INTERNATIONAL ECONOMIC & ENERGY WEEKLY

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP97-00770R000100640001-2
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 37
• Document Creation Date: December 22, 2016
• Document Release Date: June 21, 2011
• Sequence Number: 1
• Publication Date: November 7, 1986
• Content Type: REPORT

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Directorate of
Intelligence
International
Economic & Energy
Weekly
DI IEEW 86-045
7 November 1986
Copy 6 7 7
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Secret
Internati
onal
Economi
c & Energy Weekly
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iii Synopsis
I Perspective
-Increasing Soviet Involvement in the World Economy
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2Al
3 USSR: See
king a Broader International Economic Role
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7 Soviet Con
sumer Services: Prospects for Change Under Gorbachev
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11 India-USS
R: Continued Economic Relationship Despite Strains
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LJ/~ I
17 Egypt: Com
ing to Terms With the IMF
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Energy
International Finance
Global and Regional Developments
National Developments
Comments and queries re arding this publication are welcome. They may be
directed to Directorate of Intelligence,
Secret
DI IEEW 86-045
7 November 1986
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Secret
International
Economic & Energy WeeklyF___7 25X1
Synopsis
1 Perspective-Increasing Soviet Involvement in the World Economy
In the past several months, the USSR has embarked on a wide-ranging campaign
to increase its role in international economic affairs. The course of future Soviet
activity in the world economy will depend, in large part, on Soviet decisions
regarding the role of Western technology and equipment in Gorbachev's modern-
ization drive.
In the last several months, Moscow has launched a spate of initiatives that portend
an increase in the breadth and depth of Soviet participation in international
economic and financial arenas. The success of these initiatives, however, will, in
large part, hinge on Moscow's willingness to increase the role of Western
technology in Gorbachev's modernization drive to accept Western managerial
involvement and corporate ownership in the domestic economy, and to expand the
acceptable level of hard currency indebtedness.
7 Soviet Consumer Services: Prospects for Change Under Gorbachev
Despite the leadership's highly publicized commitment to boost Soviet living
standards, the new focus on industrial modernization limits its ability to increase
the share of labor or investment devoted to services. Although an expansion of the
role of the private sector could boost quality and output of services, the economic
and political obstacles to such measures suggest that change will be slow in
coming.
11 India-USSR: Continued Economic Relationship Despite Strains
The falling value of Soviet oil exports to India and India's interest in Western high
technology have produced some strains in the economic relationship, but hard
currency constraints facing both countries provide a powerful incentive to increase
their bilateral trading relationship.
Faced with rapidly growing debt arrearages and depleted cash reserves, Cairo has
begun negotiating with the IMF over terms for a standby program. Protracted
negotiations or, even worse, a deadlock over the terms of an agreement will
increase the probability of sizable defaults-only with extensive new assistance
from the United States or Saudi Arabia could Egypt muddle through.
iii Secret
DI IEEW 86-045
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International
Economic & Energy Weekly 25X1
Perspective Increasing Soviet Involvement in the World Economy
In the past several months, the USSR has embarked on a wide-ranging campaign
to increase its role in international economic affairs. Recent Soviet moves include
the restructuring of its foreign trade apparatus, proposing new forms of economic
cooperation with Western firms, and applying to participate in GATT. These
initiatives reflect, in part, a new generation of Soviet leaders who are willing to
consider alternate tactics in the pursuit of their economic goals. The sharp drop in
hard currency revenues from energy exports has probably added further impetus to
Soviet interest in new trade and financial avenues.
The course of future Soviet activity in the world economy will depend, in large
part, on Soviet decisions regarding the role of Western technology and equipment
in Gorbachev's modernization drive. Rhetoric aside, the leadership will probably
spend the next year or two assessing domestic programs-shifts in investment
priorities, management reorganizations, and the discipline campaign-before
reconsidering their conservative positions regarding reliance on foreign technology,
Western participation in the economy, and the willingness to substantially expand
indebtedness to the West. Gorbachev's new managerial team also needs the time to
acquire the experience and expertise necessary to move confidently ahead into
Until the Soviets settle on a long-term economic strategy vis-a-vis the West, we
can expect cautious but steady expansion of their economic activity in the
international arena. Even a gradual expansion of activities in the near term,
however, could have important repercussions on US policy interests:
? Increased cooperation with Western firms is likely to improve Soviet assimilation
of Western technology at given enterprises, although diffusion throughout the
economy will remain difficult. Moreover, joint ventures established outside the
USSR or subsidiaries of joint ventures in third countries could give Soviet
technicians greater access to controlled technology.
? Greater Soviet involvement in international trade and financial markets would
make it easier for Moscow to hide the level of its financial activities through the
use of numerous instruments, such as interbank deposits, or borrowing from
nonbank institutions and banks that do not report their international lending.
? A higher level of Soviet activity in the international economy-especially
multilateral forums-will provide Moscow with new opportunities for political
activism. In addition, a larger number of Soviet officials in the West increases
the potential for KGB activity.
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Regardless of the level of Soviet economic links to the West, an increased Soviet
understanding of international financial and commercial markets carries a risk
that Moscow may attempt to manipulate these markets to the detriment of US na-
tional security interests. The West has been moving rapidly toward globally
integrated financial and commodity markets and this, along with the sharp rise in
transaction volume and relative inexperience of many of the players, has created a
potential for an international crisis precipitated by one or more shocks to the
system. We believe that the probability of Soviet misuse of the system would be
small as long as the USSR's growing involvement is paying off in economic and
even political dividends. Indeed, to the extent that these activities tie the USSR
closer to the world economic community, the West probably benefits because it
gives the Soviets a greater stake in working to solve problems within the system.
Moscow's stake, nonetheless, is not likely to weigh heavily in Soviet decisions
where political and strategic interests are involved.
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USSR: Seeking a Broader
International Economic Role
In the last several months, Moscow has launched a
spate of initiatives that portend an increase in the
breadth and depth of Soviet participation in interna-
tional economic and financial arenas. Many of these
actions have received widespread publicity-the ap-
plication for participation in GATT, the restructuring
of the foreign trade apparatus and new regulations on
joint ventures, and the unexpected settling of out-
standing Czarist bonds. In addition, the Soviets are
quietly working with Western banking and trading
institutions to expand the range of financial instru-
ments available to finance Soviet hard currency im-
ports. The success of these initiatives, however, will
hinge, in large part, on Moscow's willingness to
increase the role of Western technology in Gorba-
chev's modernization drive, to accept Western mana-
gerial involvement and corporate ownership in the
domestic economy, and to expand the acceptable level
of hard currency indebtedness. The Soviets, however,
are likely to move cautiously with ad hoc adjustments
to current policy, and, unless Moscow abandons its
conservative approach to both domestic economic and
foreign trade policy, the results will probably be
unimpressive.
Moscow's recent initiatives to expand economic links
to the West probably result from the interaction of
several factors:
? The emergence of new senior economic managers
who are more action-oriented individuals and real-
ize that new tactics must be used to meet Soviet
economic challenges, particularly modernization
and accelerated growth. Such activism goes hand in
hand with a revamped foreign policy apparatus that
is taking a more dynamic approach to Soviet eco-
nomic and international affairs.
challenges. The new trade policy team probably
realizes that Soviet goals have been frustrated in the
past by conservative and ideologically constrained
approaches and, in general, by a relative ignorance
of the operations of the international financial and
commercial markets.
? The desire to develop a competitive Soviet export
sector for manufactured goods that has increased
pressure for Soviet representation in international
economic organizations. Moscow probably feels that
its current reliance on raw material exports for the
bulk of its trade earnings leaves it vulnerable to
fluctuations in world commodity prices and is at
odds with its level of economic development.
? The recent reduced level of hard currency earnings
from both oil exports and arms sales. This has
probably also driven the Soviets to explore alternate
sources for financing imports.
Reorganizing the Foreign Trade Apparatus
In late September, the Soviets announced a major
overhaul of the Ministry of Foreign Trade (MFT).
More than 20 ministries and 70 large associations and
enterprises are to be granted authority to conduct
trade directly with their foreign partners as of 1
January 1987. Under the proposed plan, the minis-
tries and production associations themselves will have
foreign trade organizations placed under their juris-
diction, many of which will be transferred from the
M FT.
Breaking the MFT's monopoly over foreign trade is
clearly an effort to expand exports of manufactured
goods by strengthening the link between producers
and world markets. In addition, it is designed to
improve import efficiency by giving end users more
? The reorganization of key domestic economic sec-
tors and the foreign trade apparatus to streamline
the bureaucracy to respond to Moscow's economic
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say in contract negotiations-under the current sys-
tem, price considerations of the foreign trade organi-
zations often win out over technical specifications.
While the MFT will continue to control a large
portion of exports, purchasing authority for most
imports may fall to the various ministries
At present, it appears likely that distribution of hard
currency to cover imports will continue to be centrally
determined, with Vneshtorgbank (VTB}-the Soviet
Bank for Foreign Trade-playing a larger role, in-
cluding the extension of hard currency credits. Failure
to meet export targets, however, will result in a
reduction in hard currency allocations. Selected min-
istries and enterprises will be able to spend up to 90
percent of export earnings for imports-although the
US Embassy indicates that this will pertain only to
above-plan exports.
Moscow is likely to complement increased end user
autonomy with the capability to conclude joint ven-
tures with Western firms. A framework for joint
enterprises with other members of CEMA has recent-
ly been introduced, and the Soviets appear willing to
offer similar business opportunities to the West. High-
level Soviet officials have mentioned the possibility of
joint ventures with Western firms on numerous occa-
passed a decree that will permit up to 49-percent
foreign equity and allow for some management con-
trol, repatriation of profits, and other provisions to
make such ventures attractive to Western firms.
The Soviets probably see several advantages to such
arrangements:
? Partnership with a Western firm would provide
access to established markets and trademarks that
could make it easier to sell Soviet-made goods in the
West.
? Quality control by the Western partner would help
assure that products meet world-market standards.
? A long-term equity relationship with a Western firm
could allow for updating of production lines to keep
up with changing Western demands and technology.
? Joint ventures would also allow for transfer of
technical know-how related to organization and
management of production and the use of advanced
technology that are not easily transferred through
traditional equipment purchases.
? Such arrangements would allow for the transfer of
Western technology at little or no hard currency
cost to the Soviets until after production begins.
Increased Financial Sophistication
Gorbachev's financial managers are clearly interested
in taking full advantage of the wide range of Western
financial markets and instruments in an effort to
improve the effectiveness of Soviet borrowing activi-
ties. Past financial managers were extremely conser-
vative in their dealings with the West-relying heavi-
ly on Eurocurrency borrowings and government-
backed credits. Now, VTB and Soviet-owned banks in
the West are adopting a more sophisticated approach:
? Swapping debts with other banks to diversify their
portfolios.
? Trying out more sophisticated financial instru-
ments, such as "note issuance facilities" and accep-
tance financing.
? Making unprecedented moves in world bond mar-
kets. For example, in August VTB agreed to invest
$3.2 million in a yen-Eurobond issue, marking the
first entry of the USSR into the international bond
market.
These moves probably indicate Moscow's interest in
marketing its own bonds, a cheaper source of long-
term funds than syndicated borrowing. The recent
settlement with the British on Czarist bonds in default
since 1917 removes a longstanding impediment to the
issuance of Soviet bonds.
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Secret
As part of its decision to broaden its financial deal-
ings, the Soviets are moving aggressively to build the
requisite expertise and access. They have reportedly
initiated numerous seminars and bilateral meetings to
learn more sophisticated banking and finance tech-
niques. Moscow has also recently opened a subsidiary
of its London bank in the Cayman Islands to issue
new financial instruments, and appears to be attempt-
ing to expand its network of banks into Japan, and
Moscow clearly wants some form of official EC
recognition for CEMA to enhance its status within
the international community.
Kuwait.
The Soviets are also exploring the possibilities of
expanding ties to a number of multilateral institu-
tions. Despite the recent rebuff by the GATT, Soviet
interest in eventually becoming a member probably
remains keen. Moscow apparently hopes that mem-
bership in GATT will be more likely once its foreign
trade reorganization is in place and believes member-
ship will expand its general knowledge of world
economic conditions, provide trade opportunities, and
make Soviet exports eligible for reduced tariffs. The
Soviets may also believe that GATT membership
would make them less vulnerable to economic sanc-
tions.
Although there has been some reported interest in
joining the IMF and World Bank, Soviet officials
have denied any intention of seeking membership. The
USSR rejected IMF membership as too restrictive
after participating in the Bretton Woods meetings in
1944. In particular, the USSR was unwilling to give
up autonomy in determining its own trade and ex-
change rate practices, did not agree with the gold
subscription requirements, and refused to release sen-
sitive economic data such as gold reserves and bal-
ance-of-payments information. Moscow's position has
probably softened somewhat, but it still sees the costs
as far outweighing benefits at the moment.
The Soviets have been interested in establishing for-
mal EC-CEMA ties since the early 1970s and have
actively pursued this goal since the CEMA Summit in
June 1984. While economic and trade issues probably
were an important Soviet motive in earlier years, the
present effort has a more pronounced political flavor.
With the reorganization of the foreign trade appara-
tus already under way, the Soviets' next major move
is likely to be in the area of joint ventures. The first 25X1
joint-venture contracts could be signed within the next
few months, but substantial progress along these lines
may be slow. There is still considerable uncertainty
among midlevel Soviet officials, who deal regularly
with Western businessmen, over what, exactly, joint
ventures will entail. While some Western firms may
be willing to make a relatively small investment to
gain entry into the Soviet market, most are likely to
take a wait-and-see attitude. Years of dealing with
cumbersome Soviet bureaucracies, shoddy Soviet
manufactures, and unimpressive results from joint
ventures with other socialist countries will make most
businessmen wary. Even Western enthusiasm for joint
ventures in China-the Communist country with the
most liberal regulations-has recently waned.
Even if impediments to successful joint ventures can
be overcome, the level of investment is likely to be too
small to have much of an impact on Soviet exports of
manufactured goods. Nor will the recent changes in
the foreign trade apparatus likely have much success
in expanding exports. Although they will probably
improve the operation of trade by removing the MFT
as a cumbersome middleman, the changes do not
remedy the lack of domestic incentives for producers,
the distorted price structure, and the inadequate
technological base. In addition, depressed earnings
from traditional exports will severely constrain pur-
chases of foreign equipment that could compensate
for some of these shortfalls.
As long as Moscow maintains its conservative ap-
proach toward reliance on Western technology, a
major role for the USSR in the international financial
arena is also unlikely. The Soviets will probably
become more adaptable to new financial instruments
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and more flexible in the management of their assets.
Nonetheless, the present limitations on Moscow's
hard currency earnings, coupled with some vestiges of
traditional Soviet conservatism, are likely to restrict
any large-scale speculative approaches to financial
management
The Soviets will continue their approaches to selected
international organizations for both political and eco-
nomic reasons. GATT membership will probably re-
main a key economic goal for the USSR, but GATT's
concerns over compatibility will still plague Soviet
prospects despite recent reorganization efforts. The
Soviets will also pursue a formal EC-CEMA arrange-
ment, but probably with expectations of only minimal
economic gains
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Soviet Consumer Services:
Prospects for Change Under
Gorbachev
General Secretary Gorbachev has made the improve-
ment of consumer services 2 a prominent part of his
highly publicized commitment to boost Soviet living
standards. The new leadership's focus on industrial
modernization, however, limits its ability to increase
the share of labor or investment devoted to services.
Although an expansion of the role of the private sector
could boost quality and output of services, the eco-
nomic and political obstacles to such measures sug-
gest that change will be slow in coming.
Consumer Services in the USSR Today
In Gorbachev's Soviet Union, where criticism of
economic performance is the order of the day, few
sectors provide as much ammunition for the leader-
ship's attacks as that of consumer services. Premier
Ryzhkov frankly acknowledged the problem in a
December 1985 speech in which he labeled the state
of basic services as "embryonic."
The leadership's concern is well founded. Although
per capita availability of services has roughly doubled
in the past two decades, per capita expenditures on
consumer services amount to roughly one-fourth of
the level Soviet economic planners regard as the
"rational" standard of consumption.'
Even in the largest Soviet urban areas, service outlets
tend to be scarce. For example, Moscow, a city of
more than 8.5 million people, has fewer than 4,000
' The services we assess in this article correspond roughly to the US
definitions of "personal services," "automotive repair services," and
"miscellaneous repair services." These include laundry, dryclean-
ing, barber, beautician, and public bath services; repair of clothing
and consumer durables; and a variety of other services such as
rentals of consumer durables.
' Soviet planners set "rational norms" for consumption. These
norms set standards for how much an average Soviet citizen should
consume in food, housing, clothing, and other goods and services.
They generally represent a comfortable living standard, albeit a
USSR: Real Per Capita Consumption, Percent
1971-85
Average Annual Growth
1971-75
1976-80
1981-85
Personal care and
repair seervices
Total (includes
4.4
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3.1
private sector) a
a As is true of all activity in the so-called second economy, estimates
of the value of privately provided services are necessarily imprecise.
We estimate that the private sector currently provides more than
one-fourth of the total based on data for private services of 5-6
billion rubles given in Izvestiva, 19 August 1985. We assume a per
capital growth rate of these services of I percent annually, which
seems consistent with the rise in money incomes. We have no other
data on the trend in supply of private service.
b Adjustments to official data include removal of services sold to
enterprises and institutions and addition of the cost of materials
used in providing services.
service enterprises. The picture is even bleaker in
rural areas, where per capita consumption of services
is 60 percent of the urban level. The multitude of
consumer complaints appearing in the Soviet press
makes it clear that the quality of state-provided
services also leaves much to be desired.
The state of the services sector in large measure
reflects severe underinvestment in services-services
received less than one-half of 1 percent of state
investments in 1966-80, according to a 1983 Soviet
journal-and there is no evidence that its share
increased in 1981-85. Despite its labor-intensive na-
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ture, the service sector has also been a stepchild with
respect to the supply of labor. According to Soviet 25X1
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Checking on complaints of poor-quality services in
Orenburg, several Soviet reporters visited a laundry,
and then described for their readers what they found.
? The first thing they did was hand us a razor blade
and needle. After managing to cut the buttons off
the coats we had brought to be cleaned, we began
sewing on the tags we had been given. The people,
about 40, in the line behind us began to raise a fuss
and urge us to hurry.
? We barely finished our sewing when the clerk
disappeared into the back room.... When she
returned 15 minutes later, she didn't even look at
our coats. She tossed them into a single pile on the
floor, next to some greasy quilted jackets.
The journalists did not reveal how their experience
ended, but, presumably, they got their coats back,
unlike some Moscow consumers who wrote local
papers complaining that state laundries had lost their
? Produce for bulk consumers rather than individual
consumers. Service outlets are authorized to sell
services and a limited amount of goods to institu-
tions such as hospitals, hotels, and factories. The
share of sales to institutions has been rising, even
though official policy has decreed its decline.
? Produce goods rather than services. For example,
shoe repair shops prefer to make and sell shoes
rather than repair them. Soviet statistics indicate
that production of goods now accounts for about 40
percent of the sales of service enterprises.
In the judgment of Soviet officials and economists,
the deficiencies of the state service sector impose
serious political, economic, and social costs. Among
them:
? Soviet consumers spend an estimated 40 billion
man-hours annually shopping for goods and services
with about one-half that time spent standing in lines
or traveling to and from the service shops. Because
few shops stay open after normal working hours, the
time lost is often work time.
clothes.
statistics, about 2.4 percent of state workers (some 2.8
million persons) are employed in furnishing consumer
services, up from 2.1 percent in 1970. In contrast,
an estimated 17-20
million private-sector service workers-legal and ille-
gal-provide personal services, largely on a part-time
basis.
Deficiencies in quality and variety of services also
reflect the perversity of Soviet success indicators,
which judge enterprise performance by fulfillment of
output targets imposed from above. The distortions
tend to be particularly severe in consumer services,
where the gap between what is advantageous for the
producer and what is satisfying for the consumer is
especially wide. For example, service enterprises:
? The scarcity of household services adds to the
already heavy burdens borne by Soviet women and
contributes to marital and family problems. Soviet
calculations indicate that women can rely on the
state service sector to assist them with only about
3 percent of household chores.
? The lack of consumer services in rural areas and
remote regions of the country makes it difficult for
farms and factories in those areas to attract and
retain skilled workers.
? The scarcity and poor quality of state consumer
services reportedly fosters rampant corruption. This
contributes to a mood of cynicism and apathy
among the populace that, in turn, lowers worker
productivity and undermines public respect for law
and order.
? Concentrate on providing high-cost services, even if
they are not in demand. High-cost services are the
quickest path toward fulfillment of targets for total
sales.
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There are no easy solutions to the sector's problems.
Evidence suggests that the regime is hoping to boost
the output and quality of services on the cheap. For
example, the Politburo last year approved the
Consumer Goods and Services Program, which calls
for ambitious growth in sales of services of 40 percent
by 1990 and 140 to 150 percent by the year 2000. The
program, however, does not provide the resources
needed to meet these goals. Instead, attainment of the
program's goals depends on gains in efficiency not
previously achieved and on administrative measures
similar to those that have failed in the past.
Some Soviet economists have advocated a more radi-
cal approach: allowing the private sector to play a
broader role in providing services as has been done for
years in Hungary and East Germany. Soviet press
comments indicate that the private sector already
provides more than one-fourth of all personal care and
repair services. As one Soviet economist has acknowl-
edged, service in the private sector is often of better
quality and takes about half the time. Economist Abel
Aganbegyan, an informal adviser to Gorbachev, has
been a prominent advocate of adopting the East
European model.
Aganbegyan and other advocates of expanding the
private sector have encountered strong opposition
from officials who see dangerous social and political
consequences attending any such moves. Conservative
officials have specifically warned that measures of the
sort proposed by reform minded economists could
result in:
? Loss of state control over resource allocation
decisions.
? Diversion of workers from labor-short state indus-
tries to more lucrative opportunities in the services
sector.
? "Unjustifiably" high incomes by service-sector
workers.
One compromise solution had been the use of collec-
tive contracts that make workers responsible for costs
but also allow them to retain a large share of profits.
Press reports indicate, however, that collective con-
tract arrangements in services and other sectors have
encountered many obstacles limiting their impact. For
example, contracts stipulate that management is to
provide the collective with necessary supplies, but
managers have little control over sources of supply
outside the enterprise. Frequent supply disruptions
often stop work in the collectives and prevent them
from earning the large amounts they anticipated.
Given the formidable ideological barriers to anything
that smacks of individual private activity, it is not
surprising that reform-minded economists have tried
to find a way to get around these barriers. Several
recent press articles have called for reviving coopera-
tives that played a large role in the economy during
the 1920s. Proponents argue that cooperatives would
provide a quick fix for the service sector while requir-
ing few additional resources and avoiding the undesir-
able side effects that conservatives argue would ac-
company a large-scale expansion of private activity.
Allowing cooperatives a larger role would also have an
advantage from the perspective of national prestige: in
taking this road the Soviets could argue that they are
drawing on their own experience of the 1920s and
therefore developing a distinctively Soviet model rath-
er than imitating the Chinese or the Hungarians.
Gorbachev's public remarks indicate that he favors
such approaches. While in Khabarovsk in September
he called for a search for new forms of "individual
work activity" in the service sector and raised the
issue of reviving cooperatives. Also, in remarks to
Leningrad party workers in May 1985, he suggested
that the regime should take a more "realistic" atti-
tude toward the activities of individuals moonlighting
in the service sector.
services.
While Gorbachev and other officials would prefer to
improve the existing system first, past attempts to
adjust plan indicators and managerial incentives in
the state service sector have done little to improve
performance. Furthermore, the new leadership's com-
mitments to industrial modernization limit its ability
to increase the share of labor or investment devoted to
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Movement to increase the role of personal initiative
may become increasingly attractive if, as we believe,
efforts to improve the system on the cheap fail to
produce a major improvement in consumer services.
In fact, according to a recent publication of the
Supreme Soviet, legislation to encourage citizens'
individual labor in services will be released by the end
of the year. Arrangements designed to stimulate
personal initiative will have little effect, however, if
they are not accompanied by effective steps against
some of the planning and management problems that
have stymied past attempts at reform in services and
other sectors. Problems that would have to be ad-
dressed include:
? Ensure operating autonomy. Overregulation by cen-
tral planners and ministerial officials often deprives
the collective contract of its incentive effect. The
same fate could befall cooperatives and even private
individuals if they are not given sufficient indepen-
dence to run their businesses profitably and serve
their customers well. This would include the power
to expand operations, control the number of employ-
ees, and adjust prices to reflect supply and demand.
? Provide facilities and supplies. Chronic shortages
of materials and equipment make it difficult for any
type of enterprise to operate profitably. Creation of
adequate legal sources of supply will be essential to
success of contract, cooperative, or individual
operations.
? Increase incentives. Private operators working le-
gally are now required to pay 60 to 65 percent of
their profits to the state in taxes. New arrangements
to encourage individuals to operate legally rather
than underground would have to make provisions
for a more equitable tax rate. The regime would also
have to set the level of taxes or deductions from
profits of cooperatives and contract collectives at a
reasonable level and prevent planners and managers
from adjusting it upward if the incentive effect of
those arrangements is to be maintained.
In view of the serious economic and political obstacles
to personal incentive measures, change will probably
be slow in coming.
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India-USSR: Continued Eco
Relationship Despite Strains
Economic issues are likely to rank high on the agenda
during Soviet General Secretary Gorbachev's visit to
New Delhi in late November. The falling value of
Soviet oil exports to India and India's interest in
Western high technology have produced some strains
in the economic relationship, but hard currency con-
straints facing both countries provide a powerful
incentive to increase their bilateral trading relation-
ship. Gorbachev is likely to push New Delhi to step up
imports of arms, machinery, and equipment. New
Delhi probably will press Moscow to honor its import
commitments and refrain from trading practices that
cost India hard currency. Regardless of the outcome
of the visit, we expect the economic relationship to
remain strong. India needs to increase exports to the
Soviet Union to pay for Soviet military equipment
already purchased and to meet its overall export
targets. The Soviets will seek ways to use the econom-
ic ties to maintain their close political relationship
with India.
Origins of the Indo-Soviet Economic Relationship
Soviet willingness to finance major public-sector in-
dustrial projects following Indian independence stim-
ulated economic cooperation between Moscow and
New Delhi. Machinery and equipment accounted for
one-half to three-fourths of Indian purchases from
the Soviet Union during the mid-1950s to the mid-
1970s as New Delhi built up its heavy industrial base.
The public-sector projects built with Soviet collabo-
ration now account for roughly 40 percent of India's
steel output, 80 percent of metallurgical equipment,
40 percent of mining equipment, 55 percent of heavy
power equipment, 35 percent of oil extraction, 40
percent of oil processing, and 10 percent of power
generation. Nevertheless, these projects are consid-
ered by many Indian economists as inefficient-
partly because of the poor quality of the equipment.
The Economic Relationship
The Soviet Union-neck and neck with the United
States as India's largest commercial trading part-
ner-had a total two-way trade of slightly less than
$3.7 billion in 1985. The value of bilateral trade grew
by an average of almost 20 percent annually between
1970 and the early 1980s, largely because of growing
Soviet oil deliveries and higher oil prices. The growth
in trade has leveled off in the last few years as the
Soviets cut back on purchases of Indian agricultural
products and consumer goods to correct the large
trade imbalance that had developed in India's favor
during 1981-82.
The Soviet Union has become more important to
India as a trading partner in the last decade. Exports
to the Soviet Union as a share of total Indian exports
Growth in bilateral trade had nearly stalled by the
mid-1970s, according to US Embassy officials, be-
cause Indian purchases of Soviet goods were not
sufficient to sustain a rapid growth in Soviet imports
of Indian goods. Indian manufacturers had reached a
point where they could supply much of the country's
requirements for machinery and equipment. A new
phase in New Delhi's economic relations with Mos-
cow began in the mid-1970s when the Soviet Union
agreed to sell India more petroleum. Several in-
creases in the quantity and price of petroleum provid-
ed Moscow with higher rupee earnings, financing a
rapid growth in trade in the early 1980s.
Secret
DI IEEW 86-045
7 November 1986
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India: Trade Relations With the USSR,
1980-94
have increased from 12 percent or less in the late
1970s to more than 20 percent in the early 1980s. The
increase in import share, while less dramatic, has
grown from 7 percent to about 10 percent in the same
period.
Commercial Exports and Imports a
The trading relationship in nonmilitary goods consists
largely of an exchange of Soviet petroleum for Indian
agricultural products and consumer goods. Crude oil
and petroleum products have accounted for about 70
percent of ivioscow s nonucicnsc CAPUI LS LU ILIUM UVC1
the last three years and averaged roughly 40 percent
of India's net oil imports. India has consistently
resisted a major increase in the import of Soviet
manufactured goods, contending that its own industry
can satisfy most of these needs.
The Soviets are the biggest buyers of a number of
Indian products, with some industries almost wholly
dependent on the Soviet market. The Soviet Union
became the largest customer for India's tea last year,
purchasing 40 percent of Indian exports. In one
district, Darjeeling, the Soviets buy 65 percent of the
I I I I I I I I I I I I I I
0 1980 85 90 94
a May include some unspecified military items.
b Projections exclude payments for contracts signed in 1986.
annual tea production. Almost 90 percent of woolen
knitwear manufactured in the Punjab goes to the
Soviet Union. Sales of cosmetics also are heavily
dependent on the Soviet market.
$1.8 billion by 1994.
Indian exports play an important role in New Delhi's
military relationship with the Soviet Union. We be-
lieve Indo-Soviet bilateral agreements call for an
Indian surplus in commercial trade to be used to
finance New Delhi's purchases of Soviet military
equipment. Several Indian officials have indicated
that Indian military payments are taken into account
when planning trade adjustments to achieve an overall
balance. India has bought more than $9 billion in
Soviet arms since 1979. Annual payments to Moscow
for arms already purchased will probably increase
from an estimated $600 million in 1985 to at least
The Soviet Union, on the other hand, is not dependent
on Indian trade for any critical imports or markets.
New Delhi accounts for less than 5 percent of Mos-
slovo 11-86
cow's trade.
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India: Trade With the USSR, by Commodity, 1970 and 1985
Exports
1970
Total = US $269 million
Imports
1970
Total US $136 million
Machinery and
equipment - 64
1985
Total = US $1,800 million
1985
Total US $1,887 million
Other - 12
Chemicals - 3
Machinery and
equipment - 12
Machinery and Oil - 70
equipment - 15
Last December, India and the Soviet Union signed a
new trade agreement that calls for as much as a
doubling in bilateral trade over the next five years.
The agreement set a two-way trade target for this
calendar year of $4.1 billion-Indian exports of $2.2
billion and imports of $1.9 billion-an increase of
about 10 percent in total trade over 1985. The trade
pact also extends the longstanding arrangement under
which India pays for its imports in nonconvertible
rupees and provides favorable credit terms to Indian
importers of Soviet machinery and other equipment.
Strains in the Relationship
While maintaining a balance in bilateral payments is
an objective of the trade protocols, the difficulties in
achieving that goal have introduced new tensions in
the relationship during the past few years. India's
indebtedness to the Soviet Union has increased. Soviet
trade statistics indicate that, in the last six years,
India's exports to the Soviet Union exceeded imports
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Secret
India's economic relations with the Soviet Union are
governed by an agreement to balance all bilateral
payments for imports, exports, and debt. All transac-
tions, whether commercial or military, are handled in
Indian rupees through the Indian banking system;
neither party has any need to pay nor opportunity to
earn hard currency.
In 1978 Moscow and New Delhi agreed to make
periodic adjustments in the rupee-ruble rate on the
basis of changes in the value of the Indian rupee in
terms of a specified basket of currencies. The variable
exchange rate helps protect Moscow against a decline
in the purchasing power of rupees India pays under
long-term contracts and for debt servicing. In July the
Reserve Bank of India announced a 3 -percent devalu-
ation of the rupee in terms of the ruble. The current
exchange rate is 13.37 rupees per ruble compared
with the earlier rate of 12.96.
by less than $300 million compared with about $700
million in the years 1974-79. We estimate that annual
payments due Moscow from 1980-85 for military
equipment alone ranged from $350 million to $600
million compared with $150-350 million from 1974-
79. India met or exceeded the level of imports from
the Soviet Union specified in the trade protocol while
Moscow fell below its quota for purchasing Indian
exports. Many Indian officials were concerned that, if
this trend continued, India would have a difficult time
repaying its military debts to the Soviet Union.
Nonetheless, in the short run, India should have little
problem meeting its debt payments to the Soviet
Union. This year, lower oil prices are swinging the
imbalance in India's favor and could lead to a decline
in the value of total imports from the Soviet Union.
We believe the Soviets lowered the price of their oil to
India-by about 50 percent-to market levels after
protracted negotiations last spring. This change could
save India up to $750 million at the level of deliveries
scheduled for 1986. Reflecting the decline in oil
prices, the value of total Indian imports from the
Soviet Union during the first half of 1986 was down
Moscow, however, is putting pressure on New Delhi
to offset lower oil prices by increasing purchases of
other Soviet goods. The Soviets are threatening to
hold down future purchases from India; imports from
India for the first half of 1986 already were down 15
percent from the same period last year. Trade talks in
June aimed at setting a timetable for a doubling of
Soviet textile imports from India ended inconclusively
and offered little more than a continuation of current
levels.
Another Indian complaint is that Soviet purchases
can vary from year to year, destabilizing parts of
India's economy. For example, last year's increase in
tea purchases allowed the Soviets to hold off pur-
chases this year, contributing to depressed prices for
Indian tea exports, according to Indian press reports.
India would also like to minimize the indirect hard
currency costs it incurs because of certain Soviet
trading practices. Moscow imports some Western
goods through Indian firms, paying in rupees while
the Indians bear the hard currency costs. In addition,
the Soviets reexport Indian goods to the West for hard
currency in direct competition with Indian exports,
undercutting India's hard currency earnings.
Prime Minister Gandhi's emphasis on modernizing
India's economy through increased imports of West-
ern technology probably is Moscow's major concern
about the future of the economic relationship. Indian
officials and businessmen have for several years resist-
ed Soviet pressure for a major increase in imports of
machinery and equipment because of poor quality.
Gandhi's interest in Western high technology and
New Delhi's signing of a memorandum of under-
standing on technology transfer with the United
States have increased Soviet concerns that Indian
commercial ties to the West will grow at Soviet
expense.
Both sides are working to sustain economic ties. Last
year Gandhi signed a $1.2 billion Soviet aid agree-
ment that provides India with a low-interest loan to
40 percent from the same period in 1985.
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purchase Soviet goods and services. The new agree-
ment apparently marks a shift of Soviet financial
support away from Indian manufacturing industries
to emphasis on thermal power stations, coal mining,
and oil exploration-areas in which Moscow has a
better chance in competing with the West.
The Soviets also are trying to adjust to Gandhi's call
for more private-sector involvement in economic de-
velopment. About 90 percent of Moscow's imports
come from India's private sector, but almost all of its
exports go to the public sector. The Soviets are now
looking into joint ventures with Indian companies as a
way to increase exports to India's private sector. An
India-USSR Chamber of Commerce and Industry
was set up last year to promote Indo-Soviet coopera-
tion in the private sector.
Concern over the potential of lost sales to the Soviet
Union has prompted New Delhi to look for new ways
to offset lower oil prices and to replenish the Soviet's
rupee funds. An Indian trade delegation to Moscow in
August agreed to increase purchases of urea, wood-
pulp, and, for the first time, bought a large amount of
ammonia.
Outlook For the Relationship
The Gorbachev visit to New Delhi will focus on
improving Indo-Soviet economic relations. The hard
currency constraints facing both countries provide a
powerful incentive for increased bilateral ties.
Moscow could increase purchases of consumer goods
and manufactured items and New Delhi could import
more raw materials and semifinished goods and cover
a larger part of its military debt without resorting to
hard currency expenditures. The Soviets are willing to
make some concessions to solidify the political rela-
tionship. Moscow has continued concessionary aid to
New Delhi at a time when Western countries are
hardening the terms of their loans.
New Delhi will have to increase exports to Moscow to
meet economic growth targets and larger payments
for purchases of Soviet military equipment. India's
current five-year economic plan is pegged to a 7-
percent average annual increase in total exports.
Tight world markets will force India to work hard to
increase trade with Moscow if it is to meet this target.
While the incentives to expand commercial trade are
strong, we do not see a doubling in Indo-Soviet trade
by the end of the decade. Lower world prices for oil
and other raw materials as well as ample world
supplies are likely to hold down the value of Indian
imports from the Soviet Union. We see no major
upswing in imports of Soviet equipment, as India
looks to the West for sophisticated technology and
services for its important growth industries. The
private sector, now given more responsibility for stim-
ulating economic growth, has frequently indicated it
does not want to increase purchases of Soviet equip-
ment. Moreover, New Delhi will have to expand and
diversify its hard currency exports and seek Western
loans and aid to pay for Western technology.
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Egypt: Coming to Terms
With the IMF
Faced with rapidly growing debt arrearages and
depleted cash reserves, Cairo has begun negotiating
with the IMF over terms for a standby program.
Resolution of the differences separating Cairo from
the IMF, however, may prove difficult. President
Mubarak remains fearful that full compliance with
Fund-proposed reforms will provoke civil disorder and
provide new impetus to the Islamic fundamentalist
opposition. Protracted negotiations or, even worse, a
deadlock over the terms of an agreement will increase
the probability that Egypt will default on debt obliga-
tions, drying up short-term credit facilities and forc-
ing sharp cuts in imports. This would leave the
government unable to maintain adequate levels of
subsidized goods for the population and could contrib-
ute to the political unrest Cairo is attempting to avoid.
In the absence of an IMF agreement, Egypt will turn
to the United States and Saudi Arabia for the
extensive new assistance that will be necessary if it is
to muddle through.
according to Egyptian Government statements, at
least one-fourth of Egypt's 2.2 million expatriate
workers returned home this year while others, accord-
ing to press reports, have suffered pay and benefit
cuts. More important, the portion of remittances
flowing into official government coffers-as opposed
to unofficial deposits held outside the banking sys-
tem-may be declining even more rapidly, spurred on
by a 40-percent differential between the free or black-
market exhange rate and the government's best offer
rate.
Tourism, another major hard currency provider, has
also experienced a sharp decline. Official Egyptian
data show tourist earnings off 43 percent during the
first half of 1986 compared with the same period last
year. Adverse publicity surrounding terrorist incidents
in the Middle East and the Cairo police riots in
February appear largely responsible for the downturn.
Barring further outbreaks of terrorism, tourism may
begin to recover slowly, but not nearly enough to
offset losses in much larger oil and remittance
Egypt's hard currency earnings began to plummet
early this year following the dramatic decline in world
oil prices. Oil revenues netted only $315 million
during the first six months of the year, a 66-percent
decline over the same period last year. Despite a
reported third-quarter rebound to 154,000 b/d, crude
sales remain well below the 200,000- to 250,000-b/d
range that had prevailed over the past several years.
Moreover, an overly rigid pricing policy is likely to
once again place Egyptian crude at a price disadvan-
tage during the fourth quarter if the oil market
remains soft. Cairo's oil revenues are unlikely to
exceed, by our estimate, $1 billion during 1986,
compared with $2.4 billion in 1985.
A decline in most other sources of foreign currency
earnings has exacerbated Egypt's financial crunch.
Remittances from expatriate workers, the single-larg-
est hard currency earner, also appear to be declining;
earnings.
Indications that Egypt is drawing closer to an actual
default continue to mount. In October, international
banks with significant loan exposure in Egypt were
reporting arrearages on supplier credits of nine to 10
months, compared with six to seven months in March
and April. Many banks dealing with Egypt have been
cutting credit lines over the past year, some by as
much as 80 percent. In a similar move, the French
official government export credit agency recently
announced a downward revision of Egypt's credit line
because of a rapid increase of arrearages and the
threat of default on obligations totaling $180 million.
Secret
DI IEEW 86-045
7 November 1986
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Major Points of Contention
Egypt's attempts to portray the differences separating
it from the IMF as minimal are misleading and
ignore significant areas of disagreement. Some of the
more important differences are.
? Exchange Rate Reform. The Egyptian Government
proposes to unify the commercial bank rate with the
prevailing free market rate over a 12- to 18-month
period. The IMF contends that this slow movement
will delay an increase in worker remittances, not
stimulate exports enough, and not promote capital
inflows. It is likely to recommend that the free
market rate be applied to all transactions in the
commercial bank pool starting January 1987 and
that the Central Bank pool be moved into the
unified market as soon as possible.
? Interest Rates. Cairo does not believe higher inter-
est rates are necessary. Higher rates, it maintains,
would discourage private investment and would
encounter the strong opposition of Islamic groups.
The IMF, on the other hand, argues that higher
interest rates on domestic deposits are needed to
attract worker's remittances as well as to slow
down the growth of credit and reflect the real cost
of capital.
? Energy Prices. Egyptian officials plan to undertake
energy price adjustments over the next five years so
have expressed sur-
prise at how long Egypt has been able to avoid major
import cuts despite its extremely adverse international
financial position.
=Cairo has tapped the capital reserves of the state
petroleum company to meet short-term financial obli-
gations, a move that, if true, could have damaging
long-term effects on oil exploration and development
in Egypt. Cairo has also reportedly benefited from
higher prices in the refined petroleum product mar-
ket, with refueling of aircraft at Cairo Airport-one
of the busiest in the Middle East-a prime money
earner. In addition
the Mubarak government has drawn heavily on
that domestic prices for petroleum products will be
at international levels by 1992. The IMF, while not
explicitly opposed to a gradual increase in energy
prices, would probably favor a shorter time frame,
perhaps three years. In addition, it maintains that
major increases in fuel oil, diesel, and kerosene
prices must be passed through the entire economy,
including the public sector.
? Agricultural-Sector Policies. In spite of some pro-
gress in restructuring agriculture and raising pro-
curement prices, the incentive structure is still
biased toward such crops as fodder, fruits, and
vegetables at the expense of cotton, rice, and other
crops in which Egypt has a comparative advantage.
Such distortions and disincentives would have to be
removed so that farmers receive full world-market
value for their crops.
? Industrial-Sector Policies. Public-sector industry
operations are still hampered by controls over
pricing and employment as well as over centralized
decisionmaking. Under an IMF-endorsed program,
the government would have to commit itself to a
basic restructuring of public-sector industries, in-
cluding more decentralized management to include
greater plant manager control over hiring and out-
put prices.
the foreign currency assets of the commercial banking
system, a policy that could, if pushed much further,
undermine depositor confidence and precipitate a run
on the banks and massive capital flight.
While Egypt has muddled through, we believe that
unless Saudi Arabia or some other major donor steps
in with large-scale financial assistance within the next
six months there is a strong likelihood that Cairo will
default on major portions of its international debt.
the contraction
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in short-term credit lines that began last year and
accelerated midyear is finally working its way
through the import financing system, and shortages of
essential imports could materialize by early next year.
A growing sense of urgency characterizes the Egyp-
tian Government's efforts to achieve agreement with
the IMF over the terms of a standby program. As
recently as eight months ago Egyptian officials saw
little need for an IMF-endorsed reform program.
According to Foreign Minister Abdul Meguid,
Cairo's stated goal now is to achieve a standby by
mid-December-a deadline most financial observers
feel is unrealistic. We believe this major reversal in
policy is due, in part, to Cairo's own bleak reassess-
ment of its financial position.
Cairo's basic game plan in negotiating an IMF stand-
by almost certainly is to secure a major economic
assistance package with minimal concessions on its
part. While such a policy is rational from the stand-
point of leaders whose focus remains on preserving
domestic order, it suggests a less than wholehearted
commitment to the necessity for fundamental reform.
As a result, achieving a consensus on the conditions of
a standby will be difficult. This will be particularly
true if the IMF insists, as is likely, on implementation
of some measures before funds are disbursed.
A fundamental point of contention between the IMF
and Egyptian officials revolves around the interrelat-
ed nature of the reforms themselves. Fund officials
stress, correctly we believe, that for a reform package
to work all facets of the program must be introduced
simultaneously. In this way each element reinforces
the other, creating a ripple effect throughout the
economy.
It is this issue of timing more than any other that is
likely to become the most hotly debated point in the
negotiation over a standby. The concept of several
major policy adjustments being introduced simulta-
neously is alien, we believe, to Mubarak's instincts.
Instead, his regime espouses the importance of gradu-
alism in introducing change and continues to seek
piecemeal implementation of reform. Gradualism
may have considerable merit from the perspective of
political stability; it is unlikely, however, to ignite the
economy and propel it into a period of self-sustained
growth.
Should negotiations between the IMF and Cairo drag
on or, even worse, falter, the capability of Egypt's
official economy to meet the population's demand for
low-cost goods and services will rapidly erode. Short-
term credit facilities, already severely contracting,
would virtually dry up, forcing Egypt to finance
imports out of already inadequate export earnings.
Egypt's large and dynamic parallel economy cannot
provide an adequate cushion if the official economy
falters. Without major reforms, the government has
little access to these resources and it is the govern-
ment, not the private economy, that underwrites the
extensive system of subsidies and price controls.
If negotiations over a standby stall, Cairo is likely to
seek US intervention in pressuring the IMF to adopt a
more "realistic" negotiating stance. Such entreaties
are likely to become more frequent and forceful as
Egypt's economic situation deteriorates. Egypt also
will almost certainly ask the United States for further
bilateral assistance. We do not exclude the possibility
that Mubarak or his aides will, in desperation, threat-
en to undo some elements of the US/Egyptian special
relationship if aid is not forthcoming.
Economic adjustments in line with the IMF's present
conditions for a standby, on the other hand, would
risk an escalating series of strikes and street distur-
bances, and we are skeptical about the Mubarak
regime's commitment to the terms of a standby
program if civil disorder breaks out. Cairo would be
strongly tempted to rescind important components of
the program. Should this occur, the flow of IMF and
other multilateral funds contingent on the standby
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would be suspended. Debt rescheduling under the
Paris Club, if not completed, would be similarly
affected. The Egyptian Government would, more than
likely, turn again to foreign donors-particularly the
United States-for emergency relief, citing the threat
of political instability as transcending economic
considerations.
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Spot Oil Market
Developments
Venezuela Developing
Heavy Oil Belt
seriously undermining prices.
Spot oil prices have been volatile during the past several weeks in response to both
events and market fundamentals. Prices for several key crudes dropped by nearly
$1.00 per barrel following the conclusion of the OPEC meeting on 22 October,
then increased a week later on the news of Saudi Oil Minister Yamani's ouster and
his replacement's call for an OPEC target price of no less than $18 per barrel. In
recent days, prices have again slipped on the belief that the market remains
oversupplied and that significantly higher prices are only possible if OPEC comes
up with a workable production allocation scheme for 1987. A number of producers,
including the Saudis and the Mexicans, have offered $0.50 per barrel discounts on
recent shipments. North Sea Brent and West Texas Intermediate crudes are now
selling at about $14 and $15 per barrel, respectively. Market conditions remain
uncertain given the large inventory buildup that took place during the second and
third quarters of this year. In the coming weeks, inventory drawdowns and the sea-
sonal increase in demand will determine if OPEC can increase production without
the world's largest and least developed hydrocarbon deposits.
The Venezuelan state oil company (PDVSA) is experimenting with a water
injection process to develop the heavy oil belt north of the Orinoco River-one of
Venezuela is keenly interested in such sales, because they consider the water-heavy
oil emulsion a nontraditional energy source falling outside their OPEC quota.
Other OPEC members are almost certain to challenge this as an attempt at quota
Indonesia Postpones Jakarta has postponed building its first nuclear power plant for financial and
Nuclear Power Plant safety reasons. The Director General of the National Atomic Energy Agency told
reporters last month that construction would be difficult to justify in light of the
depressed oil-based economy. He also attributed the delay to doubts over nuclear
plant safety in the light of the Chernobyl' accident. Despite the postponement, he
claimed the government is committed to continuing nuclear research with foreign
technical assistance, as well as with the cooperation of the International Atomic
Energy Agency. Even if oil prices rebound soon, however, Jakarta will probably
first restore funds for other shelved programs-such as thermal and hydroelectric
power and transportation systems-before allocating resources to such long-range
programs as nuclear power. As a result, Indonesia is unlikely to meet its goal of
having a nuclear power plant operating before the year 2000.
21 Secret
DI IEEW 86-045
7 November 1986
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South Korea
Reduces Foreign Debt
Latin America's
Dwindling Foreign
Investment
South Korea plans by yearend to reduce its officially estimated $47 billion foreign
new financial activities currently off limits to foreigners.
Seoul may refrain from borrowing until mid-1987, despite the
availability of favorable terms, including Japanese bank offers of rates below
LIBOR. Seoul believes the reduction is possible because most economic analysts in
South Korea expect a $3.5-4 billion current account surplus this year, the first
since 1977, according to the US Embassy. They also realize that a rebound in oil
prices, the dollar, and interest rates could reverse the surplus and make the debt
reduction a one-shot deal. Despite Seoul's longstanding policy of reducing short-
term debt-from $12.4 billion in 1982 to less than $10 billion last year-South
Korea's need for export financing will probably shift the focus to retirement of old-
er, high-interest, medium-term loans. While South Korea's annual $6.5 billion
debt service will not be greatly affected, the Chun government may gain politically
because foreign debt has been a prime target for opposition sniping. The
government's move to limit borrowing probably will increase outside pressures for
faster financial market liberalization. Foreign bankers, who profit from arranging
Seoul's forays into international financial markets, will be anxious to expand into
debt-the fourth largest among LDCs-by $1.2 billion. Moreover
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7 November 1986
foreign investment regulations.
Foreign direct investment in Latin America is dropping sharply this year, at a time
when worsening trade balances and cuts in new lending are squeezing debtor
country foreign exchange positions. According to our calculations, direct invest-
ment-including reinvested earnings as well as new capital inflows-in the region
from abroad will fall below $3 billion compared with $4 billion in 1985 and nearly
$8 billion in 1981. Economic disincentives and political uncertainties are both
hampering new investment. In Brazil, for example, the largest Latin beneficiary,
foreign investment is expected to plunge from $1.2 billion last year to about $750
in 1986, the lowest total in 15 years, according to recent Brazilian statistics. The
US Embassy reports that multinational corporations are concerned about growing
economic nationalism-particularly calls for expanding market reserve protec-
tion-and are deferring investment decisions pending a clearer view of future
government economic policy, including the elimination of price controls. Substan-
tial declines in foreign direct investment in other leading recipients-Mexico,
Argentina, and Colombia-reflect restrictive government policies, weak regional
market conditions, guerrilla activity, and diminishing opportunities for converting
debt to equity. Most Latin governments are hoping for substantially greater
foreign investment, but we judge that widespread nationalist political sentiment in
the region will limit them from taking more than modest steps to liberalize their
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power program as well as political motives.
the agreement with Argentina that was to have been signed during
for its nuclear program.
President Alfonsin's visit to Cuba on 18-19 October will involve training of Cuban
nuclear technicians in safety and protection practices. The agreement not only
suggests that Havana is more concerned about nuclear safety since the Chernobyl'
accident, but also represents an attempt to expand bilateral ties to Buenos Aires.
Details of the agreement signed with India, reported by Caribbean press on 19
October, are not yet available, but the accord probably is aimed at demonstrating
Cuba's solidarity with the Nonaligned Movement and increasing Havana's stature
in the world. Neither agreement appears to involve the transfer of sensitive
technologies, or to signify any decrease in Havana's reliance on the Soviet Union
Indian-Chinese
Science Cooperation
Considered
and the September Sino-Pakistani nuclear cooperation agreement.
A report prepared by a delegation of leading Indian scientists, including the
Chairman of the Science Advisory Council to Prime Minister Gandhi, has
recommended Sino-Indian collaboration in several areas of research, including
lasers, electronic materials, plant tissue culture, and seismology. The scientists,
who visited China last July as guests of the Chinese Academy of Sciences, were re-
portedly impressed by China's rapid progress in S&T over the last eight years, ac-
cording to Embassy reporting. They acknowledged that the Chinese had surpassed
them in a number of areas-including those proposed for cooperation. Their
impression that Chinese institutes are well equipped and have strong links to
industry is in marked contrast to comments by Western observers, and probably
reflects the limited scope of their visit as well as the comparatively poorer facilities
in India. We do not expect either government to endorse formal S&T cooperation,
however, because of bilateral strains over mutual accusations of border violations
Cuban Nuclear Cuba reportedly has concluded nuclear cooperation agreements with India and
Cooperation Agreements Argentina, reflecting Havana's growing concern over the safety of its nuclear
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7 November 1986
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Japanese Concern About Japan's National Police Agency is seeking increased resources in order to reduce
Technology Loss the high level of technology diversion to the Warsaw Pact nations
the police want tighter controls on Soviet Bloc
activities to thwart what they regard as disturbingly high levels of technology
transfer. he inability of the police to monitor Warsaw
Pact visitors closely and industry's failure to recognize the strategic value of many
dual-use technologies. With the budget for next year now under review, the
National Police Agency apparently is hoping to strengthen its current program of
encouraging expulsions of Eastern Bloc diplomats suspected of technology theft
and providing briefings to Japanese industry on Soviet collection activities. The
agency is also attempting to wrest responsibility for investigations of suspected
COCOM violations from MITI. Principal authority to stop illegal trade, however,
which is the Bloc's primary channel for technology acquisitions from Japan,
remains firmly with MITI. Police oversight of foreign visitors is also constrained
by Japan's lack of an espionage law. The ruling Liberal Democrats are scheduled
to submit a new espionage bill next month, but it will face stiff opposition
resistance, even though it is narrower in scope than one defeated last year.
West German Growth Concern about prospects for growth may increase pressure on Bonn to stimulate
Prospects Uncertain the econom ___]several regional West German
economists believe GNP growth next year could be only 2 to 2.5 percent-less
than the 2.8 percent estimated by West Germany's five leading economic
institutes. the economists believe export growth will be
much weaker than projected; as a result, expansion in 1987 will be even more de-
pendent on domestic spending. Most economists, however, expect the surge in
domestic demand to dissipate sometime next year. If growth slows, Finance
Minister Stoltenberg is said to be willing to reexamine Bonn's plan to enact tax re-
form in 1989. Bonn is not likely to expand the scope of tax reform or implement it
a year early, however, unless growth slows markedly by spring. Moreover, the
Bundesbank probably will not enact monetary measures to stimulate the economy
until it can drain the financial system of the excess liquidity that built up this year.
Impending Shakeup in A high-level shakeup in the Direction des Relations Economiques Exterieures
French Trade Ministry (DREE) is likely within the next three to six months,
Philippe Jurgensen, who is closely tied to the previous Socialist government, is
likely to be removed as Director and replaced by Francois David, a former DREE
official who is currently staff director for Trade Minister Michel Noir. David, in
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turn, is likely to be replaced by Jean-Pierre Landau, currently number-three man
at the DREE in charge of multilateral affairs and a key French point man on the
new GATT round. The departure of Jurgensen 7r, XFt
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Noir, a political appointee who has little experience in trade affairs and has won
little respect from DREE professionals. Prime Minister Chirac would probably
like to retain Noir but could assign him to another ministry if criticism grows.
indicates that trade policy will probably be left in the hands of professionals who
have come up through the ranks in the DREE. In addition to the DREE changes,
France's lackluster trade performance could increase pressure on Trade Minister
Sweden's Public-Sector The month-long public-sector strikes that ended on 30 October highlighted
New Zealand
Government
Riding High Despite
Economic Woes
sector real wage increases.
government spending restraint-the core of its anti-inflation strategy-to demon-
strate its prounion credentials. Moreover, the private-sector unions have become
increasingly critical of their public-sector counterparts. The private-sector unions
realize that past public-sector wage increases have led to higher government
expenditures, higher taxes, and increased inflation, which in turn stymie private-
growing strains between the Social Democratic government and its union allies.
The strikes began when both the unions and the employers rejected a mediator's
"final" offer. Last month, however, the government moved to reach a settlement,
saying it would make room in the budget for public-sector real wage increases. De-
spite a fear of inflation and a commitment not to raise taxes, the government
agreed to increase its wage bill by 15 percent-roughly the same proposal it
rejected in September. Although the unions conceded to postponing the pay parity
issue until 1988, they did obtain a pay hike for lower paid workers 50-percent
larger than was offered in September. The strike-the third in the public sector in
18 months-demonstrates increasing problems within the Swedish collective
bargaining system. Despite the mediator mechanism, the negotiations effectively
pitted the Social Democratic government against its nominal trade union allies. In
the end, the government felt forced to give ground on its policy of wage and
percent next year.
New Zealanders' optimism about their economy contrasts markedly with forecasts
of a fourth-quarter contraction-GDP has declined for the past nine months-
rising inflation, and growing unemployment. According to recent polls:
? The largest share of respondents since September 1985 believe the economy will
be better 12 months hence.
? More New Zealanders are satisfied with the current state of the economy than at
any time since Prime Minister Lange was elected in July 1984.
? Support for the Labor government's handling of the economy has risen to 48 per-
cent, the highest approval rating since October 1985.
Inflation during the third quarter, however, reached a 15-month high of 14 percent
at an annual rate, and almost certainly will increase this quarter because a
national sales tax is being implemented. Unemployment, above 4 percent, is high
by New Zealand standards, and New Zealand economists predict it will top 5.5
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Brazil's Weakening
Trade Position
Brazil Adjusts
the Cruzado Plan
Less Developed Countries
in its quest for major cuts in annual debt payments.
A deterioration of Brazil's trade balance this year probably will lead to the first
sizable current account deficit since 1983 and increase pressures for substantial
economic adjustments. In our judgment, Brazil's vaunted trade surplus will decline
from last year's $12.5 billion to $11.5 billion, largely because of a major dip in ex-
port earnings since May. We project a fall in exports below $25 billion in 1986
largely due to low prices for primary commodities, robust domestic demand for
consumer goods, and a prolonged freeze of the exchange rate against the dollar
that reduced price competitiveness. Meanwhile, Brazilian imports in 1986 may
slightly exceed last year's $13.2 billion as sharply increased purchases of food and
capital goods more than offset a $2.5 billion cut in oil imports. To deal with the
eroding trade position, the government probably will resume aggressive devalua-
tions and take steps to cool domestic demand. The 1.8-percent devaluation last
month, although insufficient to match domestic price increases, may signal such a
new policy. There is some risk, in our judgment, that Brasilia may reject such
adjustments as politically infeasible and adopt a more strident stand with creditors
President Sarney will announce adjustments to the Cruzado Plan-his anti-
inflation program-before Brazil's congressional and gubernatorial election on 15
November, The local press is decrying
growing food shortages, rising inflation, and the halt in investment, prompting
Sarney to consider price increases on some foods in short supply and new moves to
encourage savings. A final decision on details has not been made,
but the President believes his willingness to make tough decisions shortly
Mexico Looks To Boost
Automotive Exports to
the United States
Secret
7 November 1986
ingly supported Sarney's coalition in the past.
before the election will improve his standing with the public. Sarney probably is
worried about growing discontent among voters and declining business confidence.
Price hikes will sit well with the business community but will do little to alleviate
the shortages before election day. They risk a popular backlash against ruling-
coalition candidates, particularly from middle-class voters, who have overwhelm-
other developing countries such as South Korea and Taiwan.
addition, Mexican exports face tough competition from Japan as well as from
US and other foreign automotive firms with plants in Mexico are planning to
expand exports of vehicles and parts to the United States. The automakers are re-
sponding to weak domestic sales brought on by the dismal state of the Mexican
economy. For its part, the Mexican Government hopes that the auto sector will
spark an industrial upturn through its export actions. We believe that a sharp rise
in exports would require sizable foreign investment to update product offerings. In
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Zaire Backpedaling
on Economic Reform
Seychelles President
Reacts to
Currency Crisis
King Hussein
Addresses the
Jordanian Economy
year.
Zaire's ruling party last week proposed sweeping economic policy changes that
may jeopardize IMF and World Bank programs. The US Embassy reports that
party leaders recommend limiting Zaire's debt service payments, returning to a
fixed exchange rate, and reimposing trade restrictions. Although President
Mobutu is not formally obligated to implement these proposals, he has endorsed
them in principle. He has also demoted the Prime Minister, who has been closely
identified with the current reform effort. The IMF and the World Bank have
suspended disbursements pending official clarification of Kinshasa's economic
policy intentions, according to the Embassy. The new proposals cap months of
growing frustration with more than three years of IMF-backed austerity. Mobutu
may be trying to renegotiate current agreements and probably is not prepared to
abandon all cooperation with the multilateral institutions. The IMF and the World
Bank are unlikely to relax significantly their conditions for credit, however,
increasing the possibility that Mobutu will choose a go-it-alone strategy by next
Economic advisers have convinced President Rene that the government's high
capital expenditures are to blame for the country's severe foreign currency
shortag . Rene reportedly has informed his 25X1
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inefficient parastatals, and restrict imports. In addition, Rene may indirectly
devalue the country's currency by removing its link to the SDR. Although receipts
from tourism, the main source of foreign exchange, have risen since 1983 to a re-
cord $47 million last year, local banks and businessmen are having trouble
obtaining hard currency from the Central Bank for new letters of credit or ones al-
ready approved. Although the proposed moves would help alleviate some of the
Seychelles economic problems, Rene has a poor track record in implementing
reforms and his willingness to adopt politically risky measures in light of a recently
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Palestinians.
King Hussein's 1 November speech focused on ways to reactivate Jordan's badly
slumping economy. The economic situation is worsening as all important external
sources of income-Arab aid, worker remittances, and export earnings-continue
to decline. Moreover, foreign exchange reserves now are the equivalent of less than
six weeks' imports at the current rate, according to the US Embassy. Shrinking ex-
port earnings have pushed many businesses, particularly in agriculture and
construction, to the brink of bankruptcy, and, more disturbingly, contributed to
growing unemployment. To counter these trends Hussein proposed government
assistance to agriculture, industry, and construction, including price supports,
concessionary loans, export incentives, and vocational training. Without new
infusions of aid, however, the likely decline in external earnings over the next two
years will force Amman to constrain the economy further. Additional austerity
may generate labor discontent, especially among the unemployed workers return-
ing from abroad and West Bank Palestinians. Declining revenues may also disrupt
Jordanian funding of the West Bank portion of its development plan, which
Amman sees as a way of promoting the peace process among moderate
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Iranian Government A recent editorial in a government-controlled newspaper stridently criticized the
Criticized in regime's handling of the economy. The article attacked the government for failing
Official Press to deal with inflation, unemployment, and falling production and expressed
concern that these difficulties might threaten popular support for the regime. It
also claimed that press censorship had contributed to anxieties over shortages of
food and fuel and had encouraged rumormongering. The editorial is the harshest
public criticism that the government has allowed. It probably reflects growing
concern among Iranian leaders about the economy plus an effort to prod the
regime into being more candid about current difficulties and to prepare for severe
shortages this winter. Although no faction was singled out for criticism, the
publication of the article may reflect factional fighting over economic policies and
dissatisfaction with the cost of the war.
Pakistani Ffforts
To Increase
Cotton Exports
Malaysia Selling
Local Shares
to Foreigners
Pakistan's subsidized raw cotton exports have undersold many world producers
this year-including the United States-but Islamabad is troubled by delays in
deliveries that have irritated major buyers,
percent of total Pakistani exports.
Islamabad has increasingly targeted traditional US export markets-
notably South Korea, Taiwan, Japan, and Western Europe-since China ceased
Pakistani cotton imports in 1984. China had been Pakistan's largest cotton export
market. Islamabad tasked its Cotton Export Corporation (CEC) in early 1986 to
expand export markets and the CEC has budgeted over $125 million for export
subsidies. CEC officials freely admit that they will do whatever it takes to sell
Pakistan's surplus cotton, even if world prices remain low. The US Agricultural
attache has revised his forecast for Pakistan's cotton exports upward in light of this
year's expected bumper crop. In 1985, raw cotton sales accounted for almost 10
to 10 percent of its holdings in two subsidiaries to major international investors.
Kuala Lumpur, in an effort to trim its budget deficit and bolster private
investment-key elements in the government's economic recovery strategy-is
approving the sale of locally owned shares of Malaysian corporations to foreigners.
The decision was foreshadowed last spring when Prime Minister Mahathir
suspended Malay capital ownership targets under the New Economic Policy,
despite the risk of intensifying ethnic Malay fears that they will be left further be-
hind economically by the government's efforts to deal with the economic slump.
Last week the government sold 15 percent of its shares in the national airline,
Malaysian Air System, to foreign investors, according to the US Embassy. In
October, Malaysia's Sime Darby, ASEAN's largest private conglomerate, sold up
Leading Indonesian Indonesian tycoon and presidential financial adviser Liem Sioe-Liong-reputedly
Businessman Comments the sixth-wealthiest man in the world-believes that the rupiah devaluation in
on Devaluation September has hurt the government's credibility and damaged prospects for
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7 November 1986
foreign investment Liem, who indicated that he
is transferring capital abroad, believes that rising prices and uncertainty over
future economic policies discourage foreign investors. His views on the devaluation
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almost certainly reflect concerns in the domestic business community. For
example, the US Embassy reports that the devaluation, which came after repeated
government denials, has eroded confidence in the Soeharto regime's ability to cope
with Indonesia's economic slump. Liem's pessimism, however, probably also
reflects financial losses he suffered because of devaluation. Unlike Soeharto family
members who, according to the US Embassy, allegedly purchased US dollar
futures hours before the currency adjustment, Liem reportedly converted $140
million to rupiah just prior to the devaluation. Dispite Liem's apparent bitterness,
we believe his remarks are significant because of his longstanding business ties
Impact of
Solomon Islands
Budget Austerity
US Firm
Assists in Assessing
Chinese Aircraft
with the President and his dominant role in Indonesian financial circles.
by the Solomon Islands in US military training programs.
The Solomon Islands Government has sharply pared back spending because of
declining tax revenues from copra, timber, and palm oil exports. Some of the
spending cuts have long been needed; for example, the government hiring freeze
should help the Finance Ministry's campaign to reduce the bloated and inefficient
public service. Honiara is also reducing travel and foreign training for government
personnel. Other cuts hit at US interests-a 50-percent reduction in the subsidy
for the Solomon Islands Broadcasting Corporation eliminates the daily broadcasts
of VOA-supplied programs and news. In addition, according to US Embassy
officials in Port Moresby, the austerity measures appear to rule out participation
world market.
Chinese aircraft engineers are working side by side with their US counterparts at a
US aerospace company evaluating the performance of China's Y-7 aircraft and
comparing it with all other comparably sized transports now in operation
worldwide. Early test results-which show that the 52-seat Y-7 performs poorly in
virtually every category-may convince the Chinese that making the Y-7 an
acceptable, airworthy aircraft for the world market would be more costly than
they anticipated. Furthermore, a comparison of the characteristics of Y-7 parts
and components is expected to prove that many Y-7 components are much heavier
than those of similar aircraft. Still, the aircraft's overall performance could be
improved significantly-although not to world standards-by reducing the weight
of selected components. Nonetheless, the Civil Aviation Administration of China
(CAAC) is on record as favoring Western aircraft. CAAC has only 15 Y-7s in its
inventory-largely a result of political pressure-and another 40 on order.
Moreover, China's aeronautics ministry-the builder of the Y-7-has explored
coproducing either the 36-seat Canadian De Havilland Dash 8-100 or the 42-seat
French-Italian ATR-42. Coproduction of either aircraft would advance China's
commercial aviation sector and eventually provide an aircraft suitable for the
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China Seeking US
Aircraft Equipment
China Upgrading
Aluminum Plant
tourists-an important source of hard currency.
China is negotiating a $10 million contract with a US firm to design and build new
constant speed drives to power accessories on its Trident passenger jets. Without
new drives, these jets-which compose 20 percent of China's passenger jet
inventory-will not be operable after 1988 or 1989. The Chinese probably will
view the purchase as cost effective because the Tridents primarily carry foreign
other local plants.
China is upgrading the 25,000-metric-ton-capacity Baotou Aluminum plant in
Inner Mongolia to 70,000 tons. The Chinese plan to increase aluminum production
to reduce their dependence on imports and conserve foreign exchange. Because
aluminum is an electricity-intensive industry, China also is working to bolster
electric power capacity in the region. A new coal mine at Shenfu, 200 kilometers
from Baotou, will fuel a 23- to- 28-megawatt power plant nearby. In addition, a
rail spur is under construction to transport as much as 5 million tons of coal from
Shenfu to Baotou, which may also fuel electricity generation for the aluminum and
Cuban Hard Currency With prolonged debt rescheduling talks exacerbating Cuban foreign payments
Situation Deteriorating problems and with no increase in Soviet hard currency assistance expected,
President Castro appears to have little choice but to eventually tighten economic
austerity. Negotiations with commercial creditors stalled when Havana rejected
the creditors' offer in September of a $60-70 million package and insisted it
needed at least $300 million in new loans to cover planned imports this year.
Havana may try to negotiate its July
rescheduling agreement with the Paris Club in hopes of reversing the commercial
creditors' decision not to commit any new funding. In any case, we believe Havana
faces a major crunch on its Paris Club payments by the end of this month.
many Western traders are reviewing lending policies
after experiencing payment problems with the Cubans.
Cuban policymakers appear to be planning spending cuts, probably under the
assumption of little immediate hard currency relief.
Havana is planning to postpone all but emergency imports until spring
Secret
7 November 1986
already exhibited in escalating antisocial activity.
1987. Havana
may have to resort to such measures as redirecting domestic food for export,
conserving more fuel for reexport, and slowing some industrial production.
Increased austerity, however, is likely to raise the level of domestic dissatisfaction
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