INTERNATIONAL ECONOMIC & ENERGY WEEKLY

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP97-00770R000100710001-4
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 38
• Document Creation Date: December 22, 2016
• Document Release Date: June 10, 2011
• Sequence Number: 1
• Publication Date: December 19, 1986
• Content Type: REPORT

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Directorate of
Intelligence
Weekly
GI_/O
1~v /~J"~iwrf
International
Economic & Energy
JFVIA wt
DI IEEW 86-050 60000'
19 December 1986
Copy 6 7 9
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Secret
Internatio
nal
Economic
& Energy W
eekly
19 Decemb
er 1986
iii Synopsis
1 Perspective
-GATT's Uru
guay Round: Keeping the Ball Rollin
g
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3 Modernizin
g the Soviet Ste
el Industry: No Easy Solutions 25X1
2bAl
7 Indonesia:
The Imperative
for Economic Reform 25X1
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11 Israel: Econ
omic Pressures
Threaten Reform Package 25X1
ZoA]
15 China: New
Foreign Invest
ment Incentives Unveiled
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Energy
International Finance
Global and Regional Developments
National Developments
Comments and queries regarding this publication are welcome. They may be
directed to Directorate of Intelligence,
Secret
DI IEEW 86-050
19 December 1986
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Secret
International
Economic & Energy Weekly
Synopsis
1 Perspective-GATT's Uruguay Round: Keeping the Ball Rolling
We believe the burden of maintaining momentum of the GATT negotiations will
largely fall on the United States but may provide opportunities to further US trade
policy interests.
3 Modernizing the Soviet Steel Industry: No Easy Solutions
On balance, we believe the Soviets will fall far short of their steel modernization
goals. Wthout major improvements in the quality and variety of steel products,
General Secretary Gorbachev's program to develop and produce modern techno-
logically sophisticated machinery and equipment will be seriously hampered. 25X1
7 Indonesia: The Imperative for Economic Reform
In the absence of either far-reaching economic reforms or dramatic increases in
the price of oil, Indonesia's economy appears incapable of generating the growth
necessary to stem rising unemployment. We believe Jakarta must ease protection
and overregulation of domestic industries, curb pervasive corrupt business prac-
tices, and diversify its oil-dependent and inefficient government-dominated eco-
nomic system to attract foreign investment and rekindle economic growth.
11 Israel: Economic Pressures Threaten Reform Package
A failure to resolve conflicting economic policies could disrupt Shamir's reform
package and, in the worst case, lead to a political crisis and early elections.. F 25X1
15 China: New Foreign Investment Incentives Unveiled
To improve the country's deteriorating investment climate, in October Beijing
announced new regulations to encourage foreign investment. The new policies,
however, offer little relief for the problems of repatriating foreign exchange and
access to China's domestic market-the two issues of most concern to foreign
Secret
DI IEEW 86-050
19 December 1986
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Key GATT Country Groupings
Australia
Canada
Argentina
Brazil
Uruguay
Thailand
Hungary
Chile
Malaysia
Indonesia
Philippines
Colombia
Fiji
Brazil
India
Egypt
Yugoslavia
Argentina a
Singapore
South Korea
Colombia
Chile
Uruguay
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International
Economic & Energy Weekly 25X1
Perspective GATT's Uruguay Round: Keeping the Ball Rolling
We believe that the burden of maintaining the momentum of the GATT
negotiations will largely fall on the United States but may provide opportunities to
further US trade policy interests. To maintain progress in the negotiations, the
United States will have to contend with several power groups:
? The hardline LDCs-chiefly Brazil and India-are continuing their efforts to
hinder progress in the areas of key interest to the United States-services,
intellectual property rights (IPR), and investment. By engaging in their usual
tactics of obstruction and delay, they are attempting to isolate the effort on
services and limit the scope of IPR and investment. On other issues, they are
pushing for special treatment for the LDCs, probably in an attempt to solidify
LDC opposition to the US initiatives. Efforts to rebuild their power base, which
was fragmented during the GATT Ministerial, may be difficult because both
countries have already alienated a number of LDCs by claiming to speak for all
LDCs without prior consultation and by their uncompromising, hardline
positions.
? The moderate LDCs are not inclined to take a leadership role in the negotiations,
especially on the new issues where support is weak. They expect the United
States to take the initiative. They were instrumental in reaching a compromise
for the draft agenda at the GATT Ministerial and now look for something in re-
turn. They expect adherence to the "standstill/ rollback" commitment and rapid
progress on traditional GATT issues such as tariffs and subsidies to gain greater
access to the US market. We believe that with encouragement they could
participate more assertively and, as a bloc, provide powerful opposition to
hardliner initiatives.
? The developed countries are split over agriculture. The United States, Canada,
and Australia are pushing for rapid liberalization, while the EC and the rest of
Western Europe hope to slow and narrow the focus of the negotiations. On the
whole, the developed countries are committed to progress on traditional issues
and services and will boost US efforts in these areas. Recent reports, however, in-
dicate they will look to the United States for leadership on IPR and investment.
? The Cairns group of nonsubsidizing agricultural exporters will be the key force
on the agriculture issue. The group is attempting to maintain cohesion, meeting
informally to coordinate positions. While they maintain the common goal of
rapid agricultural liberalization, they differ on tactics. The United States may be
forced to play the role of mediator between the group and the EC, as it did dur-
ing the Ministerial. They also expect the United States to fulfill its pledges on
agricultural reform.
Secret
Secret
DI /EEW 86-050
19 December 1986
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International economic developments to a large extent will determine the level of
LDC support for the round. If the global economic situation declines, pressures to
raise trade barriers, rather than to liberalize, will predominate. The key indicators
will be progress on the debt issue, developed country protectionism, and bilateral
disputes. We believe a worsening in any of these areas, particularly the first two,
will cause the LDCs to seriously question the value of participating in the
negotiations.
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Modernizing the Soviet Steel Industry:
No Easy Solutions '
Modernizing the Soviet steel industry is crucial to the
success of General Secretary Gorbachev's industrial
modernization effort. Nonetheless, this sector presents
some formidible problems. The overall record of the
steel industry during the past 10 years has been one of
repeated failure to meet expectations, despite substan-
tial imports of Western equipment and technology.
The preponderance of out-of-date domestic machinery
has resulted in low quality, a narrow assortment, and
frequent shortages of steel products. On balance, we
believe the Soviets will fall far short of their steel
modernization goals. Without major improvements in
the quality and variety of steel products, the General
Secretary's program to develop and produce modern
technologically sophisticated machinery and equip-
ment will be seriously hampered.
The Modernization Program
Moscow has adopted a wide-ranging program for
reequipping the Soviet steel industry. In contrast to
the past focus on increasing production capacities, the
current plan emphasizes plant renovation and replace-
ment of outmoded equipment, specifically by:
? Reconstructing older steel plants.
? Replacing open-hearth steelmaking furnaces with
basic oxygen or electric furnaces. Open-hearth steel
still accounts for more than one-half of Soviet crude
steel compared with less than 10 percent in the
United States and none in Japan or West Germany.
? More than doubling the share-currently only
about 12 percent-of steel produced by continuous
casting by 1990. The US share is about 31 percent;
the Japanese and West German, 86 and 72 percent,
respectively.
? Upgrading rolling mills and pipe-producing shops to
provide the 500 types of new steel products called
for in the 1986-90 plan.
To reach these goals, the Soviet press reported that 50
percent of investment in the ferrous metals industry
during 1986-90 will be used to renovate existing
plants, 30 percent will go toward improving variety
and quality, and only 20 percent will finance capacity
expansion. This is in sharp contrast with past plans,
which allocated up to 75 percent of investment to
capacity expansion. Overall gains in finished steel
output are to be achieved not with increases in
production of either inputs such as coke and pig iron
or in the size of the labor force, but with increases in
labor productivity and resource savings.
The cost of effectively carrying out the program may
outstrip the resources available for it. Replacement
and renovation of steelmaking furnaces and rolling
mills will still require large investment outlays for new
equipment and, in many cases, for new facilities to
house the equipment at a time when national invest-
ment resources will be stretched thin by other de-
mands of Gorbachev's economic revitalization effort.
Moreover, domestic machine builders will be unable
to meet the demand for more reliable and sophisticat-
ed metallurgical machinery until an improved mix of
high-quality steel products starts rolling out of steel
plants on a large scale.
Qualitative improvements in metallurgical equipment
production will be further inhibited because such
equipment is a sideline at heavy-machine-building
enterprises. The proportion of metallurgical equip-
ment in the total volume of output is declining at
several of these plants. Moreover, machine-building
plants generally lack appropriate incentives for the
complex and labor-intensive production of metallurgi-
cal equipment.
Secret
DI IEEW 86-050
19 December 1986
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Secret
USSR: Production of Ferrous
Metals, 1975-85
Rolled steel
Plan
Actual
0 1975 76 77 78 79 80 81 82 83 84 85
In addition to the difficulties in obtaining new and
better machinery, a program based on reconstruction
and technical reequipment poses near-term difficul-
ties for the operation of the Soviet steel industry. For
example, the renovation strategy has traditionally
been resisted by managers of steelmaking enterprises
because the downtime required to replace old machin-
ery, as well as the uncertainty inherent in new
production processes, threatens their achievement of
short-term performance goals. An equal concern is
how quickly workers adapt to the new equipment,
which often is more complex and requires more
training to operate and maintain. Appropriate incen-
tives must also be given to construction firms that
have generally steered clear of renovation projects
because they tend to be more labor intensive than new
construction.
Turning abroad for help, Moscow will find little near-
term relief from this Catch-22 situation. The collapse
of world oil prices will limit Soviet foreign exchange
spending to items of the highest priority, probably for
the rest of the decade. In this context, most of the
steel industry's projects for 1986-90 that are slated to
use Western equipment are those that involve addi-
tions of new capacity and are already well under way.
As a result, renovation projects appear to be more
vulnerable to cancellation.
The volume of future imports of Western equipment
is likely to depend largely on the terms Moscow is
able to negotiate with Western firms. Moscow has an
excellent credit rating and may push for additional
loans with lower interest rates and longer repayment
terms for pending projects. The Soviets cannot expect
to depend heavily on their East European client states,
which already supply Moscow with a large share of
their machinery production and are ill prepared, and
probably unwilling, to meet heavy new demands for
more and better machinery exports.
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On balance, we believe the Soviets will fall far short
of meeting their goals for modernizing the steel
industry. As a result, we can expect to see:
? Continuing complaints from various ministries (es-
pecially the machine-building ministries) about in-
adequate variety and quality of steel products that,
in turn, will inhibit progress in modernizing the
machine-building sector-the centerpiece of Gorba-
chev's industrial modernization program.
? Machines that, compared with Western counter-
parts, perform fewer functions and need to be
repaired or replaced more often-thus siphoning
scarce resources away from modernization and into
capital repairs.
? Continued need for imports of many Western steel
products, such as plate and sheet for the machine-
building branches and pipe for the oil and gas
industries, adding to the strain on dwindling hard
currency resources.
Soviet planners will have to weigh carefully the
tradeoffs between purchasing Western plant and
equipment to upgrade the technological level of the
steel industry and importing Western steel products.
Cutbacks in Western equipment purchases would
further slow the pace of steel modernization and
lengthen the Soviets' technological lag in ferrous
metallurgy. New Western steel technologies would be
particularly beneficial to the Soviets because they
offer flexibility in the use of raw materials, save
energy, and cost less per metric ton of installed
capacity than conventional processes. As a result,
Moscow may well decide to initiate within the next
few years an aggressive program for their acquisition
through joint ventures or other arrangements that
minimize the up-front outlay of hard currency. But
the payoff from such a program would not materialize
until well into the 1990s.
Despite potential advantages to Moscow of joint
ventures, Western steel firms are unlikely to rush to
enter into such deals. Years of dealing with the
cumbersome Soviet bureaucracy, poor-quality Soviet
USSR: Imports of
Western Steel Products, 1980-85
Million US $
Total
3,158
3,217
3,964
3,355
3,093
3,201
Rolled steel
1,650
1,412
1,353
1,135
1,174
1,332
Pipe
1,508
1,805
2,611
2,220
1,919
1,869
materials and semifinished goods, and negotiations
that go on interminably will make most Western
businessmen wary. Moreover, the Soviets themselves
are apt to approach such negotiations cautiously.
Granting the amount of control over production pro-
cesses that would probably be required by the West-
ern firms would go against the grain of most Soviet
managers.
The failure to make major improvements in the steel
industry over the next few years will make industrial
modernization more difficult and protracted, increas-
ing the risk that Gorbachev's ambitious moderniza-
tion goals for the remainder of the decade will not be
met. As the Soviet leader is able to assess how
modernization is faring, he may be in a position to
better plan improvements that could be implemented
in the 1990s. For example, he could double the value
of imports of Western equipment-by increased bor-
rowing in the West-to modernize steelmaking with-
out increasing the share of domestic investment re-
sources for steelmaking and finishing processes.
Prolonged delays and setbacks to current moderniza-
tion plans, however, will also increase pressure on the
regime to either back off its ambitious program or
make more fundamental changes in the system that
might provide both the incentives and the resource
slack necessary for meaningful improvements to take
place.
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Indonesia: The Imperative for
Economic Reform
In the absence of either far-reaching economic re-
forms or dramatic increases in the price of oil,
Indonesia's economy appears incapable of generating
the growth necessary to stem rising unemployment.
We believe Jakarta must ease protection and overre-
gulation of domestic industries, curb pervasive corrupt
business practices, and diversify its oil-dependent and
inefficient, government-dominated economic system
to attract foreign investment and rekindle economic
growth. The key to meaningful economic reform, in
our view, is President Soeharto, who is the final
arbiter of all major economic and political decisions in
the country. We see little prospect, however, that
Soeharto would jeopardize the political structure he
has created over 20 years, a system of privileged
economic access that has allowed his family to build a
financial empire
Barring comprehensive reform, the Soeharto
government almost certainly will face increasing so-
cial unrest and violence in the next few years.
An Ailing Economy Forces Jakarta to React
The sharp decline in Indonesia's economic growth-a
result of the collapse in world oil prices earlier this
year-is forcing severe retrenchment in the Indone-
sian economy. Jakarta is reacting to reduced govern-
ment revenues with draconian spending cuts-a tactic
that has received kudos from foreign bankers al-
though it stifles economic growth. In September,
Jakarta announced a 31-percent devaluation in an
attempt to cut its current account deficit, which we
calculate could reach $6 billion this year. This action
was followed two weeks later by a series of additional
economic measures that include dismantling six im-
port monopolies and the elimination or reduction of a
wide range of import duties. The government hopes
this will increase the efficiency of manufacturing
industries and, together with the devaluation, promote
nonoil exports.
An Economy Under Stress
Since 1981, Indonesia's economy has reeled under the
pressure of falling oil prices:
? In the last four years, petroleum receipts fell more
than 25 percent, resulting in $17 billion in cumula-
tive current account deficits.
? In real terms, the budget for FY 1987-beginning 1
April-will be about 85 percent of what it was in
1984, and about on a par with that of 1981,
according to our estimates.
? During 1982-85, average annual real economic
growth has been 3 to 4 percent, compared with 25X6
about 8 percent in 1973-81. Growth this year could
be zero or negative.
? According to our estimates, unemployment in urban
areas is on the order of 35 percent, with substantial 25X6
underemployment as well.
In our judgment, however, the devaluation and most
other economic remedies will not significantly spur
growth or remedy unemployment as long as Indone-
sia's economy remains dependent on the oil sector.
According to our projections, which assume world oil
prices of $15 to $18 per barrel through the end of the
decade and modest growth in nonoil exports, econom-
ic growth will average no more than 3 to 4 percent
annually-the World Bank and the IMF estimate
that 5 to 6 percent growth is needed to employ the 2
million entrants to the work force each year. Al-
though the unemployed pose no direct threat to the
regime at this time, the steady increase in their
numbers, particularly in the cities, could easily fuel
antiregime activity. In the past, Jakarta reacted to
rioting and public tensions by using oil revenues to
remedy the symptoms, but must now come to grips
with the shortcomings of an economic policy that has
done little to lay the groundwork for sustained growth
and alleviating the plight of the country's poor.
Secret
DI IEEW 86-050
19 December 1986
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A High-Cost Economy
Indonesia: Direct Foreign Investment,
1982-85
We believe Indonesia's economic troubles in part
reflect manufactured exports that are not competitive
in world markets. Despite plentiful and low-cost
labor, Indonesia's high-cost economy is an outgrowth
of the government's dominant role, which is a reflec-
0 Approved
tion of its colonial legacy and its political culture. We 3.0
believe several factors contribute to the high cost of
doing business in Indonesia:
? A pervasive financial and investment regulatory 220
structure that frustrates domestic and foreign
investment.
? Extensive trade barriers-including high tariffs, .0
severe quantitative restrictions, tortuous customs
procedures, conflicting regulations, import monopo- 0.5
lies, a profusion of middlemen, licensing require-
ments, and other impediments that permeate most
aspects of Indonesian economic activity.
? The Javanese disdain for a competitive environment
necessary to develop an efficient economy. Indone-
sians prefer, instead, to maneuver behind the scenes
to gain an advantage over business rivals.
According to US Embassy reporting, a major debate
Focusing on the Cure
The Soeharto regime is grappling with the task of
rejuvenating the economy while avoiding the political
risks associated with reforming a complex regulatory
structure in which personal connections and political
favoritism dominate. Since coming to power two
decades ago, the Soeharto regime has used its virtual
monopoly over economic access-control of govern-
ment contracts, jobs in the bureaucracy, business
permits, and state bank financing-to reinforce its
political dominance. In addition, authorities have
stifled critics by threatening their economic interests,
according to US Embassy reporting. The IMF and
the World Bank have repeatedly recommended a
strategy of export-led growth using Indonesia's abun-
dant labor supply. Key elements of such a strategy
include simplifying investment regulations and licens-
ing procedures; eliminating or reducing import quo-
tas, tariffs, and other trade barriers; and moving to
privatize the economy.
is brewing within the government over the most
appropriate strategy for economic development. The
so-called technocrats or reformers-led by a cadre of
Western-trained economists-are vigorously arguing
that the best way to foster increased efficiency is by
dismantling the protectionist regulatory structure.
The other faction, made up of entrenched protection-
ist interests-the so-called developers-argue that the
road to economic growth lies in continuing, state-led
development behind protectionist barriers for all
phases of production, from raw materials to finished
products. They see protection from imports as a
means to shelter Indonesia's high-cost, undeveloped
economy
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Indonesia: Merchandise Exports,
1980-86
policymaking processes, we cannot rule out the possi-
= Crude oil Liquified natural gas
Billion US $
1980
Estimated.
6 Projected.
although signs of unease-such as the incidents of
bombing and arson conducted by Muslim fundamen-
talists in 1984-85-are clearly present. Despite the
lack of popular participation in the political and
Other bility that the growing perception of Jakarta's unwill-
ingness to move against vested business interests could
generate pressure for reform from such institutions as
the parliament, bureaucracy, military, and middle-
class and Muslim groups.
If the regime fails to make needed reforms or to deal
effectively with the social strains stemming from the
weak economy, we believe that the potential for
popular violence is likely to increase, beginning with
violence aimed at the relatively prosperous but widely
resented Chinese. Even in the unlikely event that
Jakarta moves ahead with economic reform, we be-
lieve that tangible results would take several years at
least to materialize. In the meantime, increasing rural
landlessness, migration to the cities, disappointed
Stumblingblocks to Reform
311346 1286 expectations, and growing dissatisfaction with poor
living conditions will continue to exert severe strains
on the government's financial and managerial re-
Economic reform would undercut powerful interests,
including Soeharto family members and key figures in
the military and the bureauracy. As a result, we are
not optimistic that the government will follow through
with effective implementation of reform measures-a
problem with various reform packages that Jakarta
has announced over the years. According to US
Embassy reporting, for example, two of the most
striking exclusions from the recently announced list
abolishing some import monopolies are plastics and
steel, sectors that have significant First Family busi-
ness involvement. Moreover, according to press re-
ports, only a small share of Indonesia's imports will be
affected by the monopolies Jakarta plans to eliminate.
As of yet, we see no indication that disparate elements
of society have begun to make common cause against
the ruling elite and the system of economic access,
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Secret
Israel: Economic Pressures
Threaten Reform Package
The prospect of a sharp increase in Tel Aviv's budget
deficit looms as the major obstacle to Prime Minister
Shamir's much-heralded economic program. Compet-
ing demands from labor, business, and even his own
ministries, threaten to undermine his attempt to con-
tain the projected deficit. A failure to resolve conflict-
ing economic policies could disrupt Shamir's reform
package, and, in the worst case, lead to a political
crisis and an early election.
Shamir has inherited a much-improved economy as a
result of former Prime Minister Peres's initiatives, but
not without some costs. Tighter monetary policy and
stringent fiscal measures lowered the budget deficit
and slashed inflation from triple-digit levels in 1985 to
about 20 percent this year. An 18.9-percent devalua-
tion of the shekel-and substantial US financial
assistance-contributed last year to the first positive
foreign payments position in more than 30 years.
These gains, however, came at the expense of higher
unemployment-currently about 7.9 percent com-
pared with 6 percent before austerity was imposed-
and a recession that has affected many businesses.
With an eye to the next election that must be held no
later than the fall of 1988, Shamir knows he needs
economic successes to match those of his predecessor.
To put his imprint on the economy, Shamir has
introduced an amalgamation of earlier programs that
emphasizes both growth and austerity. In his inaugu-
ral address to the Knesset in October, Shamir called
for improving the standard of living, increasing em-
ployment opportunities and reducing the govern-
ment's role in the economy through a program of tax
reform, restructuring the capital market, and privati-
zation. At the same time, he intends to resist poli-
cies-especially wage increases-that might enhance
his popularity with the electorate but undermine the
still fragile gains of the austerity program.
In our judgment, Shamir has strong economic incen-
tives to implement some degree of tax reform before
the next election. Reducing Israel's heavy tax bur- 25X1
den-the average effective tax rate is 25 percent-
would spur industrial productivity and growth, stimu-
late investment, and eliminate distortions that hinder
efficient economic activity. Moreover, a political con-
sensus is building within the government and the
private sector for tax reform. A number of govern-
ment officials believe that unless a tax change is made
many firms and individuals, especially highly trained
workers, will find it more profitable to move overseas,
according to the US Embassy.
Shamir and his Likud colleagues intend to move
ahead on capital market reform begun under the
Labor government. A restructuring of the capital
market is aimed at eventually breaking the govern-
ment's near stranglehold on available capital and
freeing badly needed money for private investment.
Finance Minister Nissim has already won initial 25X1
approval from the Peres-led inner cabinet for reform
measures that include restricting government acquisi-
tion of funds to the exact amount needed to finance
the budget deficit and allowing private companies to
raise money directly.
Shamir also is committed to privatization of govern-
ment enterprises as a way to raise revenue and, if
possible, rid Tel Aviv of financially troubled compa-
nies that are a drain on the budget. In 1985, Israeli
Secret
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Israel: Consumer Price Inflation and
Unemployment Rate, 1980-86
parastatals lost over $44 million, including $10 mil-
lion in red ink posted by El Al Airlines. The Israeli
Government Corporations Authority plans to sell or
offer shares in 11 companies. On the auction block are
the government's $80-100 million share of Paz, the
national gas company, and 74 percent of Mamen, the
management authority for Israel's airports. The gov-
ernment also will attempt to sell equity shares in
foreign markets and on the Tel Aviv Stock Exchange.
has made no headway, however, on lowering expendi-
tures for programs that directly affect the populace,
such as social security and many transfer payments.
Moreover, cutting these budget items must have the
approval of the Knesset, whose members predictably
oppose any measures that adversely affect their con-
stituents. We do not believe Shamir has the necessary
backing to lower spending to the targeted level. As a
result, the budget is likely to run a slight deficit this
year despite about $1.5 billion in additional revenue
from a series of one-time taxes.
The Budget Deficit-A Conflict
The government is struggling to reduce this year's
budget deficit-the prerequisite for any major eco-
nomic reform action. Shamir so far has achieved only
about one-half of the $480 million mandated reduc-
tion for the fiscal year ending in March 1987 by
taking politically easy chops at development programs
and government purchases of goods and services. He
An almost certain drop in revenue for the fiscal year
beginning 1 April 1987 will require additional budget
cuts if Shamir is to keep the stabilization program on
track. Automatic expiration of the temporary taxes,
including a car levy and tax on child allowances, will
cost the government about $170 million, according to
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Israel: The Government Budget, Billion US $
1984-87-
- Fiscal period ending 31 March of the stated year.
b Projected.
the US Embassy. A planned reduction in customs
duties, in accordance with an agreement with the
European Community, is scheduled to take effect this
January, and may further reduce government revenue
by up to $200 million. In addition, employers will
reduce payments to the National Insurance Institute
by $300 million.
Special Interests Limit Options
Any attempt to reduce spending or, as a last resort, to
raise taxes would meet with stiff opposition within
Shamir's Cabinet. According to US Embassy report-
ing, Finance Minister Nissim has ruled out any tax
increase to solve the deficit problem and is endorsing
tax reform. Ariel Sharon, the Minister of Industry
and Trade and a strong supporter of industrialists,
already has proposed assisting exporters with addi-
tional subsidies-on top of the $1.5 'billion already
provided. Other big spenders have taken an even
tougher stand, including the Ministry of Defense that
has publicly announced it will seek a $200 million
increase in its budget for FY 1988, and the Ministries
of Health and Education that probably will resist
further budget reductions.
Although the populace remains generally satisfied
with the government's handling of the economy, they
probably are not ready for another round of austerity.
Eliminating popular subsidies would alienate consum-
ers, business, and Histadrut, Israel's powerful labor
measures.
organization. Recent Israeli press reporting that sug-
gests a budget cut is not necessary probably has
weakened private resolve to support tough future
Histadrut, a Labor Party stronghold, has warned it
will not support a reform program that reduces the
standard of living of its constituents. As a result, the
government has avoided further subsidy reductions or
tax increases that would offend the unions and has
found it virtually impossible to implement a planned
reduction in the government payroll. Indeed, the
government currently is using some of the extra
revenue from this year's temporary taxes to subsidize
the employers' contributions to social security. The
loss of key subsidies would trigger compensating
demands for higher wages and lead to a spiral of price
increases that would effectively kill the stabilization
program.
No Resolution in Sight
Lacking strong political and popular support, Shamir
probably does not have the personal prestige to win
approval of controversial expenditure reductions, the
key to the success of the reform. We believe-and
Israeli economic policy makers agree-that the best
Shamir can do is to hold the line on spending
increases. Even if discretionary spending were frozen,
he still would face automatic spending increases
triggered by population growth and inflation. This
would force Shamir to adopt highly inflationary mea-
sures of borrowing or printing money to cover the
deficit.
The impending financial crunch means Shamir proba-
bly will have to accept a sharply curtailed version of
his tax reform proposal or perhaps even postpone the
plan altogether. Enough opposition still exists to kill 25X1
any reform that is not linked to a simultaneous
reduction in tax rates. Unless Shamir can find other
ways to replace all the lost budget income-an unlike-
ly event-he probably would not get a tax package
approved by the Knesset Finance Committee. Nissim
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Secret
is not apt to press the issue unless public opinion polls
show a popular majority supporting further reform.
Without reducing the budget deficit, the Shamir
government has no chance of making significant
progress on capital market reform before the next
election. Instead, Tel Aviv again will need to tap the
capital markets for debt financing. Even if the pro-
gram were on track, the government would still have
to contend with vested interests that would oppose and
complicate the reform effort, according to the US
Embassy.
Implications for the United States
Israel almost certainly will turn to the United States
for additional supplemental aid to cover its budget
shortfalls. Shamir probably will argue in part that it
would be unfair for the United States to deny assis-
tance to his government after granting Peres $1.5
billion in supplemental aid during his tenure. Tel Aviv
is likely to press for additional money for a wide range
of specific projects in defense and high-technology
industries. The Israelis also will push to sell large
government enterprises on US markets.
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Privatization will not come close to meeting the
government timetable because of a lack of viable
purchasers, investor reluctance, and ministerial oppo-
sition. Most domestic companies do not have the cash
to buy a government enterprise. Many foreign buyers
will remain reluctant to entertain Israeli offers be-
cause of concern over the long-term prospects for the
stabilization program, the Arab boycott, and the
possibility of another Arab-Israeli war. Moreover, Tel
Aviv probably will experience protracted difficulties
with ministers who do not want to lose the political
power that goes with the control of manpower and
patronage of government ownership.
If Shamir approaches the election with no significant
economic accomplishments, he may come under
heavy pressure from his party to implement popular
measures such as wage hikes and subsidy increases.
Shamir may well acquiesce to head off maneuvering
by Sharon and Deputy Premier Levy, his major Likud
rivals, who want to unseat him as Likud leader.
Shamir also is likely to attempt to pass some of the
blame for any shortcomings onto Peres and the Labor
Party. In the worst case, failure to agree on an
economic policy that resolves the conflict between the
deficit and the reforms could lead to a political crisis
and early elections.
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China: New Foreign Investment
Incentives Unveiled
To improve the country's deteriorating investment
climate, in October Beijing announced new regula-
tions to encourage foreign investment. A major goal
of the guidelines is to channel foreign investment into
joint ventures that produce primarily for export or
introduce advanced technology. The new policies,
however, offer little relief for the problems of repatri-
ating foreign exchange and access to China's domestic
market-the two issues of most concern to foreign
investors. Even so, the measures represent a step in
the right direction. The high-level attention afforded
these changes, moreover, suggests significant pressure
will be applied at the grassroots level to encourage
successful implementation and experimentation. Suc-
cessful local programs probably will serve as models
for future changes in national policy.
On 11 October, Beijing announced its long-promised
and much-touted new guidelines for encouraging for-
eign investment. The regulations seek to reverse a
reported 20-percent decline in overseas investment
commitments for the first six months of this year as
compared with the same period in 1985. The US
Consulate in Hong Kong believes the decline was even
greater-its figures show the value of foreign invest-
ment commitments dropping 42 percent during the
first half of 1986 to $1.2 billion.
The new guidelines include a number of provisions
affecting all foreign enterprises:
? Guaranteed autonomy over production, funds, in-
puts, wage and bonus levels, and personnel-includ-
ing the right to hire and fire workers and senior
managers.
? Import license exemptions for machinery and equip-
ment, vehicles, raw materials, and spare parts re-
quired for production.
? Export licenses, where applicable, obtainable at six-
month intervals rather than on a case-by-case basis.
? Exemption from income taxes on profits subse-
quently reinvested in expanding or establishing ex-
port-oriented or advanced technology enterprises.
? Authority for foreign enterprises to transfer foreign
exchange among themselves.
? Maximum three-month waiting period for official
responses to investment matters that require approv-
al by state and/or local departments.
Granting foreign investors autonomy over their enter-
prises mirrors many of the domestic economic reforms
implemented in recent years, such as labor and enter-
prise management reforms.
In addition to these across-the-board incentives, ex-
port-oriented and advanced technology enterprises are
singled out for special treatment that includes: 25X1
? Exemption from the payment of state wage subsi-
dies to Chinese employees, with the exception of
labor insurance, welfare, and housing.
? Reduction and standardization of site use fees.
? Priority status for the provision of water, electricity,
transportation services, and communication facili-
ties at rates on a par with those paid by state
enterprises.
? Preferential access to short-term loans.
? Reduced income taxes after the expiration of appli-
cable tax holidays as well as income tax exemptions
on profits remitted abroad.F___1 25X1
Earlier this month Beijing issued new customs regula-
tions eliminating the need for foreign-invested enter-
prises to obtain import licenses for materials and parts
used in manufacturing exports. These imported inputs
are also exempt from industrial and commercial
consolidated tax if used in finished export products.
Furthermore, the Ministry of Labor and Personnel
has formally announced a new labor regulation in
support of the earlier announced guidelines that es-
pouse autonomy for foreign joint ventures over em-
ployment, wages, and welfare funds. It also stipulates
Secret
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Secret
Doing Business in China: The Litany of Complaints
Complaints about the difficulty and excessive cost of
doing business in China largely result from frustra-
tion and disappointment among foreign investors who
rushed in to take advantage of China's "open door"
policy. Many discovered that the opportunity to
secure a share of the world's largest untapped poten-
tial market was available only under extremely
restrictive conditions. Moreover, the Chinese are sen-
sitive about being cheated, and measures to guard
against this have led to the creation of artificial price
structures and resulted in excessive costs. Conse-
quently, in matters involving labor, taxes, customs
duties, and living costs, foreign investors have been
marked for discriminatory treatment, which has of-
ten made doing business in China more expensive
than in Tokyo or Hong Kong.
Although low labor costs initially attracted many
foreign investors to China, the taxes and subsidies
levied on top of the wages of Chinese workers in
foreign-funded enterprises significantly increased the
cost of labor. Recently, the Foreign Investment Ad-
ministration announced that Chinese wages in joint
ventures could be up to 150 percent higher than those
of workers in state-owned factories. This wage premi-
um, largely pocketed by the government, makes
China less competitive for unskilled labor than some
neighboring countries in Southeast Asia.
enterprise responsibility for the pensions, unemploy-
ment insurance premiums, and housing subsidies of its
Chinese employees. Additional investment incentives,
reportedly to be introduced soon, include greater
market access for foreign enterprises that produce
goods currently imported, with part of the hard
currency saved payable to the enterprise.
More Regional Competition for Investment
The State Economic Commission has encouraged
localities to experiment with the new guidelines, and
they have responded with added enticements to en-
courage foreign investment. Ironically, excessive di-
versity could increase uncertainty for foreign inves-
tors, who already complain about the lack of
In addition, foreign enterprises are often plagued with
poor productivity because many state-assigned work-
ers are unqualified. The inability of foreign enter-
prises to fire incompetent workers and long delays in
obtaining more suitable replacements perpetuate the
low productivity that, according to some investors,
makes production costs higher in China than in
Western Europe or the United States.
Furthermore, in its efforts to restrict long-term for-
eign involvement in its economy, China has carefully
limited the penetration of joint ventures in its domes-
tic market, the life expectancy of such joint ventures,
and the period of protection of intellectual property
rights. The foreign investors are expected to transfer
technology and management know-how, produce
products for export to pay for the transfer, develop
markets for these products abroad, and depart after
the expiration of joint venture contracts.
China's nonconvertible currency is another major
sticking point. Only a few investors-mainly owners
of luxury hotels built to accommodate foreign tour-
ists and business executives, which have guaranteed
hard currency earnings-are untouched by the prob-
lem. But most joint ventures have yet to show a profit
in anything but local currency, a profit of question-
able value.
consistency in China's investment climate. In most
cases, however, the local incentives offer only minor
variations of the central regulations. In several in-
stances, however, the critical issue of foreign ex-
change was treated in more detail, including offers of
local government funds to cover temporary foreign
exchange imbalances. Shanghai officials had previ-
ously experimented with several other measures to
ease foreign exchange shortages for joint ventures,
including a widely publicized currency swap last July
between a Sino-US joint venture short of foreign
exchange and a Sino-Hong Kong venture with excess
foreign exchange. Last month another currency swap
was enacted between the Great Wall Sheraton Hotel
and the Beijing Jeep Corporation. Some localities also
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Secret
are offering access to the domestic market for sales-
at least partially in foreign exchange-of previously
imported goods.
The new regulations represent a positive step, but fall
short of the advance rhetoric and fail to adequately
address the major impediments faced by foreign
investors-access to the domestic market and the
inability to remit profits. Concerns over the country's
continuing foreign exchange shortages probably had a
dampening effect on immediate efforts to resolve
foreign-exchange-related problems.' We believe the
provision allowing foreign enterprises to adjust their
foreign exchange balances among themselves may
have been a concession to those in the leadership who
argued against more liberal provisions in light of the
country's foreign exchange shortage. Beijing also may
have dictated limits to the supplemental guidelines
offered by the local governments, according to the US
Consulate in Guangzhou. Guangzhou's investment
guidelines, for example, omitted a provision disclosed
earlier to US Consulate officers allowing foreign-
funded enterprises to convert profits into foreign
exchange-up to the level of foreign exchange equity
capital invested by the enterprise-for overseas remit-
tance.
Although the measures will provide relief from many
of the fees and taxes burdening foreign enterprises in
China, they fall short of the "bold measures" prom-
ised by the leadership. Despite the initial disappoint-
ment among foreign investors, however, we believe
foreign investment commitments will improve slightly
in the near term. The publicity surrounding the
regulations and the recent resolution of problems in
the AMC Jeep joint venture will reassure investors of
Beijing's commitment to foster successful relation-
ships with foreign-funded enterprises. An initial in-
crease in investment, however, probably will represent
' China suffered a severe depletion of foreign exchange reserves
over the last year and a half, with reserves falling from a high of
$16.7 billion at yearend 1984 to a current level of $10.3 billion. To
control rampant imports, Beijing imposed tighter foreign exchange
controls in March 1985.1
planned investments that have been postponed in
anticipation of more favorable regulations. According
to the US Consulate in Hong Kong, the decline in 25X1
foreign investment in the first half of 1986 reflects, in
part, such delays by investors.
In the coming months, we expect Beijing to keep a
watchful eye on the implementation of local supple-
mentary incentives, particularly with regard to for-
eign exchange. If these regional experiments proceed
smoothly, we believe Beijing will be ready to under-
take the more difficult issues over the next year. To
maintain investment momentum in the longer term,
Beijing will need to tackle the more thorny issues-
particularly market access and profit repatriation-
that dog foreign investors. Chinese officials have
stated that the country's investment climate cannot be
changed overnight, but that further amendments will
follow. How the regulations are implemented at the
local level will be a key indicator for assessing the
impact of these new incentives. The high-level atten-
tion afforded this issue suggests that significant pres-
sure is being applied at the grassroots level to encour-
age success.
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Secret
Saudi Oil
Production and
Pricing Strategy
Brazil's Looming
Electricity Shortages
Britain Likely
To Build New
Nuclear Power Plant
Saudi Arabia has signed oil-pricing agreements 25X1
with three foreign oil firms that will keep Saudi production at 5 million b/d
through February-700,000 b/d above the current quota. The agreements allow
either party to reduce the amount of oil involved with 30 days' notice. Meanwhile, 25X1
OPEC members meeting in Geneva are making progress on a production-sharing
accord. The unusually early approval of price terms suggests that the Saudis will
continue to emphasize maintaining market share, despite their public support for
production cuts to achieve a price of $18 per barrel. The agreements probably
reflect Saudi skepticism that OPEC will adhere to any production-sharing accord.
Without Saudi cuts-which King Fahd believes are unwarranted-oil prices
almost certainly will decline over the next several months. 25X1
Reduced hydropower production along with higher energy consumption may lead
to blackouts and electricity rationing in southern Brazil during 1987. According to
the US Consulate in Porto Alegre, hydropower-ordinarily 80 percent of the 25X1
power for Brazil's industrial south-has suffered as sparse winter rains this year
left reservoirs well below normal levels. Brasilia can compensate by adding new
transmission lines from the Itaipu Dam and by completing construction of fossil-
fuel plants, but such fixes would take several months. Meanwhile, industry-the
largest end user of electricity-is at near full capacity to meet overheated
consumer demand caused by the Cruzado Plan. Moreover, press reports indicate
that electricity prices are among the lowest in the world, encouraging wasteful
consumption. Electric power presents a long-term structural bottleneck to growth.
Electricity demand, growing at 10 percent annually, is outstripping the country's
ability to finance new generating capacity. an 25X1
estimated $5 billion per year in new investment is necessary to bring sufficient ca-
pacity on stream. Given Brazil's limited access to Western capital markets, we
believe that a continued lack of investment could lead to widespread shortages of
electricity in the future 25X1
London is likely to approve the constuction of a new nuclear power plant, a move
which would represent the largest expansion of a nuclear power program since the
Chernobyl' disaster. A 27-month government study, issued this fall, raises no
serious questions about the safety, necessity, and environmental impact of nuclear
power expansion. The report also says that nuclear power has economic advan-
tages, although it disagrees with the Central Electricity Generating Board's claim
that a nuclear plant would be significantly cheaper than a coal-fired one. While
19 Secret
DI IEEW 86-050
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Secret
Egypt Upbeat
on IMF Talks
Secret
19 December 1986
Parliament has yet to study the report, the electricity industry is confident of
approval because Prime Minister Thatcher and Energy Secretary Walker are
strong supporters of nuclear power and have expressed a desire to start building
the new plant by June 1988. Opponents have not given up hope, however, and
probably hope that a future Labor government would reverse Thatcher's approval.
Egyptian officials appear satisfied with the support they received from key IMF
executive directors at a 4 December Fund discussion of the country's economic
reform program, but may be overestimating the imminence of Fund approval of a
standby arrangement. Cairo believes that the support voiced at the meeting
indicated IMF acceptance that the proposed reform package is the most that is
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Philippine Debt
Negotiations Likely
To Resume
Indonesia's Pending
Financial Crisis
and a meeting of key IMF executive directors scheduled for next week.
politically possible for Egypt, setting the stage for speedy Fund agreement on a
standby arrangement. Critical elements of the standby negotiations-including
agreement on economic performance criteria-are still ahead, however, and the
details of exchange rate unification and interest rate hikes-each a potential
sticking point-remain to be worked out. To the extent that the IMF insists on
tougher reform measures, standby talks will be contentious. Meanwhile, informal
talks on Cairo's financial problems continue with a Paris Club discussion today
Negotiations that broke down in November with major creditor banks to
reschedule $3.6 billion in foreign debt are likely to resume next month. The banks'
advisory committee has agreed to compromise on interest rates, grant a three-
month moratorium on principal repayments, and extend for six months a $3 billion
trade facility due to expire at the end of this year.
The
Philippine side is probably especially pleased that the talks with private banks are
back on track because the World Bank has delayed a $300 million economic
recovery loan citing dissatisfaction with Manila's plan for selling nonperforming
to help forestall a payments crisis resulting from depressed oil exports,
Indonesian finance officials earlier this month were trying to assemble a $350
million short-term loan from US, Japanese, Middle Eastern, and European banks
. Even if Jakarta eventually obtains this relatively modest
Persian Gulf
Economic Aid
to Jordan Decreases
becoming restricted as Indonesia's international credit rating among commercial
bankers erodes. Indonesia has been unable to earn the $6 billion in foreign
exchange required to continue servicing its nearly $40 billion foreign debt, and
Jakarta has already drawn heavily on its $2.5 billion credit lines with foreign
lenders. As a result, the government will probably have to rely on its dwindling for-
eign exchange reserves that totaled about $10 billion last April.
loan, for the first time in more than a decade its access to foreign credit is
Global and Regional Developments
commitments but is still demanding that Amman pay the $195 million owed since
last year for Saudi oil. Abu Dhabi gave $65 million in September, and Amman is
confident that Oman will continue its monthly payments of $5.8 million through
r chemicals. The US Embassy reports that Riyadh is up to date on its aid
Economic aid from Persian Gulf states to Jordan this year probably will be less
than the 1985 level of $970 million-despite last-minute payments-and assis-
tance probably will be even less next year. Kuwait has given Jordan $75 million in
cash this year and promised an additional $50 million in 1987 in the form of petro-
Secret
19 December 1986
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LZDAI
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LJA I
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Soviet-Iranian
Economic Meeting
Yields Little
continue, and Qatar may still provide small amounts of assistance.
the end of 1987. If Riyadh does not forgive Jordan's oil debt, Gulf aid actually will
be significantly below 1985 levels. Riyadh may waive the oil-import debt as partial
compensation for reduced aid in 1987. Kuwait probably is offering petrochemicals,
which it would have trouble selling in the glutted market. Omani aid probably will
Moscow has changed its position.
Tehran has been more effusive than Moscow in assessing the results of a meeting
last week of the Soviet-Iranian Joint Economic Commission, the first in six years.
Iranian media report protocols on trade, energy, transportation, banking, steel
mills, agriculture, fisheries, the holding of further commission meetings at six-
month intervals, and the return of Soviet technicians to Iran. The Soviets have not-
ed only that the two countries intend to expand cooperation in trade, transporta-
tion, and "other fields," and to continue regular ministerial-level contacts; they
have not mentioned a return of Soviet experts. The media accounts indicate
continued coolness in political relations. The Iranian version of the talks is
probably more an effort to portray improved economic relations than an accurate
reflection of significantly greater cooperation. The Soviets have said for some time
that their technicians would return if their safety could be guaranteed, implying
that Iran must first agree to negotiate an end to the war; there is no evidence that
No Huge Saudi Aid Press reports that Saudi Arabia will provide Sudan with $1 billion a year in
Package for Sudan
Restructuring the
Auto Parts Supply
Network in Japan
$300 million given in 1986.
economic assistance for the next three years are greatly exaggerated. The reported
aid package calls for the Saudis to provide $300 million in cash and $700 million in
commodities, including oil, fertilizer, and manufactured goods. Sudan, in turn,
would export surplus agricultural products to Saudi Arabia. Although Sudanese
and Saudi officials are engaged in economic negotiations that Khartoum believes
will yield substantial financial assistance, no agreements have been reached.
Nevertheless, Saudi aid to Sudan next year is unlikely to rise above the nearly
reduce costs as requested by the auto companies. Moreover, this creates a
possibility for foreign auto parts suppliers to try to enter the Japanese market
most heavily by small-to-medium-size suppliers, and by the partmakers that do not
In an attempt to counter the effect of the appreciated yen, Toyota, Nissan, and
Honda Motor Companies are turning away from their traditional Japanese parts
suppliers in favor of lower cost suppliers in South Korea, Hong Kong, and
Singapore. The impact of the automaker's cost-cutting efforts will probably be felt
25X6
25X6
Secret
19 December 1986
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Secret
Central American
Trade Problems
New Canadian
Grain Support
Program
Cool Response
to Canadian
Unemployment Study
Honduras's suspension of bilateral trade agreements with Guatemala and Costa
Rica in late November and early December has dealt a new blow to faltering
official commercial relations in Central America. Tegucigalpa acted after failing
to gain concessions to reduce its large trade deficits with both countries, caused in
part by its overvalued exchange rate. Guatemala last summer suspended local
currency credit lines to Honduras because of Tegucigalpa's outstanding trade
debt. Negotiations to reduce an imbalance with Costa Rica also have failed. The
suspension effectively puts all trade between Honduras and the two other countries
on a cash basis. Bilateral agreements with El Salvador and Nicaragua remain in
force, in part because the trade balance favors Honduras, and Tegucigalpa has
expressed an interest in expanding trade ties to San Salvador. The inability of the
Central American countries to eliminate chronic trade debts will probably
sabotage recent efforts to implement a new regional payments system and will
Although touting "new money in the hands of farmers," the Mulroney government
has been foot-dragging on disbursment because the budget deficit this fiscal year is
expected to top $23.4 billion-$1.8 billion above the initial estimate. Conse-
quently, Ottawa has committed only $216 million for disbursement by January
1987, with the remaining $504 million to be given out in the next fiscal year. De-
spite its political expediency, the new program does not provide enough to compete
with US and EC farm programs. The new subsidies will only add to Canada's defi-
cit problems and will encourage farmers to produce more for an already glutted
Individual payments will be limited to $18,000-the expected average is $3,600.
Ottawa recently announced its formula for distributing $720 million of additional
aid that Prime Minister Mulroney had pledged to the nation's grain growers. The
payment plan, which is in part intended to offset the impact of US subsidies,
attempts to balance the interests of producers in eastern and western Canada.
endorsed only by chairman Forget and one of the six commissioners-would cut
the annual cost by one-fourth, primarily by requiring 52 weeks of employment
before a claimant can collect benefits. Other recommendations include cutting
additional benefits for claimants in high-unemployment regions, eliminating
benefits for self-employed fishermen, and reorienting regional and industrial
assistance toward new and small businesses and long-term job creation. While the
.people to remain in economically depressed regions. Its recommendations-
Widespread opposition to the Forget Commission's proposal for revamping
Canada's unemployment compensation system has prompted Ottawa to delay
comment until May. The commission was estalished in response to complaints that
the current system is costly and unfair, reduces work incentives, and encourages 25X1
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Secret
Positive Signs
for Japanese
Agricultural Reform
likely to give the proposals lukewarm support at best.
commission also proposed an increase in the maximum benefit rate and low-
income supplements, the media and opposition parties have focused mostly on the
higher eligibility requirement. Any attempt to reduce benefits will be strongly
risisted, particularly in Atlantic Canada. As a result, the Mulroney government is
The momentum for reform of Japan's agricultural price supports generated by
Prime Minister Nakasone's early October questioning of the system in the Diet
shows no sign of abating. the opposition
Democratic Socialist Party (DSP) is preparing to adopt in February 1987 a policy
calling for elimination of price supports for rice, Japan's most important crop. This
would undercut Agriculture Minister Kato's argument that all political parties
favor subsidies for rice farmers and keep the pressure on the ruling Liberal
Democratic Party to support reform. The influential agricultural cooperatives also
are responding to mid-October complaints-indirectly endorsed by the Prime
Minister-about the low efficiency of rice farmers. The cooperatives plan to begin
importing limited amounts of lower cost foreign fertilizer, according to a Japanese
newspaper. The cooperatives, which handle over 80 percent of all fertilizer sales
and have major investments in Japan's fertilizer industry, have previously refused
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Secret
19 December 1986
to purchase foreign fertilizer.
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Portuguese Budget
Deficit Continues
To Plague Economy
Challenges Facing
Brazilian President
Sarney
come in far below the 9.5-percent target.
Lisbon's projected 1987 budget deficit indicates that the government has still not
come to grips with Portugal's chaotic public finances. The deficit is officially
projected at 9 percent of GDP-about a 1-percentage-point increase from 1986-
but may well be worse. Expenditures probably will increase by more than the
projected 13 percent because efforts to cut spending are constrained by the large
portion of fixed expenditures-interest payments and salaries account for more
than 60 percent of current spending-and by the lack of significant cost-cutting
reforms. Meanwhile, the government's projected 23-percent revenue increase is
misleading. If petroleum tax receipts-previously excluded-are added to the
1986 budget figures, the projected 1987 revenue increase is only 8 percent. The
larger deficit is likely to make it difficult for Lisbon to achieve two major goals of
its recovery program. Increased internal demand may well hamper efforts to cut
inflation by one-third to 8 percent, while more public borrowing-coupled with
tighter domestic credit controls-is certain to depress private-sector credit growth.
Given the weak financial positions of Portuguese firms, investment is likely to
Less Developed Countries
In the face of these challenges, Sarney will find it difficult to implement other ad-
justments to get the economy back on track, including broader price relief to slow
consumer spending, to stimulate sorely needed plant expansion, and to stem the de-
terioration in the country's trade accounts. Despite economic imperatives, Sarney
is likely to adopt a patchwork approach to economic adjustment, which would lead
to lower growth, rising inflationary pressures, and more external payments
problems. The overall decline in the President's popularity will probably weaken
following the announcement, and interest rates have jumped 50 percent.
Only six days after voters provided resounding support for Sarney and his
anti-inflationary Cruzado Plan, the government's announcement of large price
hikes-dubbed Cruzado II-on some luxury goods and on public services set off a
firestorm of protest. Newly elected leaders of the ruling Democratic Movement
Party criticized the administration for breaking the party's campaign promise not
to increase consumer prices. A spontaneous protest on 27 November led to the
largest and most violent antigovernment demonstration ever held in Brasilia.
Labor unions announced plans for a general strike to protest the adjustments and
to call for a debt moratorium. Since the announcement, Sarney has suffered a
sharp decline in his personal popularity, according to a private public opinion poll.
The new adjustments have also aroused uncertainty among businessmen and
bankers about the government's economic team, according to the US Consulate in
Sao Paulo. The stock exchange there dropped 20 percent during the week
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19 December 1986
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his ability to withstand the party's demands for greater influence in the cabinet
and in key policy posts. Leftists, who fared poorly in the election in November, will
probably exploit popular resentment over Sarney's austerity measures and over the
burden of the country's foreign debt. In addition, popular growing expectations of
a return to rampant inflation may spark wildcat strikes and antigovernment
demonstrations.~
Tanzania Faces Loss Tanzania faces a critical foreign exchange shortfall in 1987 and rising rural
of Cotton Exports discontent if Dar es Salaam cannot market this year's bumper cotton crop. Cotton,
Fijian Economy
Improves But
Obstacles Remain
USSR Boosting Oil
Sales to Romania
Secret
19 December 1986
which accounts for 12 to 14 percent of total exports, is second only to coffee as a
foreign exchange earner. According to foreign press reports, 65,000 bales of cotton
worth $18 million have yet to be purchased and transported to ports by the
government-the sole legal marketing agent-and probably will soon rot in
inadequate storage facilities. Another 60,000 bales are expected to be harvested
before the end of the growing season, but crippling fuel and vehicle shortages
probably will continue to hinder Dar es Salaam's efforts to move the crop to ports
in a timely fashion. In a related development, farmers in northern Tanzania
recently threatened to burn over 780 metric tons of unsold cotton piled up at
railway stations. The farmers are angry that lack of transportation is preventing
them from taking advantage of a recent 15-percent hike in cotton producer prices.
The situation may erode support for President Mwinyi's four-month-old IMF
program, which has yet to make a significant impact on Tanzania's deteriorated
agrarian economy despite popular expectations of a quick boost in living standards.
dependent on sugar and a few other agricultural commodities.
Fiji's economy is recovering from last year's 3.5-percent decline. According to the
US Embassy, GDP this year will be up by 2.5 percent, and Suva expects a growth
rate approaching 4 percent in 1987-a trend likely to further strengthen Prime
Minister Mara's ruling Alliance Party in next February's election. The turnaround
primarily reflects a rebound in sugar production-up nearly 40 percent from last
year's storm-damaged crop-tourism, and manufacturing. Sustaining the recovery
will be difficult, however. The government's budget deficit is nearly 5 percent of
national output; the trade deficit-in part a result of low export prices for Fiji's
traditional commodities-shows no sign of narrowing; and the economy remains
the Soviet Union is sharply increasing oil deliveries
to Romania in accordance with an agreement signed in December 1985. The
Soviet Embassy in Bucharest reportedly announced at a press conference in
October that the USSR would supply Romania with 120,000 b/d in 1986-as
compared with an estimated 40,000 b/d in 1985. Soviet trade statistics for the first
half of 1986 support the announcement. Total exports to Romania are up' by $650
million over the same period in 1985-more than enough to account for the
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Secret
Soviet Trade Show
Opens in Beijing
Improved East
European Agricultural
Performance
small surplus through the first half of 1986.
additional oil exports. Moreover, Romania reportedly intends to import 141,000
b/d of Soviet-supplied oil in December. Part of this year's increase is explained by
Soviet reexports of 36,000 b/d of Middle Eastern oil to Romania in the first nine
months of 1986, a practice not seen in previous years. Increased Soviet oil
deliveries are tied to growing imports of Romanian goods. In contrast to the $400
million Soviet trade deficit with Romania in 1985, Moscow has been running a
Soviet automobiles, aircraft, and other scientific and technological hardware.
According to the Soviet Embassy's deputy trade commissioner, the Soviets are also
staging lectures and video presentations for Chinese technical groups in a separate
exhibition hall. Approximately 300,000 people are expected to visit the trade
show-including Vice Premier Li Peng, who participated in the exhibition's
opening-matching the number of visitors to China's trade fair in Moscow last
summer. This is yet another indication of warming economic relations between the
two countries; bilateral trade more than doubled last year to $1.9 billion. We
expect no major purchases by the Chinese as a result of this exhibition, however,
as, contrary to Chinese press reporting, none of the displayed items are available
for export. Moreover, some of the items are not yet available for sale in the Soviet
Union.) 25X1
'Salyut orbital space station, and a Vega scientific satellite, in addition to the latest
The USSR is holding its first trade and industry exhibition in China in three
decades, the result of a protocol on exchanges of trade exhibitions signed last
summer. Displays include models of a Tokamak 15 nuclear fusion reactor, a 25X1
probably because Bucharest is increasing exports to raise hard currency.
The economies of most East European countries will be boosted slightly this year
by above-average harvests, primarily the result of good weather. Poland and East
Germany reported record or near-record grain crops. Harvests of grain and most
other crops in Romania, Bulgaria, and Yugoslavia-hit by drought last year-also
increased. Drought in Hungary, however, cut grain production for the second
straight year, although the Hungarian press reported that overall agricultural
output might rival the record 1985 levels. In Czechoslovakia, production probably
will be below average because of weather problems. These generally good results
should ensure adequate consumer supplies and help trade performance. Yugoslavia
should be able to export more than last year, while Poland and possibly East
Germany and Bulgaria may reduce imports of Western grain. Disappointing crops
in Hungary and Czechoslovakia will not pose major consumer problems; Budapest
probably will cut exports to the West, and Prague will draw down reserves. Despite
a better harvest, food supplies in Romania appear to be deteriorating sharply,
27 Secret
19 December 1986
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China To Increase
Metals Output
Cuba Trying
To Revive
the Economy
of aluminum, copper, and zinc.
Beijing plans to increase output of 10 major nonferrous metals by 1990. The
largest increases will be in nickel-set to double over the next five years-and in
aluminum, with planned growth of 90 percent. China also plans to increase
production of lead and zinc by 31 percent and copper by 12 percent. China closely
holds production data on nonferrous metals, but industry sources estimate nickel
output to be at least 20,000 metric tons a year and aluminum about 400,000 tons a
year. The Chinese increased exports of nickel this year, but remain net importers
entrepreneurs into the new car market.
China is offering auto loans to government and private enterprises in an effort to
move an overstock of imported cars, Under the
policy, enterprises buying 10 or more cars will be extended credit for up to three
years. An earlier discount program for cash payments on quantity purchases
proved unsuccessful. The backlog of unsold autos probably is the result of volume
purchases of foreign cars that were made without a buyer order. Similarly, the
higher output at Chinese auto plants produced an overabundance of slow-selling
domestic models. Although there is large potential demand for both imported and
domestic models, the high cost of enterprise modernization leaves little cash for
outright purchases. If the loan option succeeds at the enterprise level, credit will
probably also be extended to individuals to entice the wealthier peasants and
domestic consumption to absorb the brunt of the new stringencies.
President Castro, preoccupied with the failing economy, closed the recent Third
Party Congress with a call for renewed revolutionary vigor and increased austerity.
Necessary belt-tightening and Castro's apparent recommitment to economic and
ideological positions reminiscent of 20 years ago are likely to erode Cuban
productivity, increase social discontent, and possibly push Castro to seek new
channels for emigration. Castro told the closing session that Cuba's current debt
problems are the worst they have ever been, that imports will have to be cut by
one-half to $600 million next year, and that exports must increase. Major
investment would continue to go to the energy and export-earning sectors, leaving
the Central Planning Board is preparing for rationing through the
Secret
19 December 1986
agreement with the United States.
The announcement of a 50-percent reduction in hard currency imports may be
more of a ploy to appease Cuba's creditors than a policy Castro intends to carry
through. Moreover, Castro's renewed emphasis on ideology is at odds with the
rationalization measures being pursued in the USSR by General Secretary
Gorbachev. Any attempt by Moscow to assume more control over Havana's
economic management could lead to increased friction, but a permanent rift is
unlikely. More sacrifices for-the average Cuban and increasing popular dissatisfac-
tion with the regime will result from these policies. Castro may try to relieve this
pressure by ridding Cuba of the malcontents through a renewed immigration
political and ideological work.
year 2000. Castro also termed overreliance on market mechanisms a serious
ideological mistake and stressed that Communism will be built primarily through
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Secret
Cuba Looking
to South America
for Imports
Cuba's strategy of shifting from West European to South American suppliers for
its import needs is foundering on Argentine and Brazilian unwillingness to extend
trade credits. Argentina was Cuba's third-largest Western supplier in 1985, but
trade stagnated this year after Buenos Aires suspended credits to Havana because
credits from Brazil have been largely frustrated and is unlikely to retreat from its
firm bargaining stance toward Havana. The failure of Cabrisas's lobbying in both
Brazil and Argentina further restricts Cuba's declining access to imports needed
for modernization.
uenos Aires is undoubtedly aware, however, that Cuban efforts to obtain trade
29 Secret
19 December 1986
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Secret
Secret
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