,366
Net services and transfers
?2,353
?2,042
?2,100
?2,195
Interest
?2,158
?1,889
?1,867
?1,930
Capital account
1,978
1,333
1,338
1,296
Foreign direct investment
67
81
90
90
Net foreign borrowing
1,684
994
1,078
1,070
Net IMF credit
227
258
170
136
Change in reserves
?82
4
?39
8
Estimated.
b Projected.
may have dropped, job creation was heavily weight-
ed toward low-paying and low-productivity com-
merce and service sectors?such as street vending
and household help?while shantytown dwellers
are turning to the growing black market to find
employment. Small businessmen and middle-class
homeowners?hurt by tight credit and a crushing
personal debt burden?are increasingly disgruntled
with government policies.
Politics Shaping Economic Policy
Until recently, Pinochet's economic policies were
primarily shaped by the dual pressures of foreign
creditor demands for fiscal and monetary austerity
and timely debt repayment and domestic demands
for economic recovery. Moreover, beginning last
year Pinochet has had to contend with a new factor:
international pressures for political liberalization.
Creditor countries?upset with Pinochet's harsh
Secret
repression and imposition of a state of siege?
withheld support for a loan package to shore up the
country's deteriorating external accounts. By June,
Pinochet bowed to international pressure for lifting
of the state of siege, and the loan package came
together at yearend.
Creditor countries are again threatening to with-
draw support for Chile in international financial
institutions unless Pinochet agrees to political liber-
alization measures that would ensure a transition to
democracy. In our view, Chile needs its present
multilateral loans to maintain growth in 1986 and
will require an additional $300 million in 1987 to
keep its economy from stagnating. We believe that
Pinochet is sensitive to these threats because he
realizes that a worsening economy will give the
opposition additional issues with which to confront
his regime. Nevertheless, we doubt that economic
growth will significantly cool domestic political
unrest that is largely fueled by popular support for
Pinochet's de arture from office?his term expires
in 1989.
Santiago,
will comply with the conditions of its IMF program
by:
? Continuing its export-oriented program to spur
growth and earn foreign exchange to service its
debt.
? Encouraging import-substitution to conserve for-
eign exchange and support domestic
manufacturing.
? Shifting borrowing to multilateral lending institu-
tions to obtain lower interest rates and easier
repayment terms.
? Decreasing the public-sector deficit by trimming
government work programs and delaying cost-of-
living increases.
? Allowing a rise in interest rates to foster savings
and to reduce growth in domestic consumption to
spur investment.
Outlook
We believe that Chile's 1985-87 IMF program
provides a good framework for Santiago's efforts to
reduce the burden of the public sector on the
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Chile: Selected Economic
Indicators, 1984-87
Percent
Real CDP Growth
Inflation
8
30
0
Real Wage Growth
Public-Sector Deficit.
5
-2
Unemployment
1984 85 866 87b
339259 5-86
1984 85 86h 87
a Public-sector deficit as a
share of GDP.
b CIA projections.
economy and to boost exports. Although we believe
foreign lending levels are adequate for Chile to
meet its external obligations this year, growth
probably will remain below 3 percent because of
continued tight budgets, sluggish world commodity
prices, and restricted imports. The standard of
living for the lower and middle classes will proba-
bly stagnate?although unemployment may fall
slightly, real wages probably will decline. Chile's
export push could begin to bear fruit by 1987, but
only if Santiago obtains another $300 million in
loans. Chile could achieve over 3-percent growth
should the creditors grant these loans in 1986 and
disburse them in a timely manner in 1987.
Pinochet's negative response to growing foreign
insistence on political liberalization, however, could
hurt Chile's economic program. Creditor countries
are threatening to deprive Santiago of access to
multilateral development bank funds by voting
against new project loans and delaying Chile's
1986-87 World Bank structural adjustment pro-
gram. Nevertheless, should creditor countries de-
clare that they will only veto new project lending,
Pinochet could probably avoid an international
confrontation and a loss of prestige at home by
deferring?or canceling?new loan requests until
late 1986 or early 1987. Although this could mean
delays in receiving needed funds in 1987, Santiago
could cover its financing gap by drawing down net
reserves?currently around $1 billion?and seeking
IMF waivers on its program targets until new loans
were arranged. This would give Pinochet more time
to try to defuse domestic pressures and probe
foreign government intentions before deciding what
concessions to offer.
Pinochet, however, would face a more serious do-
mestic threat if creditor countries announce that
they will delay Chile's second structural adjust-
ment loan?one-half of which is due to be dis-
bursed this year?when it comes up for World
Bank Board approval in October. Loss of these
funds could provoke capital flight, take Chile out of
compliance with its IMF program later this year,
and slow commercial bank loan disbursements to
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Santiago. It would also accelerate the decline in
foreign direct investment?Finland recently with-
drew from a major copper mining project, reported-
ly over human rights concerns.
Under these circumstances we believe Pinochet
would either tighten fiscal and monetary policies?
hurting economic growth?or draw down reserves
to keep the economy moving. In either case, we
believe the President's support would erode as the
public?and, in all likelihood, the military?put the
blame for the country's economic troubles on Pino-
chet's mismanagement. In the end, the President
probably would have to either make political con-
cessions or risk even greater challenges to his rule.
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Kuwait: Weathering the
Drop in Oil Revenues
Kuwait faces a number of economic challenges?
the decline in oil prices, the Iran-Iraq war, and the
lingering effects of the stock market crash in
1982?that are hampering government efforts to
revitalize the economy. Nonetheless, with a foreign
asset cushion of $80 billion and a small population,
the government probably will be able to shield most
Kuwaitis from serious economic hardships. To limit
the impact of lower crude prices, the government
has boosted oil production by pricing it competi-
tively and marketing products through its distribu-
tion networks in Western Europe. The National
Assembly will closely monitor the government's
efforts to manage the economy and will intensify its
criticism of the regime if it is dissatisfied with the
government's performance.
Tinkering With the Budget
Kuwait's oil earnings?which account for nearly 90
percent of government revenues?have fallen by
almost one-half since 1982. Since then the govern-
ment has carefully adjusted its budget and for FY
1984 (July 1984?June 1985) adopted a series of
austerity measures to keep spending in check.
Although defense expenditures were maintained,
the government cut development spending and for-
eign aid and without public announcements re-
duced actual expenditures 17 percent below budget
projections, according to the US Embassy in Ku-
wait.
The cuts planned for FY 1985 proved inadequate
once oil prices began their precipitous slide. Last
February the government announced an additional
15-percent reduction in expenditures from those
projected in the FY 1985 budget. Retrenchment
included the cancellation of nonessential develop-
ment projects, reduced benefits for expatriates, and
a freeze on the employment of foreigners. Despite
vociferous opposition from the National Assembly
and accusations of widespread mismanagement and
corruption, the drastic decline in revenues even led
the government to consider cutbacks in generous
7
Kuwait: Budget Deficits,
1983-86 a
Million US $
1983
1984
1985b
1986
Revenues
10,501
9,149
10,744
6,411
Oil
9,745
8,160
9,657
5,520
Other
756
989
1,087
891
Total expenditures
10,902
10,829
13,009
11,408
Current expenditures
9,741
9,801
11,832
10,767
RFFG d
1,058
925
1,074
641
Increase in KFAED capital e
103
103
103
Deficit f
401
1,680
2,265
4,997
d Fiscal year beginning 1 July of stated year.
b Budgeted.
c Proposed.
d Reserve Fund for Future Generations is set at 10 percent of total
revenues but may not be used until 2001.
c Kuwait Fund for Arab Economic Development.
f Deficits are covered by withdrawals from the State General
Reserve Fund. Budget deficits are misleading, however, because
transfers to the reserve funds are included in expenditures, but
investment income is not included in revenues.
domestic subsidy programs. Last November the
government proposed an increase in electricity
rates?the first since 1966?that would save $450
million per year and has considered imposing fees
for medical and other services that are currently
free. Although only 1.5 percent lower in real terms
than in the FY 1984 amended budget, the reduced
spending prolonged Kuwait's economic slump be-
cause of the key role the government plays in
stimulating economic growth.
The draft FY 1986 budget reflects the govern-
ment's goal of trimming fat and reducing subsidies
without choking economic growth. It projects a 40-
percent drop in revenues and a nearly 10-percent
cut in current spending compared to last year's
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budget. For the most part, the cuts will not directly
affect Kuwaiti citizens. Kuwait's annual contribu-
tion of about $100 million to the Kuwait Fund for
Arab Economic Development has been dropped.
Spending for government salaries has increased,
however, and Finance Minister al-Khurafi affirmed
that cutbacks would not affect previously planned
social services and housing projects, according to
press reports.
The government will be able to cover the nearly
$5 billion deficit projected in the new budget. The
deficit figure is misleading because of Kuwaiti
accounting practices, which understate revenues to
keep expenditures down. The government excludes
investment income as revenue, and counts contribu-
tions to the government's two investment funds as
expenditures. According to the US Embassy, in-
vestment income has been averaging $4 billion in
recent years and could be even higher if the
government sells some of its equity holdings.
Financial Sector Bailout
Although willing to bail out some banks and bor-
rowers to preserve the integrity of the financial
system, the government has proposed sharing the
burden among all three parties. A compromise plan
put forward by the Kuwaiti Chamber of Commerce
calls for the government to provide long-term de-
posits at favorable rates, guarantee all commercial
banking activities for the next decade, and
strengthen the central bank's regulatory role.
Banks would be forced to absorb part of their loan
losses and accept reduced profits by rescheduling
debts at concessionary rates. The plan also deals
harshly with debtors?many of whom refused to
pay their obligations even when they had the means
to do so?but this would be difficult to implement
because of the high number of I
influential businessmen among the
The economy is still suffering from the effects of
the collapse of the unofficial stock market in 1982.
When the speculative bubble burst, nearly 6,000
investors saw their financial positions crumble.
Banks were faced with huge writeoffs because of
the liquidity crunch suffered by many borrowers
and the plummeting value of collateral?mainly
securities and real estate. The government inter-
vened to rescue failing companies and increased its
ownership from 36 percent of all shares on the
stock market to more than 50 percent.
The government recognizes the magnitude of its
economic problems and last November called in the
World Bank and the IMF to chart a future course
for the economy. Meanwhile, it proposed to buy out
local shareholding companies at a cost of $700
million and is looking for ways to resolve the debt
crisis faced by commercial banks as a result of the
crash. Reaching a solution has been complicated by
disagreement over who is to blame for the problem
and by the influence of some of the biggest losers in
the crash.
Secret
debtors.
National Assembly leaders are worried about the
government's growing power within the economy
and oppose its ownership of such a large proportion
of Kuwaiti private companies. Some members are
concerned that the private sector is becoming too
dependent on government financial assistance. Oth-
ers believe that no public money should be used to
bail out banks because bankers' greed is to blame
for the debt crisis, according to the Embassy.
Outlook
Kuwait probably is better able than any other Arab
oil producer to cope with the current downturn in
the oil market. In addition to its $80 billion foreign
asset buffer and small population, the government
has diversified the oil sector into downstream oper-
ations?it has captured about 6 percent of the
retail market in Western Europe,
?assuring an outlet
for its crude and refined products. The current
account surplus has been shrinking, but cuts in
imports will keep it at a healthy $4.5 billion for this
fiscal year. The government has also responded to
the decline in oil prices by aggressively pricing its
exports and boosting production to more than 1.5
million b/d, its highest level in five years.
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Despite a relatively sound economic position, the
required budget cuts will further depress the econo-
my?economic growth was less than 1 percent last
year and probably will be negative this year. Re-
trenchment will increase the efficiency of economic
operations in Kuwait, but the expatriate and busi-
ness communities probably will suffer dispropor-
tionately. The impact of the loss of large numbers
of foreign laborers is unclear; reduced spending on
expatriates will provide some savings, but replacing
these laborers, particularly skilled managers and
technicians, will be difficult. The business commu-
nity will face declines in company earnings, share
prices, and bank profits. Capital flight probably
will increase because of fears generated by econom-
ic uncertainty, declining investment opportunities,
and the recent flareups in the Iran-Iraq war. This
will leave few resources to revive the economy.
The government's efforts to manage the economy
will be further complicated by its need for National
Assembly approval of the budget. Many members
are unhappy with the government's management of
the economy and are unlikely to accede to govern-
ment-proposed cuts in subsidies and benefits. The
increasing assertiveness of the Assembly probably
will make the government more responsive to its
demands. Compromise with the Assembly would
give government decisions broader support but
would make it difficult for the government to make
some of the tough policy choices it believes are
required.
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LDC State Trading Organizations:
Stunting Development and
Obstructing Trade
State trading organizations (STOs) play a signifi-
cant role in many developing country economies
and are important actors in world trade. These
organizations are located throughout most of the
developing world, usually trading in economically
important commodities such as foodstuffs, industri-
al inputs, and energy resources. In our judgment,
these organizations create numerous distortions in
LDC domestic economies that hamper the develop-
ment process and obstruct international trade.
Many LDC governments are beginning to recog-
nize that corruption, costly subsidies, and ineffi-
ciency plague these trading organizations and are
acting to reduce their role through privatization,
budget cutbacks, and streamlined procedures.
Stunting Development
STOs dominate the trade relations of many LDCs.
While no reliable data on the total number of STOs
are available, we believe that their number has
grown rapidly over the past few decades. STOs are
especially important in countries, such as Algeria,
Burma, Guinea, Iraq, Syria, Uganda, and Zaire,
whose foreign trade sectors have become virtual
state monopolies. STOs have some positive effects
on LDC economies, such as increased employment
opportunities, but, in our view, these are largely
overshadowed by their negative impacts. Indeed,
we believe STOs have stunted Third World devel-
opment by causing numerous distortions:
? They have created inefficiencies that have driven
up domestic prices, pulled capital away from
private firms, and sapped LDC treasuries of
scarce resources. For example, Mexico's food-
importing STO, CONASUPO, is expected to lose
about $1.5 billion in 1986?equivalent to nearly 1
percent of GDP.
11
STOs: A Definition
We define STOs in broad terms to include:
? Government departments?buy or sell goods on
the nation's behalf.
? Marketing boards?organizations set up to
channel exportable goods through a single gov-
ernment body. Domestic producers are usually
required to sell all of their output to the board,
giving it the power to set domestic prices. Govern-
ment marketing boards largely exist because of
the lack of a sophisticated tax infrastructure?
they are one of the few reliable means of collect-
ing revenues.
? Public production enterprises?firms using ei-
ther their own trade infrastructure or sales
agents abroad to market their output. The state-
owned oil and steel companies are the most
significant examples of public production enter-
prises involved in foreign trade.
? State trading companies?government-con-
trolled commercial corporations that are primar-
ily engaged in activities related to international
trade and that are organized and operated for the
ur ose o carrying out their entrepot mission.
? LDCs' state coffers have been drained of billions
of dollars through STO-related corruption. For
example, a Brazilian Coffee Institute audit of
warehouse records discovered that nearly 17,000
bags of coffee worth nearly $900,000 disappeared
in March 1985. In another example, Zaire's
President Mobuto has siphoned off at least $1
billion from the state mining enterprise SOZA-
COM, according to local press reports.
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Secret
? Foreign investment has been blocked by these
domestic monopolies and by practices that dis-
courage the inflow of foreign funds, restricting
competition, efficiency, and flow of technology.
Foreign investment in LDC oil industries is im-
paired by tight restrictions on foreign participa-
tion that often includes majority control by the
national oil company.
? STOs have distorted production incentives by
setting artificially low producer prices. In Tanza-
nia, the producer price of coffee was $1.42 per
kilo while the export price was $3.25 during
February 1986. These policies have caused major
declines in agricultural production in many
LDCs. For example, in Ghana?which earns well
over 50 percent of its export revenue from cocoa
sales?low producer prices have been the princi-
pal cause of the decline in cocoa production from
a peak of about 540,000 metric tons in 1965 to
about 158,000 tons in 1984.
Obstructing Trade
In addition to their adverse impacts on LDCs'
domestic economies, STOs engage in a number of
practices that are inimical to free trade. STOs
often engage in unfair export practices?dumping
and subsidies?to boost employment, expand the
volume of goods traded, increase their share of
foreign markets, and earn needed foreign exchange.
Many LDC governments also subsidize
STOs in targeted export industries, which in turn
allows the STOs to sell at lower prices. For exam-
ple, the Commerce Department has found that the
majority of US imports from the Venezuelan state-
owned steel enterprise were subsidized at a rate of
about 75 percent.
STOs may also restrict trade by raising the price of
or placing quantitative limits on imported goods.
Paraguay, for example, restricts wheat imports
Secret
STOs' Share of
National Trade
in Selected LDCs a
Percent
Imports
Exports
Algeria
100
100
Argentina
4
13
Brazil
35
65
Burundi
95
50
Egypt
90
72
India
20b
60
Mexico
75
43
Peru
87
27
Sri Lanka
12
38
Syria
89
8
Tanzania
75
75
Venezuela
95
20
a CIA estimates.
6 Exports have run as high as 50 percent in recent years as a result
of crude oil sales that are expected to be a temporary phenomenon.
through an STO as part of its National Wheat
Self-Sufficiency Program. Indirectly, the ineffi-
ciency of STOs also leads to restricted trade
through higher cost imports and lengthy, burden-
some administrative procedures. The inefficiency of
Zaire's SONATRAD adds 10 to 12 percent to the
purchase price of imported goods
STOs have been a significant force behind the
growth of countertrade?a challenge to a liberal
trade environment because it raises costs and often
results in discriminatory trade practices. Nonethe-
less, the governments of many LDCs encourage
these countertrade arrangements in hopes of in-
creasing exports and conserving foreign exchange.
STOs can justify the added costs as necessary to
meet national goals and can often force such deals
through their monopoly or monopsony positions. In
1982, Brazil's state-owned oil company announced
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that all countries exporting oil to Brazil were
required to purchase an offsetting amount of Bra-
zilian goods. As a result, according to US Embassy
reporting, countertrade deals have been concluded
with Algeria, Iran, Iraq, Malaysia, Mexico, Nige-
ria, and Venezuela.
The Future of STOs: Pressure for Reform
But Political Resistance
STOs will continue to play an important role in
LDC domestic economies and the world trading
system. We believe the growth in their number will
slow from the pace of the past few decades, howev-
er, because many LDCs are beginning to recognize
that corruption, costly subsidies, and inefficiency
plague the organizations. The government of Trini-
dad and Tobago intends to reduce the ranks of the
national sugar enterprise by 4,500 jobs over the
next three years. In a few cases, LDC govern-
ments?Argentina, Brazil, Guinea, Mexico, and
Pakistan, for example?are seeking to privatize or
liquidate some smaller public enterprises, but the
large STOs are not likely to be affected. In addi-
tion, some LDCs?such as Ghana, Nigeria, and
Zambia?are likely to disband the boards, reduce
their inefficiency, or raise roducer prices as part of
agricultural reform.
Compliance with IMF-backed austerity programs
also is driving some LDCs to undertake certain
structural adjustments that directly affect STO
Mexico is eliminating most food subsidies. Similar-
ly, the IMF has pressured Mali to reduce losses of
the trading company SOMIEX by terminating its
monopoly on the sale of basic foodstuffs. In a
tentative understanding between the IMF and Sier-
ra Leone, Freetown has agreed to reduce the role of
the Precious Metals Marketing Company, the Gold
and Diamond Office, and the Produce Marketing
Board.
Despite these pressures for reform, the dismantling
of LDC STOs is meeting considerable political
resistance. STOs often serve the vested interests of
many LDC elites. Some LDC leaders siphon off
huge sums of money from STOs for political or
13
Secret
personal purposes. STOs also play an important
role in maintaining political stability by subsidizing
critical commodities. Moreover, attempts to elimi-
nate STOs could stir nationalist sentiment as the
domestic economy is increasingly exposed to for-
eign competition. 25X1
25X1
Implications for the United States
The United States has a considerable stake in the
outcome of STO reform. The dismantling of these
organizations would help the US efforts under the
Baker Plan to promote structural adjustment in the
Third World to reduce the burden of large LDC
debts. Such adjustment would also reduce LDC
needs for increased economic aid and other conces-
sions. In the long run, reform would support US
interests in enhancing political stability by reducing
domestic economic frustration resulting from low
economic growth. Finally, reform could reduce
political strains stemming from growing economic
disparities between LDCs and industrialized coun-
tries. On the commercial side, US firms would gain
from an improved investment climate, greater ac-
cess to LDC markets, and a reduction in counter-
trade, dumping, and subsidies.
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LDC Domestic Deficits:
The Other Debt Problem
While much attention has focused on the LDC
external debt situation, many LDC governments
are also struggling with a growing internal debt.
Although the LDCs have made some progress since
1982, the measures taken to slash overall deficits
have come at the cost of long-term growth and
economic reform. Prospects for further substantial
reductions are limited because cuts would increas-
ingly hit politically sensitive areas such as public-
sector wages and consumer subsidies.
Budget Deficits Since 1980: Soaring, Then Falling
In the years preceeding the LDC financial crisis,
overall public-sector deficits soared. In 1980-82,
annual deficits as a share of GDP roughly doubled
in Argentina, Brazil, Mexico, and Peru, and more
than tripled in the Philippines. With the onset of
the LDC debt crisis in 1982, external financing of
budget shortfalls began to decline, and in several
LDCs internal financing ballooned to compensate.
Because of IMF pressure and the inability of
domestic capital markets to handle the increase,
many of the major LDC debtors?including Mexi-
co, the Philippines, Argentina, and Peru?took
steps to reduce public-sector deficits.
Despite budget-cutting measures, other LDCs have
not been as successful. Brazil's public-sector defi-
cits, for example, have continued to rise at an
average 4 percent of GDP every year since 1980,
and stood at 28 percent last year?almost com-
pletely financed internally. Although Brasilia has
nearly brought revenues in line with capital expen-
ditures and current outlays, interest payments on
the debt continue to swell the fiscal gap.
Measures To Slash Deficits: Mixed Blessing
To slash public-sector deficits, LDC governments
took actions both helpful and harmful to the long-
term development of their economies. On the
15
Secret
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Large Internal Deficits:
Inflicting Economic Damage
Beyond enlarging the role of the government in
LDC economies, internal public-sector deficits can
create obstacles to broader economic goals. To
finance their deficits, without borrowing from
abroad, LDC governments must choose between
two unattractive alternatives. Borrowing from the 25X1
nonbank private sector drives up real interest
rates?reducing private-sector investment. Borrow-
ing from the domestic monetary authorities in-
creases the money supply?fueling inflation. 25X1
Moreover, rather than channeling the borrowed
funds into public investment, LDC governments
have spent more heavily on current consumption.
Because these increased government expenditures
are not matched by increased taxes, overall domes-
tic demand grows?raising imports and undercut-
ting investment in export industries. As a result,
large deficits have weakened LDC balance-of-pay-
ments positions?reducing the LDCs' ability to
service their external debts?and have hurt indus-
trial development prospects.
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positive side, several LDCs have attempted to sell
money-losing parastatals. In particular, the Mexi-
can Government has tried to ease the strain on the
federal budget by selling unprofitable enterprises,
according to Embassy reporting. The government
reports that, as of late 1985, 129 entities were sold,
dissolved, or transferred to local governments since
the onset of the LDC debt situation. This has had
little impact on the budget deficit, however, be- 25X1
cause as the economy contracted, the government,
to protect employment, was forced to absorb more
companies than it sold or dissolved. 25X1
Even when they cannot rid themselves of such
parastatals, governments have often taken steps to
decentralize?forcing local authorities to fund their
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Secret
Selected Debtor LDCs: Financing
Public-Sector Deficits, 1980-853
Percent
Argentina
20
Brazil
0
Mexico
20
Philippines
5
0
Peru
319263 5.5
Secret
1980
External
1= Internal
85
a Public-sector deficits as a share
of GDP. The IMF definition of
public-sector borrowing
requirements, which includes local
governments and state enterprises,
is used in this study. For the
Philippines however, the limited
data available restrict us to
examining central government
accounts.
own operations rather than rely on central govern-
ment subsidies. For example, in 1985 five Argen-
tine enterprises?including the national telephone
and oil companies?that accounted for more than
16 percent of treasury transfers in 1984 lost direct
access to central funds. This loss of subsidies
creates incentives to set more realistic prices. Over-
all, many of these deficit-reduction measures re-
duce the share of the economy controlled by the
public sector?freeing resources for the more dy-
namic private sectors.
Some government policies to deal with public-
sector deficits are, however, impairing long-term
growth and other reform measures:
? Delaying Exchange Rate Reform. Because LDC
governments must often buy dollars from private
exporters to service external public-sector debt,
devaluations raise the domestic-currency cost of
debt service?putting additional pressure on the
deficit.
? Postponing Investment. Governments often
choose to shift the political effects of expenditure
reduction by targeting long-term productive in-
vestment, rather than popular programs such as
food and energy subsidies. To meet its 1986 IMF
deficit target, for example, Argentina agreed to
cut investment in its nuclear and hydroelectric
projects, according to the US Embassy.
? Increased Taxation. One obvious way to reduce
deficits in the short term is raising taxes. For
example, the tax bite in Argentina rose 2.5
percentage points of GDP last year.
In addition to raising taxes, governments often opt
for indirect revenue measures. Last year, for exam-
ple, Argentina began a forced-savings plan requir-
ing individuals and businesses to lend money to the
government, with repayment conveniently sched-
uled after the current administration leaves office,
according to Embassy reporting. In addition, we
have seen more government operations simply post-
poning payments to their domestic suppliers?
which slows the overall economy and, at high LDC
interest rates, makes the ultimate debt worse.
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Obstacles to Further Reform
Given the lack of progress after the initial deficit
cuts, we are not optimistic about further reduc-
tions. Budget projections in Brazil and Argentina
call for smaller deficits in 1986, but these countries
and most other debtors have poor track records in
meeting their budget austerity goals. In most other
major LDCs, cuts in public-sector expenditures
have been directed at central government pro-
grams, which are under closer federal government
control?spending by parastatals and local govern-
ments has been more difficult to restrain. In the
extreme case of Peru, President Garcia's move to
unilaterally limit foreign debt-service payments
reduced the pressure on the domestic budget. Other
economic reform measures?particularly devalua-
tions?are adding to the LDC budget burden.
In our judgment, political pressure for increased
government spending is likely to be particularly
acute for the major LDC debtors over the next few
years. Further expenditure cuts that would increas-
ingly hit politically sensitive programs such as
public-sector wages, direct consumer subsidies, and
subsidized parastatal prices would worsen the de-
cline in living standards. Embassy reporting from
Brasilia predicts that subsidy expenditures are like-
ly to rise as this November's nationwide election
approaches. The new Philippine Government is
unlikely to take drastic measures to cut its deficits.
In Argentina, President Alfonsin has
already faced increased opposition to his reform
programs from labor, and large repayments on the
government's forced-savings plan will be necessary
in four years
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Secret
Iran Resuming
Oil Shipments
to Syria
Somalia's IMF
Troubles Not Over
China Seeks
Western Financing
Sri Lanka May Seek
Additi nal A
Briefs
Energy
Iran is attempting to shore up its political ties to Damascus by increasing oil
shipments to Syria. The decision was apparently made during the Syrian
Foreign Minister's recent visit to Tehran. Since last summer, Syria's failure to
pay for previous shipments and a pricing dispute have held oil shipments to
well below the agreed 120,000 b/d. Tehran is probably trying to prevent a Syr-
ian tilt away from Iran, to ease tensions over Lebanon, and to stay on good
terms with Damascus at a time when both countries face increased interna-
tional criticism for their involvement in terrorism. Syria would have difficulty
making large payments on its Iranian debts?which may be as high as $2
billion?but could make at least partial payments on new oil shipments. Iran is
also short of foreign exchange but probably would accept token payments to
maintain its political links to Damascus.
International Finance
Somalia's 1985 IMF standby arrangement, recently threatened by a buildup
of arrears, was rescued by a combination of bridge loans from US banks and
Western donor support. Mogadishu, however, will continue to have difficulty
making its $147 million in scheduled payments to the Fund for the 1987-90 pe-
riod. Since 1981, exports have averaged only about $100 million per year, and
Somalia almost certainly will require substantial external assistance.
Beijing officials recently told Western banking officials that China intends to
spur economic growth by raising $50 billion from foreign sources over the next
four years. The funds are to come, in approximately equal portions, from new
loans, joint ventures with foreign firms, and other foreign investments in
China. This marks a significant change in China's international financial
activity. Since opening to Western markets in 1979, China has absorbed an av-
erage of $3 billion in foreign funds annually, only two-thirds of the amount
pledged by foreign entities. Although the new foreign investment goals are
significantly higher, domestic investment is also scheduled to increase dramati-
cally over the next four years, keeping foreign funds less than 5 percent of total
Chinese investment.
Higher defense expenditures to counter the growing Tamil insurgency may
prompt Colombo to seek an IMF standby agreement as well as ask for
increased assistance during a 3 June meeting with aid donors. Defense
spending has aggravated the country's budget deficit, which in 1985 increased
from a projected $800 million to about $2 billion. Meanwhile, the price of
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Secret
LDC Disagreement
on MFA Renewal
International
Rubber Agreement
Meeting Ends
Without Accord
Britain Signs New
Trade Agreements
With China
Secret
30 May 1986
tea?which accounts for over 30 percent of government revenues?remains
low. As a result, Colombo has relied on commerical borrowing to fill the gap.
Despite Sri Lanka's apparent need for aid, donor nations have expressed
concern over the impact of the insurgency on the economic health of the
country and may threaten to withhold future assistance in an effort to pressure
Colombo to seek a settlement.
International Trade
Textile-exporting LDCs continue to be divided over renegotiation of the
Multifiber Arrangement (MFA) and are planning to meet on 5-6 June to
deliberate issues such as product coverage and market access. Hong Kong,
Pakistan, the Philippines, and South Korea would like any new agreement to
be substantially more flexible and contain more favorable provisions, such as
increased export quotas. Many LDCs are uneasy over India's proposal to phase
out the MFA, and they oppose a return to GATT rules within three years. The
Indian proposal is being interpreted by other LDCs as another attempt to
pressure them into adopting a common position on the MFA and to providing a
direct link between textiles negotiations and the new GATT Round. The lack
of agreement over the MFA phaseout and other issues has caused a setback in
the LDC efforts toward a joint strategy.
A meeting to negotiate the Second International Natural Rubber Agreement
(INRA) ended last week without an accord. As expected, the major stumbling-
block was the floor price?the price below which natural rubber is not allowed
to fall. Exporting members, led by Malaysia, view the current floor price as too
low and want a sizeable increase reflecting the growing cost of production.
Importing members, on the other hand, view a price increase as unacceptable
and favor a pricing mechanism that more closely tracks market conditions.
Plenty of time remains to hammer out a new agreement?the current INRA
does not expire until October 1987. Success, however, will probably depend on
how much exporters are willing to give in, since readily available supplies and
probable continued slow growth in natural rubber demand have placed them in
a weak bargaining position.
Global and Regional Developments
London and Beijing last week signed financial and investment agreements that
should improve Britain's competitiveness in the Chinese market and lead to a
healthy expansion in bilateral trade?which totaled $900 million in 1985. A
soft loan facility to promote British exports could make up to $450 million in
concessional financing available for Chinese development projects over the
next 20 years. Four projects?including the Yueyang power station in Hunan
Province and telecommunications equipment for Shanghai?have already been
approved by London and 10 more are under discussion. The loan package is
20
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Secret
Beijing Seeking
US Jet Engines
From Israel
Argentina and
Britain Resume
Trade Relations
Venezuela
Forging New Ties
to Guyana
the first offered by the United Kingdom under the new mixed credit system
announced last fall; the program provides funds from the trade and aid budget
to British banks to enable them to make long-term, low-interest loans to
selected countries. Among other provisions, the agreement clarifies some areas
of Chinese law that hampered British investment, and reportedly includes a
guarantee for the repatriation of capital, profits, and fees and requires timely
and full compensation if an investment is nationalized.
25X1
25X1
The Chinese reportedly 25X1
are considering the J79-GE-17 engine, built in Israel under a US license, for
their F-8 fighter. Over the past five years, China has bought air-to-air missiles,
tank guns, and other arms from the Israelis, but
has curtailed purchases from Israel recently because of political
sensitivities. China's recent successes in acquiring military technology from
Western Europe and the United States probably also have dampened enthusi-
asm for Israeli arms. Beijing is very interested in this offer, however, in order
to gain Western engine technology or in case attempts to obtain engines from
the United States fail. Tel Aviv recognizes that US approval is required to sell
the J79 but may delay requesting permission for a transfer until a tentative
agreement is reached with Beijing.
Argentina lifted its informal trade ban against the United Kingdom and is
encouraging private-sector commercial relations between the two countries. If
this trade does not prove politically controversial, state-enterprise participation
will follow, Although the trade
resumption reopens markets for Argentine steel and agricultural products, it
may not fulfill Buenos Aires's hopes of enhancing its debt-servicing ability.
During 1981?the last full year before the Falklands war?Argentine imports
from Britain totaled $322 million while exports totaled only $218 million.
Moreover, approximately half of these exports was beef, and Buenos Aires is
unlikely to recapture its former dominant position in a market now well
supplied by the EC
Venezuela is shipping 10,000 b/d of oil to Guyana under a one-year agreement
designed to alleviate a severe petroleum shortage. According to US Embassy
sources, Caracas will finance more than one-third of the shipments with a $24
million loan and has also agreed to buy 540,000 metric tons of bauxite this
year and more next year. Venezuela is seeking new export markets for its
petroleum products generally, but the concessionary terms suggest that
President Lusinchi's main objective is to forge closer ties to Guyana's
President Hoyte. Lusinchi apparently sees Hoyte as less radical than his
predecessor, the late Forbes Burnham. Caracas may also have received reports
21
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Secret
Honduran-Nicaraguan
Barter Agreement
Vietnam Bartering
for Malaysian
Textile Mills
Canadian Economic
Outlook Gloomier
Secret
30 May 1986
that Georgetown wants to shift its foreign policy toward the West. Guyana,
desperately short of oil since Trinidad, its major supplier, demanded payment
in cash last fall, probably is responding to Venezuela's initiative out of
economic pragmatism.
Under a mid-May accord, each country can export up to $10 million to one an-
other during the remainder of 1986, according to the US Embassy. Any
imbalance is to be settled every three months under the supervision of both
countries' central banks. Some Nicaraguan firms?particularly transnationals
or others that have had close business contacts in Honduras?are likely to try
to barter some of their final product to obtain currently unavailable supplies.
The new barter deal apparently will not affect the nearly $60 million in
Nicaraguan arrearages to Honduras. Nevertheless, Honduras probably hopes
that renewed bilateral trade will eventually lead to the recovery of some of the
debt. Nicaragua probably views the new accord as a way of reducing its
economic and political isolation in the region.
Vietnam is offering to exchange seafood products for the equipment and
machines of idled Malaysian textile mills,
_I Vietnam would hope to use the Malaysian equipment to produce
textiles for sale to other Communist countries. We believe this deal is not likely
to be completed, however, because Malaysia has relatively little need for
Vietnamese seafood, and Hanoi has been hard pressed to fulfill its existing
export commitments to the USSR for seafood and other products. Moreover,
Vietnam's irregular electric power supply would almost certainly hamper
operation of the mills, and its chronic shortage of foreign exchange would limit
purchases of both raw material inputs and necessary spare parts.
National Developments
Developed Countries
Lower oil prices and a large budget deficit have prompted both public and pri-
vate forecasters to trim projections of 1986 real GNP growth in Canada?all
of the predictions are below the 1986 budget's 3.7-percent projected rate of
growth. Forecasters now expect real GNP to expand by 3 to 3.5 percent this
year compared with 4.5 percent in 1985. A dropoff in capital expenditures in
the energy sector is expected to be largely responsible for slowing real
investment growth to one-half 1985's 8.1-percent pace,
Most forecasters agree that lower oil prices will reduce inflation and
spur consumer spending, but they anticipate that higher taxes will lower the
rate of private consumption growth to 3.7 percent. In spite of the economic
slowdown, the unemployment rate probably will fall by nearly 1 percentage
point to 9.7 percent during 1986.
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Secret
Canadian Concerns
Over Foreign
Ownership
Japanese Election
Politics and
Economic Policy
Japanese Current
Account Projections
Revised Upward
Tokyo Plans
Measures To Help
Small Businesses
25X1
Ottawa is concerned that its goal of 50-percent Canadian ownership of the
energy industry by 1990 could be undermined by foreign takeovers of smaller
Canadian companies. The Tory commitment to increasing Canadian control of
the energy sector survived last year's measures to deregulate the energy sector,
despite US objections. Ottawa's effort to promote a greater Canadian role in
energy is further complicated by the need to ensure that any government aid to
oil companies does not wreck its deficit reduction targets. A further hike in the
gasoline tax, with the revenue earmarked for smaller companies, would be a
likely, though politically unpopular, option. A less likely option, though
reportedly favored by Energy Minister Carney, would require foreign firms to
divest control of any new Canadian purchase within two years.
Prime Minister Nakasone this week won both Cabinet and ruling party
endorsement for his plan to hold elections to both houses of the Diet on 6 July
by promising to back a $17.6 billion supplemental budget this fall, according
to the US Embassy. Press statements suggest that some party leaders are
leaning toward substantial economic stimulation after four years of spending
restraints; others characterize Nakasone's budget promise as a reversal of his
commitment to fiscal austerity. Nonetheless, a major shift in Tokyo's budget
policy is probably not imminent. Although larger than the government
previously contemplated, the supplement would be only 6 percent more than
the initial budget for fiscal 1986. Even this amount is not assured because of
Finance Ministry opposition. Nakasone, moreover, has stated that any supple-
mental spending must not thwart Japan's goal of ending some types of deficit
financing by 1991. It nevertheless is possible that Nakasone's wish to extend
his term past October, ruling party leaders' desire to increase public works
spending, and a sharp deterioration in the economy could create a consensus
for a much larger supplemental budget before the Diet session in September.
Over the past month, both public and private Japanese forecasters have
substantially increased their projections of the current account surplus for
fiscal year 1986, which began 1 April.
projects an $85 billion surplus, compared with the record $55 billion in the pre-
vious fiscal year. Other Japanese forecasts now range from $70-80 billion.
(Our current forecast?for calendar year 1986?is $70 billion.) The rapid
growth of the current account surplus results principally from the stronger yen,
which inflates the dollar value of Japanese exports?despite an expected
decline in volume?and the sharp drop in the price of crude oil. Tokyo?with
an eye on trade legislation being debated by Congress?has not yet publicly re-
vised its official $60 billion current account forecast
According to press reports, MITI has recently drafted measures to assist small
businesses hurt by the yen's rise. Although MITI claims no timetable has been
set for implementation of the new programs, we believe measures will be
enacted quickly given the likelihood of general elections in early July. Another
possibility is that the funds will be set aside in the supplemental budget that
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Greek Shipping
Industry Fighting
New Decree
Venezuela
Confronting
Declining
Oil Revenues
Secret
30 May 1986
will be introduced this fall. Like measures enacted in February, the new
programs would allow small and medium-sized companies?firms with fewer
than 300 employees and less than $500,000 of capital?lower interest rates on
outstanding government loans. In addition, the amount and scope of loans will
be increased. Details are not yet available, but we suspect that the new
package will have only a moderate impact on the ability of small companies to
maintain long-term export levels if the yen remains strong. In our view, the po-
litical influence and economic importance of small firms is probably sufficient
to ensure at least moderate relief measures remain part of Tokyo's efforts to
alleviate economic sluggishness caused by the yen's rise.
The Greek Government and its ailing shipping industry are battling over a new
government decree that increases shipowner contributions to the Greek
Seamen's Pension Fund from 11 percent to 14 percent of their monthly wage
bill. The move is intended to prevent bankruptcy of the fund, whose deficit
reached $83 million in 1985 and is expected to top $140 million this year.
Shipowners claim that the new policy will accelerate the decline of the Greek
fleet?down to 2,442 ships in January compared with nearly 3,900 at the end
of 1981. The high wage levels of Greek seamen, as well as increasing
government regulation and the international shipping recession, are the major
causes of the decline. The industry's problems have worsened the country's
already serious foreign payments problems. Receipts from shipping?tradi-
tionally an important source of foreign exchange?fell from $1.8 billion in
1981 to $1 billion last year.
Less Developed Countries
The Lusinchi administration is confronting a projected $5 billion shortfall in
oil revenue by extending controls on imports and negotiating revisions in the
$21.2 billion debt deal reached with banks in February. Earlier this month the
government cut the private sector's foreign exchange allocation for imports by
10 percent from last year's $5.1 billion. Certificates of origin on imported
goods are now required to discourage overinvoicing and force greater use of
trade financing. According to the US Embassy, the administration is avoiding
a devaluation because the resulting inflation would have negative political
repercussions. Although the Embassy reports that the government has yet to
finalize its negotiating strategy, we believe that negotiations with bankers are
likely to be difficult and drawn out. According to Embassy and press reporting,
possible demands include: interest rate concessions; rescheduling of $2.3 billion
in principal due in 1987 and 1988; extension of the refinancing period to 15
years from 12; and $3 billion in new money. The government has decided to go
ahead with the $750 million downpayment promised in February, according to
the Embassy. Creditor banks will almost certainly insist that the government
assume the external debt of two failed private banks in return for rescheduling
the 1987-88 maturities and extending the refinancing period. In our view, new
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Secret
Brasilia
Moves Against
Budget Deficit
New Honduran
Economic Program
Libyan Salary Cuts
money would only be possible if Caracas were to agree to an IMF or World
Bank program?a step that Lusinchi has rejected in the past. Major conces-
sions by creditor banks in the upcoming negotiations with Mexico could
further complicate the Venezuelan negotiations.
Brazil's National Monetary Council recently enacted several measures to
decrease the budget deficit. According to the US Embassy, interest rates on
subsidized agricultural credits were raised, crop subsidies were reduced, and
payments under price support programs were deferred. In addition, the council
limited lending by state banks to the public sector?a loophole that sank
several previous attempts to control the deficit. While government officials are
still publicly predicting a sharp decline in the budget deficit this year from last
year's 3.8 percent, they apparently were concerned by the $900 million deficit
in March. We believe that Finance Ministry officials recognize additional
budgetary restraint now is necessary given the likelihood that the administra-
tion will increase spending to gain political support just before the November
election. The recent measures, in our opinion, are important steps, but more
vigorous measures, such as reducing state enterprise budgets, will be necessary
to quash inflationary pressures.
The economic program presented by President Azcona maintains policy
reforms that have allowed Honduras some growth in the last two years, but de-
lays implementation of the potentially most beneficial new measures. The US
Embassy reports that the centerpiece of the program is a continued tight
monetary policy that restricts growth of overall credit to 10.6 percent, with the
private sector receiving the largest share. To increase domestic savings and
discourage capital flight, the program maintains current positive interest rates.
As expected, the exchange rate is also unchanged. Some 29 additional
measures?emphasizing tax and trade reforms, privatization, and budget
controls?are currently under study, but may not be enacted until late 1986 or
in 1987. Azcona probably feels that this program?coupled with cooperation
on security concerns?strengthens his case for additional US economic
support. In its present form, however, the package probably will not achieve
the ambitious 1986 goal of 3- to 4-percent economic growth.
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Tripoli is planning to trim the wages and salaries of government workers by
35 percent, probably to curb consumption and save foreign exchange. 25X1
the Libyan Government intends to proceed with 25X1
the reductions without waiting for approval from the People's Congresses. The
reductions would be the first in several years and would affect many because 25X1
the government is one of the largest employers in Libya. Qadhafi has long held
the belief that domestic wage levels are too high and the disparity in wages
between the upper and lower classes is too great. Qadhafi's social experiments
rankle much of the population even in the best of times, and this new measure
is sure to exacerbate domestic disgruntlement over widespread food shortages
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Secret
Libyan Airline
Spare Parts Secured
Lebanese Pound
Takes A Plunge
Possible Indian
Purchase of US
Military Technology
Money Changers
Thrive in Kabul
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30 May 1986
Libya has regained access to spare parts and maintenance for its Boeing 727
aircraft, Libyan payment problems with
Air France had disrupted Tripoli's longstanding maintenance relationship with
the French firm since late last year. The payment dispute was resolved early
last month, at which time Air France resumed its as-
sistance to the Libyan airline. These aircraft are being serviced at an airport
outside Paris. Maintenance of Libyan Boeing 707s is not covered by the
arrangement because these aircraft have been used for military purposes. The
US trade embargo against Libya has had a major impact on Libyan access to
spare parts for its primarily US-origin fleet. Libya has had to curtail flights
and cannibalize some aircraft to maintain international service. The Air
France arrangement will ease some of these problems and help the government
maintain the current diminished level of flights.
The Lebanese pound, which has fallen by 50 percent since early April, dropped
to 29.5 pounds per US dollar on 22 May. Last week's decline-2.5 pounds in
two days?came after the Central Bank eased support efforts, according to the
US Embassy in Beirut. Extensive intervention began in April, but the Central
Bank's critical foreign exchange resources are now practically exhausted after
it sold about $75 million in reserves in May. Failed attempts to support the
pound have reduced commercial bank confidence and actually fueled specula-
tion of a further decline. Downward pressure on the pound appears mainly the
result of the political stalemate and the eroding security situation in Lebanon,
which has rom ted many Lebanese to convert pound deposits into foreign
assets.
India is seriously considering the purchase of US technologies for its light
combat aircraft and a new missile test range.
Prime Minister Gandhi will make a decision soon on the engine
technology for the aircraft. Indian officials are willing to
spend $60 million on developing a suitable engine with a US company;
these officials also prefer a US-built ejection seat.
India plans to spend an
additional $20 million on US-built tracking equipment for a new 1,200-
kilometer missile test range. The Indians see their light combat aircraft project
as a means both to develop their aeronautics industry and to build a modern jet
fighter for their Air Force. Plans for the new test range, which would
complement the existing range on India's east coast, indicate India's interests
in expanding its long-range missile and space vehicle program.
Money changers continue to operate with relatively few restrictions under the
new regime
The money changers are free to set daily market exchange rates?which they
determine by listening to foreign radiobroadcasts of exchange rates?and to
open foreign currency accounts in foreign banks. Most of the union's 110
members have partners in Dubayy who provide them with links to Pakistan. In
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Secret
USSR Delays
Purchases of
Spare Parts for
Gold Mining
CEMA Executive
Committee Meeting
China
Attempting To Gain
Aerospace Technology
return for this freedom, the money changers supply the government with
needed foreign exchange at a preferential rate to finance foreign trade. The
private sector continues to function in many areas of the Afghan economy,
demonstrating the regime's willingness to compromise ideology for practical
considerations.
Communist
In late April,
hard currency shortages prevented the purchase of spare parts needed for 25X1
heavy equipment at Siberian gold mines. Although the size of the potential
order is unknown, similar spare parts contracts with Western firms in the past
have been relatively small?$10 million or less.
frequent breakdowns of imported equipment because of overuse, improper
maintenance, and very rugged operating conditions at most gold mines. A
continued unavailability of spare parts could eventually affect Soviet gold
output, which has been growing very slowly in recent years. The near-term
impact on estimated Soviet hard currency earnings would be limited, however,
because of Moscow's estimated stockpile of 2,800 metric tons compared with
average yearly sales of less than 300 tons. Soviet gold sales earned nearly $2
billion in 1985, supplying about 6 percent of Moscow's hard currency needs.
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The CEMA Executive Committee has approved a draft program for the
construction of nuclear power and heat stations as part of the group's long-
term Economic, Science, and Technology Program. At its meeting in Moscow
last week, the Committee focused on establishing direct relations among
enterprises and scientific institutions in the member countries and on the
formation of joint enterprises and associations. After hearing a detailed Soviet
report, the East Europeans expressed satisfaction with Moscow's handling of
the Chernobyl' nuclear accident. The Executive Committee session sets the
stage for the meeting of CEMA premiers next month, which probably will also
concentrate on the Economic, Science, and Technology Program. Comments
by Czechoslovakia's deputy premier suggest that the East Europeans have
been reluctant to commit resources to the program and skeptical of its benefits.
Although the East Europeans probably have more reservations about nuclear
power than their public endorsements indicate, their approval of the draft
program underscores their lack of alternative sources of energy.
China has publicly announced that it will not offer full launch insurance?
covering launch and satellite operation?unless satellite technology is shared,
according to a recent Chinese press report. The announcement was in
reference to launches for the US firm Teresat. Chinese officials immediately
denied that access to technology is a precondition. Nevertheless, we believe
past Chinese actions indicate that they are attempting to acquire satellite
technology through a variety of methods.
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Secret
China Orders
Soviet Locomotives
Chinese Firm
Goes Bankrupt
Vietnam Drafts
New Foreign
Investment Code
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30 May 1986
China was more interested in acquiring technology than selling launch
services. In a related vein, the State Department reported that China rewrote
contract specifications for firms bidding on its television broadcasting satellite.
The requirements, if issued, will emphasize earlier demands for transfer of
satellite technology and assembly know-how to China.
China has ordered 100 Soviet electric locomotives to help upgrade its
antiquated rail system, bringing to 750 the number of electric and diesel
electric locomotives purchased from the United States, Western Europe,
Japan, and now the Soviet Union since 1983. Over the next five years, China
plans to spend about $21 billion on railroad modernization aimed mainly at
doubling the system's coal-carrying capacity?coal already accounts for 40
percent of rail freight. More than 13 million metric tons of coal were
stockpiled in the first quarter of 1986 because of inadequate transportation?
the figure for all of 1981 was 17 million tons. Domestic locomotive production
plans-800 electric and 2,200 diesel locomotives?are well below anticipated
needs through 1990, and nearly half of China's production capacity is still
dedicated to making steam locomotives.
The Chinese press reports that a state firm has been declared bankrupt, the
first such case ever. The workers will become unemployed, and assets of the
unnamed firm?believed to be a collectively owned farm implement factory?
will be liquidated under the provisions of a trial Shenyang city bankruptcy law.
The failing firm is undoubtedly a test case for Beijing's planners, who are
currently drafting national bankruptcy and unemployment laws. The widely
publicized bankruptcy is also a warning to other state-owned enterprises of the
increasing penalties for failing to implement economic reforms and improve
efficiency.
Hanoi is preparing a new foreign investment code that will permit joint
ventures or wholly owned foreign firms
The draft code also allows key managerial posts to be filled by foreigners and
puts no limits on repatriation of profits. Hanoi hopes investment under the new
code will promote agricultural and mineral exports and sales of labor-intensive
goods and services such as tourism, ship repair, or aircraft maintenance. The
draft code underscores Hanoi's continuing efforts to end its economic isolation
from the industrial West, but we believe Vietnam's investment climate will
remain unattractive. Besides the political obstacle of Hanoi's involvement in
Cambodia, shortages of electric power and raw materials, transportation
bottlenecks, and an inefficient, corrupt, and xenophobic bureaucracy pose
major hurdles.
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Cuban Farmers'
Markets Abolished
President Castro's decision to abolish the farmers' free markets this month
represents a major defeat for the regime's economic pragmatists. The markets,
established in 1980 as an incentive to boost agricultural productivity, provided
peasants with an outlet to sell all production above government quotas. Castro
charged that the free markets promote corruption, contribute to the revival of
the use of middlemen, and create millionaire farmers. Castro's action bodes ill
for any liberalization in economic policy despite the country's worsening
economic situation. His singling out of one sector of society is reminiscent of
his past campaigns to divert attention from serious problems. In this case,
Castro has removed a key incentive to private farmers?the most efficient and
productive sector of Cuban agriculture?and a significant drop in productivity
is almost certain. The general public, weary of continuing austerity, is likely to
view abolition of the markets with dismay.
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