INTERNATIONAL ECONOMIC & ENERGY WEEKLY

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP88-00798R000200190003-9
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 50
• Document Creation Date: December 27, 2016
• Document Release Date: April 19, 2011
• Sequence Number: 3
• Publication Date: January 10, 1986
• Content Type: REPORT

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Directorate of
Intelligence
10 horn 1904
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to mown MI6
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Secret
International
Economic & Energy Weekly
10 January 1986
iii Synopsis
1 Perspective?Libya: The Effect of Economic Sanctions
3 Western Europe: Economic Links to Libya
11 Poland: Dim Prospects for Increasing Hard Currency Earnings
15 Egypt: Economic Prospects and Policy Implications I,
21 Latin Debtors: Increasingly Competitive Labor Costs
25 Somalia: Uncertain Prospects for Economic Reform
29 Briefs Energy
International Finance
Global and Regional Developments
National Developments
Comments and queries regarding this publication are welcome. They may be
directed to Directorate of Intelligenc0
Secret
DI IEEW 86-002
10 January 1986
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International
Economic & Energy Weekly
Synopsis
1 Perspective?Libya: The Effect of Economic Sanctions
The cutoff of US economic ties to Tripoli will have some disruptive effects, but
as time passes the impact will fade without substantial involvement by other
OECD countries.
3 Western Europe: Economic Links to Libya
Western Europe's well-known reluctance to impose sanctions against Libya is
only partly due to economic considerations because overall economic relations
with Libya are relatively small. West European unwillingness to apply
sanctions against Libya probably is driven more by fear of Libyan reprisals, by
the desire for maintaining good relations with other Arab countries, and by the
belief that sanctions would be ineffective.
11 Poland: Dim Prospects for Increasing Hard Currency Earnings
One of the Polish Government's primary goals over the next five years is to in-
crease hard currency earnings, but given the lack of effective export promotion
policies any significant increase is unlikely. The regime may tinker with its
policies, but internal pressures to increase consumption rather than exports
and weak Western demand for Polish products are likely to thwart any major
export campaign.
15 Egypt: Economic Prospects and Policy Implications
Egypt's capacity to meet its external financial obligations will become
untenable in the next two years without a combination of major cuts in import
growth, debt rescheduling, and significant increases in external assistance. The
present government is unlikely, however, to push for sweeping reform, despite
lipservice to the contrary, because it continues to believe that major restructur-
ing of the current system of price supports, subsidies, and government controls
would produce political instability.
111
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DI IEEW 86-002
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21 Latin Debtors: Increasingly Competitive Labor Costs
The five largest Latin American debtors?often as part of IMF-supported
programs?have undertaken austerity measures that have resulted in generally
falling labor costs since 1981. Low labor costs should attract some labor-
intensive investment, as it has in the East Asian NICs, but we believe that po-
litical and economic uncertainty in the Latin American debtor countries
probably will constrain significant private investment that could help fuel
economic expansion.
25 Somalia: Uncertain Prospects for Economic Reform
Somalia made limited progress toward improving its ailing economy in 1985,
but major problems remain including a growing external debt, continued high
current account deficits, and slippages in implementing the 1985 IMF reform
package.
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International
Economic & Energy Weekly
10 January 1986
Perspective Libya: The Effect of Economic Sanctions
Secret
The cutoff of US economic ties to Tripoli will have some disruptive effects, but
as time passes the impact will fade without substantial involvement by other
OECD countries. Although most of the $300 million worth of products
exported by the United States are generally available on world markets, the
time needed to locate new suppliers will aggravate current shortages of
consumer and industrial goods in Libya.
The likelihood of Libya's other trading partners following the US lead is not
high. Many, particularly the Europeans and South Korea, are owed hundreds
of millions of dollars by Tripoli and are expecting repayment in crude oil.
Others have valuable equipment, construction and service contracts with
Libya.
Tripoli will have greater difficulty replacing the $300-400 million in services
provided annually by US companies. Total contracts worth as much as $3
billion with US firms will have to be relet to firms in other countries. Japanese,
South Korean, or West European firms are capable of taking over the US role
in the Great Man-made River Project, Qadhafi's most ambitious economic
undertaking to date. Most of Libya's development program has little impact on
the average Libyan, however, and the slowdown in the domestic economy has
already greatly delayed the rate of project completion.
The new sanctions probably will be disruptive to the Libyan petroleum
industry over the next one to two months as US production companies
disengage from Libya. US firms play a major role in Libyan operations and
currently market about 200,000 b/d?roughly 18 percent of Libyan exports.
As a result, oil exports could temporarily fall from the current level of 1.1
million b/d, but Tripoli probably will take prompt action, including price cuts,
to regain sales. Beyond the marketing disruption, any short-term production
problems in fields currently involving US oil companies could be handled by
other foreign technicians and a small, but competent cadre of trained Libyan
managers. Moreover, most US companies providing exploration and mainte-
nance services operate through their West European subsidiaries, often using
European personnel. The number of US oilfield workers in Libya probably is
no more than 500 to 800 and replacements could be recruited from a number
of countries. Most essential oil field equipment is already obtained from non-
US sources.
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Tripoli could offer the US oil concessions to companies in countries such as
Austria, West Germany, Italy, France, Finland, Brazil, or even Romania.
Alternatively, Libya may nationalize the companies and operate them with
foreign technical assistance as happened after Exxon's withdrawal from Libya
in 1981.
Qadhafi is unlikely to detain US citizens or take them hostage. Following the
initial imposition of sanctions in 1982, for example, Qadhafi even helped
expedite the departure of US citizens as a propaganda ploy. Qadhafi probably
believes any move against US personnel would be used to justify a US military
strike against Libya. The Libyan leader may offer lucrative incentives to
retain the services of select, highly skilled workers, however. Some 400 to 500
US citizens did not leave Libya in 1982 because of family or cultural ties in
Libya and they probably will remain. Qadhafi probably will use the US
economic sanctions to marshal support for even greater domestic austerity and
to blame Washington for any further deterioration in economic conditions.
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Western Europe:
Economic Links to Libya
Western Europe's well-known reluctance to impose
sanctions against Libya is only partly due to eco-
nomic considerations because overall economic re-
lations with Libya are relatively small. West Euro-,
pean exports to Libya dropped to an estimated $3.2
billion last year, less than one-third of the 1981
figure and equal to only 0.4 percent of total
exports. Although imports of Libyan oil have fallen
less sharply, to about 820,000 b/d last year, they
only cover about 7 percent of Western Europe's oil
consumption?an insignificant share given the glut
in the world oil market. We calculate that even a
total cutoff of EC exports to Libya would have only
a minimal impact on West European economies.
The West Europeans, however, fear the loss of
perhaps several billion dollars of outstanding loans
and unpaid bills owed by Libya. West European
unwillingness to apply sanctions against Libya
probably is driven more by fear of Libyan repri-
sals?in Western Europe or against West Europe-
ans working in Libya?and by the desire for main-
taining good relations with other Arab countries.
West Europeans also continue to believe that sanc-
tions would be ineffective and might set an unwel-
come precedent.
Exports
The decline in West European exports to Libya
during the past few years is almost entirely due to
Libya's financial difficulties, rather than any Euro-
pean effort to restrict exports. Italy remains by far
the largest exporter, with an estimated 41 percent
of the West European total; West Germany is a
distant second. Not suprisingly, West European
exports to Libya are dominated by manufactured
products?more than two-thirds of the total as of
1984?with machinery and semifinished goods con-
stituting the two largest sub-categories.
Western Europe: Economic Ties to Libya,
1976-85
Percent
Exports to Libya as a Share
of Total Exports
2.0
1.5
1.0
0.5
0
1976
78 80 82
84 85a
Net Imports of Libyan Oil as a
Share of Total Oil Consumption
10
8
6
4
2
1976 78 80 82
.1985 based on January-September data.
b 1985 based on January-June data.
Libya's share of West European exports has
dropped from 1.4 percent in 1981 to 0.4 percent in
1985. Italy is the country most dependent on the
Libyan market, with 1.7 percent of its exports
3
307845 156
84 85b
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Western Europe: Military Assistance to Libya, 1980-84 a
Million US $
1980
1981
1982
1983
1984
Agree-
ments
Deliveries
Agree-
ments
Deliveries
Agree-
ments
Deliveries
Agree-
ments
Deliveries
Agree-
ments
Deliveries
Total
365
668
106
544
193
553
1
388
106
228
Austria
NEGL
NEGL
Belgium
277
93
216
NEGL
Finland
5
5
5
France
56
104
97
395
180
60
Greece
NA
Italy
NEGL
110
3
190
183
108
NEGL
176
97
147
Netherlands
18
18
30
8
30
Spain
NEGL
NEGL
NA
1
1
1
1
Switzerland
Turkey
5
3
13
3
NA
United
Kingdom
8
33
1
4
5
West
Germany
1
302
72
15
5
37
8
20
a DIA Estimates.
going there last year?but this share is down from
5.7 percent in 1981. Only two other West European
countries, Turkey and Greece, sent more than 1
percent of their exports to Libya last year.
Oil Dependency
Greece is most dependent on Libyan oil, which
covered 27 percent of Greece's total oil consump-
tion in first-half 1985. Following Greece were
turkey and Italy (15 percent each), Switzerland (11
percent) and Austria and West Germany (9 percent
each). West European vulnerability to a Libyan oil
embargo is presumably less than these figures
suggest, however, because of the world oil glut.
Over the last decade or so Libyan oil has typically
covered about 7 percent of Western Europe's total
oil consumption. Net oil import volume has fallen
somewhat from about 910,000 b/d in 1983 to about
820,000 during first-half 1985. Since 1983 Italy
has been the largest single West European importer
of Libyan oil, followed closely by West Germany;
together they account for more than half of West-
ern Europe's oil imports from Libya.
Secret
Arms Sales
Libya, which gets more than two-thirds of its
military assistance from the Soviet Bloc, is a
relatively small arms market for Western Europe.
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After averaging $588 million annually during
1980-1982, West European arms deliveries to Lib-
ya fell to $388 million in 1983 and $228 million in
1984. Moreover, only $107 million in new arms
agreements were signed during 1983-1984, almost
all of this in a single deal with Italy. With French
deliveries falling off sharply, Italy became the
largest West European arms supplier in 1984.
In 1985, the value of West European arms sales
agreements with Libya rose considerably, primarily
because of a $500 million Greek arrangement
which calls for future deliveries of various military
equipment, including personnel carriers and anti-
tank weapons. We do not believe this increase,
however, will result in an appreciable jump in
annual military deliveries to Libya. The Greek deal
is only an agreement in principle and Athens is
cautious about going ahead for fear that the United
States would respond by curtailing arms sales to
Greece, including F-16s. Moreover, all major West
European countries have curbed sales of lethal
weapons to Libya in light of Libya's occupation of
Chad and the terrorist incident at the Libyan
Embassy in London.
Workers in Libya
Information on the number of West European
workers in Libya is fragmentary but the total
appears to be about 60,000 to 70,000. Turkey
clearly heads the list followed by Italy and the
United Kingdom. The Turks are mainly construc-
tion workers involved in a variety of projects con-
tracted for by Tripoli. Their numbers have fallen
sharply over the last several years and their diffi-
culties in remitting their earnings to Turkey has
been a source of great concern to Ankara. Many of
the workers from other West European countries
are technicians who play a key role in Libya's oil
industry.
Investment and Debt
While our information is limited, Libyan invest-
ment in Western Europe appears to be concentrat-
ed in Italy. Libya's investments in industrial and
5
Secret
Western Europe: Approximate Number
of Workers in Libya, 1985
Turkey
35,000
Italy
16,000
United Kingdom
5,000
Greece
2,000
Portugal
1,700
Germany
1,500
France
1,200
Ireland
1,000
Netherlands
400
Austria
200
commercial firms are mainly held by the Libyan-
Arab Foreign Investment Bank. According to press
reports the bank is worth $6 billion and has
investments in 94 companies, 27 of which are in
Western Europe. It now owns 14.5 percent of Fiat's
stock, worth about $145 million, although control
of the company remains firmly in the hands of the
Agnelli family. Last November the bank purchased
a 70-percent interest in Italy's 100,000 b/d Tamoil
oil refinery, including about 1,000 service stations.
Libya has banking interests in a number of coun-
tries, including Italy, France, Spain and West
Germany.
West European investment in Libya is concentrat-
ed in the oil industry. Three West German oil
firms?VEBA, Wintershall, and Deminix?oper-
ate in Libya, two with Libyan partners. West
German investment in Libya totaled $107 million
in 1983. Italy's national energy corporation, ENI,
has substantial investments in Libya, and AGIP, an
ENI subsidiary, is a large oil producing company in
the country. The French firm Elf is also engaged in
oil exploration and production in Libya, while
Austria's state oil company, OMV, agreed last
Secret
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Western Europe: Dependence on Libyan Oil, 1980-85
(Net Imports of Libyan Oil, Crude, and Products)
Thousand bid
1980
1981
1982
1983
1984
1985 a
Western Europe
896
733
907
912
830
818
EC
687
557
692
705
636
661
Belgium/Luxembourg
5
2
61
47
31
3
Denmark
0
1
0
0
France
41
33
51
63
74
48
Greece
56
65
50
52
49
63
Ireland
0
0
0
Italy
252
214
219
218
227
248
Netherlands
19
18
38
82
38
47
United Kingdom
3
9
46
30
23
49
West Germany
312
216
226
212
195
204
Other West European countries
209
176
215
207
194
157
Austria
22
15
23
13
20
18
Finland
0
Norway
1
0
Portugal
0
2
3
Spain
97
92
80
79
79
59
Sweden
19
3
23
16
0
Switzerland
22
12
19
35
40
27
Turkey
48
53
68
61
54
52
a First half of 1985.
June to acquire 12.5 percent of Libya's largest
crude producer. The United Kingdom has not had
significant investments in Libya since British Pe-
troleum pulled out in 1969.
We believe Libya may have as much as several
billion dollars worth of debts and unpaid bills
outstanding to Western Europe, with Italy proba-
bly the largest creditor. The arrearages on bills
reportedly total about $800 million for Italy, $400
million for Turkey, $125 million for France, $80
million for Spain, and $40 million for Greece. In
January 1985, Italy began taking 40,000 b/d of oil
as payment on the debt, but Libya halted the oil
shipments in August when Rome r'efused to renew
a long-term LNG contract. Mainly as a result of
these payments problems, West Germany and Italy
Secret
have curtailed export guarantees for goods going to
Libya and Italy has also cut off suppliers' credits to
Libya.
Impact on Western Europe of
Imposing Sanctions on Libya
Imposing economic sanctions on Libya would have
little impact on economic growth in Western Eu-
rope, but might put at risk West European invest-
ments and financial claims. In fact, according to
our Linked Policy Impact Model, a total embargo
on EC exports to Libya would lower real GDP by
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Western Europe: Dependence on Libyan Oil, 1980-85
(Net Libyan Oil Imports as a Share of Total Oil Consumption)
Percent
1980
1981
1982
1983
1984
1985
Western Europe
6.7
5.9
7.7
8.0
7.2
7.2
EC
6.6
5.8
7.7
8.0
7.1
7.6
Belgium/Luxembourg
0.9
0.5
13.0
11.2
7.5
0.6
Denmark
0.1
0
0
0.6
0
0
France
1.9
1.6
2.8
3.5
4.3
2.8
Greece
22.5
27.3
21.1
22.7
20.8
27.0
Ireland
0
0
0
0
0
0
Italy
12.9
11.2
12.1
12.2
13.4
14.6
Netherlands
2.4
2.6
6.2
14.1
6.6
8.2
United Kingdom
0.2
0.6
3.1
2.1
1.3
3.0
West Germany
11.9
9.2
10.1
9.6
8.8
9.2
Other West European countries
7.1
6.3
7.9
7.8
7.6
6.1
Austria
8.8
7.0
10.9
6.4
10.1
9.1
Finland
0
Norway
0.6
0.9
0.2
0
0
0.1
Portugal
0.2
0
1.0
1.4
0.2
0.1
Spain
9.3
9.1
8.4
8.3
9.0
6.7
Sweden
3.8
0.8
5.3
4.4
0
0.4
Switzerland
8.6
5.0
8.6
14.3
16.8
11.4
Turkey
16.2
17.1
20.6
18.8
15.8
15.0
only 0.2 percentage point in the first year and 0.1
point in the second year. The impact on the unem-
ployment rate for the region as a whole would be
insignificant. The Italian economy would be hard-
est hit with a first-year GDP loss of 0.5 percentage
point and a 0.1 percentage point rise in unemploy-
ment.
While Western Europe's overall economic loss from
sanctions would be small, specific firms and regions
could suffer substantially. Exporters to Libya-led
by Fiat-probably would be the biggest losers.
Rome, for example, is counting on truck sales to
Libya to help keep a troubled Fiat plant in Bolzano
7
in operation. A cutoff of Libyan debt payments
would also cause serious financial problems for
several small Italian manufacturing and construc-
tion firms, and perhaps for some banks as well.
And, of course, the oil companies operating in
Libya could be hurt by a Libyan seizure of their
assets there. All of these affected groups, along
with West European arms producers, undoubtedly
would lobby hard for a quick end to the sanctions.
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Western Europe: Exports to Libya, 1980-85
Million US $
1980
1981
1982
1983
1984
1985 a
Western Europe
6,689
10,151
5,567
5,019
4,158
3,180
European Community
5,918
8,781
4,704
4,238
3,450
2,690
Beligum/Luzembourg
279
383
108
81
104
68
Denmark
31
55
33
51
27
16
France
671
907
428
334
212
220
Greece
168
220
113
102
89
53
Ireland
138
100
57
61
41
33
Italy
2,545
4,297
2,141
2,104
1,660
1,293
Netherlands
166
267
192
246
185
143
United Kingdom
670
1,067
460
417
328
281
West Germany
1,251
1,486
1,173
841
804
583
Other West European Countries
771
1,371
863
781
708
490
Austria
122
149
121
107
97
68
Finland
54
65
49
30
28
17
Norway
10
7
9
7
3
3
Portugal
5
5
2
2
2
3
Spain
358
427
267
276
267
151
Sweden
76
177
94
7 6
71
55
Switzerland
86
99
86
99
100
73
Turkey
60
442
235
184
142
120
a Estimate based on nine months of data for most countries.
Other Considerations
We believe the West Europeans' reluctance to
impose sanctions is not primarily driven by their
economic ties to Libya. In our view it is more a
reflection of West European governments' concern
about possible reprisals against their citizens in
Libya, and about increased Libyan-sponsored ter-
rorism at home. Given Libya's support within the
Arab League, the West Europeans may also fear
Secret
that sanctions would endanger their more extensive
economic relations with other Arab countries. Fi-
nally, the West Europeans remain convinced that
economic sanctions rarely are effective and are
concerned that imposing sanctions in this case
might set an unwelcome precedent for the future.
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Western Europe: Exports to Libya, 1980-85
Percent of Total Exports
1980
1981
1982
1983
1984
1985 a
Western Europe
0.83
1.36
0.77
0.71
0.57
0.44
European Community
0.89
1.43
0.80
0.74
0.59
0.46
Belgium/Luxembourg
0.43
0.69
0.21
0.16
0.20
0.14
Denmark
0.18
0.34
0.22
0.32
0.17
0.10
France
0.58
0.85
0.44
0.35
0.22
0.23
Greece
3.25
5.17
2.62
2.30
1.86
1.20
Ireland
1.62
1.30
0.70
0.71
0.43
0.34
Italy
3.28
5.71
2.91
2.89
2.26
1.74
Netherlands
0.22
0.39
0.29
0.38
0.28
0.22
United Kingdom
0.61
1.04
0.47
0.45
0.35
0.29
West Germany
0.65
0.84
0.66
0.50
0.47
0.34
Other West European Countries
0.55
1.03
0.67
0.61
0.51
0.35
Austria
0.70
0.94
0.78
0.70
0.61
0.43
Finland
0.38
0.46
0.37
0.24
0.20
0.14
Norway
0.05
0.04
0.05
0.04
0.02
0.02
Portugal
0.11
0.11
0.05
0.04
0.03
0.01
Spain
1.73
2.10
1.30
1.40
1.13
0.67
Sweden
0.25
0.62
0.35
0.28
0.24
0.19
Switzerland
0.29
0.37
0.33
0.39
0.39
0.29
Turkey
2.07
9.40
4.07
3.22
1.99
1.60
a Estimate based on nine months of data for most countries.
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Poland: Dim Prospects
for Increasing
Hard Currency Earnings
One of the Polish Government's primary goals over
the next five years is to increase hard currency
earnings, but given the lack of effective export
promotion policies any significant increase is un-
likely. Incentives to export are few, and the regime
does not channel adequate investment to those
industries that are potential hard currency earners.
The regime may tinker with its policies, but inter-
nal pressures to increase consumption rather than
exports and weak Western demand for Polish prod-
ucts are likely to thwart any major export cam-
paign.
Inadequate Export Incentives
The 3-percent decline in hard currency exports in
the first nine months of 1985 compared with the
same period in 1984 partly reflects Warsaw's inef-
fective export policy. There is little incentive to
export or to introduce quality products given high
domestic demand. In a recent survey, more than 40
percent of all firms expressed no interest in export-
ing. With easier and more profitable sales available
on the domestic market, few firms are willing to
undertake costly overseas marketing.
The regime has not carried through on its economic
reform policy, which?at least on paper?tied a
firm's imports of Western raw materials and capi-
tal equipment to its export revenues. Central allo-
cations of export funds remain the most common
method for financing imports as the programs
designed to promote exports have faltered:
? The hard currency retention fund?intended to
finance more than half of all hard currency
imports?had little impact because the share of
hard currency earnings that may be retained is
too small to encourage most firms to accept the
difficulties of becoming an exporter.
11
Poland: Export Incentive Policies
Hard Currency Retention Funds:
? Permit firms to keep an average 20 percent of
export earnings to fund imports.
? Restrict purchases to raw materials and capital
equipment essential to export production.
? Are held by 40 percent of firms.
? Financed 15 percent of imports in 1984.
Foreign Trade Rights:
? Allow firms to conduct trade directly without the
aid of foreign trade organizations.
? Have been granted to about 300 firms.
? Accounted for about 7 percent of exports in 1984.
Foreign Exchange Export Credit System:
? Allows firms to obtain loans from Bank Hand-
lowy, the foreign trade bank, to purchase the
machinery and equipment necessary to develop
hard currency exports.
? Funded 0.5 percent of imports in 1984, but
probably about 2 percent in 1985.
? The program to grant enterprises foreign trade
rights has not succeeded because most firms find
it easier to deal with foreign trade organizations
that possess the foreign trading skill, trained
personnel, and networks of established markets
they lack. In addition, the Ministry of Foreign
Trade excludes firms from entering markets in
which foreign trade organizations already
operate.
? The foreign exchange export credit system re-
ceives little use by firms because of the high
interest rates charged on the limited funds avail-
able.
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Several other policies limit export incentives. The
National Bank of Poland, for example, recently
failed to implement a promised reduction in the
high taxes levied on hard currency earners. The
regime also delayed a reform tying wage hikes to
increases in exports.
Despite inadequate export performance, some offi-
cials have opposed additional export incentives,
especially further devaluations of the zloty. The
zloty has been devalued from 80 to 159 to the
dollar in the last four years, but many Polish
economists believe a rate of about 600 to the dollar
is required to bring domestic prices in line with
world prices. The regime probably is reluctant to
devalue, however, because of the inflationary im-
pact and concern that increased exports would
depress consumer supplies.
Lack of Export Options
Even with more effective policies, Poland is not well
positioned in markets with high growth potential.
More than three-fourths of Polish hard currency In
1984 was earned through exports of coal, copper
and other metals, machinery and parts, chemicals,
and processed food. Warsaw's plans to increase
exports to the West by 7 percent annually in 1986-
90 appear excessively optimistic, given prospects in
its leading export markets:
? Even the Poles see marginal growth potential for
the extractive industries in the next five years.
Output of coal, copper, and sulfur will stagnate,
and production costs will escalate due to past
inadequate investment. Moreover, pleas to con-
serve fuels and raw materials have been largely
ignored. Stagnant demand for many raw materi-
als on the world market, competition from other
suppliers, and possible protectionist measures by
West Europeans also may constrain sales of these
products.
? Plans to increase exports of processed foods,
especially meat, at rapid rates during 1986-90
hinge on increased production, reversal of past
neglect of storage, packaging, and transport facil-
ities, and the development of improved marketing
Secret
Poland: Hard Currency Exports
in 1984
Percent
Fuel and energy
products 26.6
Other 22.1
Chemicals 9.0
Metals 10.6
Food 11.9
Machinery and
equipment 19.8
307834 1-88
strategies. Increasing meat exports, however,
risks consumer protests against draining domestic
supplies. Moreover, agricultural exports are vul-
nerable to the uncertainties of weather and West-
ern import restrictions.
? A rapid expansion of exports of higher priced
specialty chemicals is targeted at foreign high-
growth industries, such as electronics, pharma-
ceuticals, fertilizers, and pesticides. The econom-
ic plan, however, does not provide the investments
needed to increase output of these goods.
? Past experience suggests that Warsaw's plans to
boost exports of machinery and spare parts in the
next five years will prove unrealistic. In the first
nine months of 1985, exports of machinery to the
West were only 50 percent of the annual plan.
Moreover, the newly industrialized countries,
with better quality control and marketing chan-
nels than Poland, sell the same low-technology
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Poland: Planned Growth of Hard Currency
Exports, 1986-90
Average annual percent increase
Shaded portion represents a range
0
Hard currency exports
Extractive industry
Food processing
Chemicals
Machinery and
equipment
5
10
15
107883 1-86
machinery. Failure to develop new products, im-
port new industrial components on a large scale,
and buy production licenses from Western firms,
have widened Poland's technology gap and will
continue to hamper export competitiveness.
Exports of services also will show little improve-
ment for hard currency earnings beyond the $400
million earned in 1984. Warsaw hopes for substan-
tial future growth in tourism earnings, but consid-
erable investment in hotels and services is required.
Most tourist agencies agree that Polish prices are
high compared to other East European countries
and accommodations and services fall below West-
ern standards. While the export of construction
services has some potential, given a revival of
investment in the Third World, Warsaw must
adapt better to demand and develop an area of
expertise. Poland's geographic location offers po-
tential for increasing transit services, but invest-
ment and marketing are required. The outlook for
13
Secret
the export of technical know-how is even less
promising?Poland's outdated technology base pro-
duces few patents that are licensed on a world
basis. For example, less than 2 percent of all Polish
inventions have foreign patents compared to 10
percent of East German and 60 percent of Dutch
inventions.
Outlook
We expect Poland's hard currency export earnings
to increase marginally at best in the next five years.
The regime shows no signs that it will redirect
investment funds from outdated projects to those
industries with the most hard currency export
earning potential or greatly increase export incen-
tives for firms. Nor does a drastic devaluation
appear in the offing because of regime fears of a
negative public reaction to large increases in
domestic prices.
The regime's proposed export incentives are unlike-
ly to bring major improvement. For example, War-
saw plans to establish a Foreign Trade Develop-
ment Bank to provide loans for developing potential
exports, to raise a firm's share under the hard
currency retention fund, and to grant tax and tariff
concessions. The Poles also are encouraging joint
ventures with the West, especially in the metals
and machinery sectors, but Western firms appear
reluctant to participate due to past problems and
government policies. In addition, prospects for re-
newing old contracts, which nearly all expire by
1987, are gloomy because Western companies are
phasing out the older products now made in cooper-
ation with Poland.
Domestic pressure to increase consumption more
than exports to either the West or East is another
major impediment to export growth. As in the past,
the regime probably will yield to consumer de-
mands and permit consumption to grow by more
than the 2-percent annual rate planned for the next
five years. Such concessions would mean even less
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Contradictory Export Policies
The Polish Government has not conducted an
effective export campaign, and at times its actions
have had an unintended opposite effect. For exam-
ple, the regime in 1985:
? Ordered an exporter ci light bulbs to decrease
sales abroad by $2 million because of domestic
needs.
? Denied permission for a dairy to process and
export long-life milk because the equipment to
process the milk was leased from a Western firm
rather than purchased outright.
? Delayed for almost two years expansion on aban-
doned property of a factory producing air gliders,
resulting in a $100,000 loss in export revenue
and penalties for breach of contract to Western
importers.
Although behavior in these examples appears irra-
tional, in each case the regime made these deci-
sions by focusing on other priorities, especially
consumer needs.
export revenue to repay the debt. Despite creditor
demands to increase export revenues, their lack of
leverage over Poland means the regime most likely
will ignore the protests.
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Egypt:
Economic Prospects and
Policy Implications
Egypt's capacity to meet its external financial
obligations will become untenable in the next two
years without a combination of major cuts in
import growth, debt rescheduling, and significant
increases in external assistance. The present gov-
ernment is unlikely, however, to push for sweeping
reform, despite lipservice to the contrary, because it
continues to believe that major restructuring of the
current system of price supports, subsidies, and
government controls would produce political insta-
bility. The leadership probably assumes that the
strong US commitment to supporting a moderate
regime in Cairo will guarantee major increases in
financial assistance from the United States, lower-
ing the pressure on Cairo to undertake politically
risky reforms. Such support, however, would be
largely invisible to the Egyptian public. If US
assistance continues to grow while living standards
stagnate or decline, the opposition would likely
single out the United States with greater frequency
as the cause, not the cure, for Egypt's economic
woes.
Poor Prospects for Foreign Exchange Earnings
The combination of a weak world oil market and
rapid growth of domestic consumption will almost
certainly cause a decline in oil export revenues
through the end of the decade. Production, accord-
ing to oil industry estimates, will increase from a
current level of about 900,000 b/d to over 960,000
b/d by mid-1986 and to over 1 million b/d by early
1987. It will probably stabilize at this level for at
least the next two to three years before beginning to
decline. By 1990 we expect oil export earnings to be
down almost 40 percent from this year's level.
Remittances from workers abroad, the other major
contributor to Egypt's foreign earnings, are likely
to grow only marginally over the remainder of the
15
Oil Price Assumptions
Our oil earnings projections are based on the
premise that oil prices will decline only moderately
over the next five years. This assumption could be
overturned by decisions taken at the December
1985 OPEC meeting in Geneva. If OPEC countries
attempt to capture a larger market share, oil prices
may, according to many knowledgeable oil ana-
lysts, drop to the $20 per barrel level. A price
decline of this magnitude would have disasterous
implications for Egyptian revenue earnings and
would entail the loss of about $700 million in hard
currency during 1986 alone.
decade. Although evidence is sketchy, the economic
downturn in the oil economies of the Persian
Gulf?the area employing most of Egypt's overseas
workers?has probably already begun to affect
expatriate earnings. We believe, however, that
alarmist projections of large-scale layoffs of Egyp-
tian workers over the next several years are unreal-
istic. Much of the Egyptian work force in the Gulf
consists of skilled workers whose ethnic and reli-
gious compatibility and willingness to work at
lower wages than Western expatriates will proba-
bly ensure their continued employment. Neverthe-
less, we assume that some layoffs will occur, espe-
cially among less skilled workers, and that
reductions in pay and benefits are likely for many
more.
Egypt's other traditional foreign exchange earners
are unlikely to provide much help. Recent increases
in procurement prices for cotton may stimulate
production and exports, but not enough to make a
significant difference in overall foreign exchange
earnings. Suez Canal revenues have stabilized at
Secret
DI IEEW 86-002
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Egypt: Balance of Payments, 1985-90a
Billion US $
1985
1986
1987
1988
1989
1990
Current account balance
-1.9
-2.0
-3.4
-3.8
-4.1
-4.4
Trade balance
-6.4
-6.7
-7.4
-8.0
-8.6
-9.2
Exports (f.o.b.)
3.7
3.9
3.7
3.7
3.7
3.7
Oil
2.2
2.3
2.0
1.8
1.6
1.4
Nonoil
1.5
1.6
1.7
1.9
2.1
2.3
Imports (c.i.f.)
10.1
10.6
11.1
11.7
12.3
12.9
Service balance
3.6
3.3
3.1
3.3
3.6
3.9
Receipts
7.4
7.3
7.3
7.7
8.2
8.7
Remittances
2.8
2.7
2.6
2.7
2.9
3.0
Suez Canal earnings
0.9
0.9
0.9
1.0
1.1
1.2
Tourism
0.4
0.4
0.4
0.5
0.6
0.7
Other
3.3
3.3
3.4
3.5
3.6
3.8
Payments
-3.8
-4.0
-4.2
-4.4
-4.6
-4.8
Official transfers
0.9
1.4
0.9
0.9
0.9
0.9
Capital account
0.6
1.2
1.3
1.2
1.0
0.9
Financial gap
-1.3
-0.8
-2.1
-2.6
-3.1
-3.5
? Egyptian fiscal year is 1 July-30 June.
just under $1 billion during the past few years, and
any growth will remain constrained largely by
sluggish economic activity in the Gulf region.
Tourist revenues recently have sunk, according to
US Embassy sources, and prospects over the next
several years do not appear bright. Aside from a
few luxury hotels in Cairo, the Egyptian tourist
industry is plagued with inadequate infrastructure
and notoriously poor service, characteristics that do
not encourage return visits. Terrorist hijackings in
the Middle East also have influenced tourists,
particularly US citizens, to avoid the area.
policies make them poor vehicles for export expan-
sion.
1 /textiles will face severe international competi-
tion and protectionist policies abroad. Moreover,
industrial exports are largely uncompetitive and
likely to remain so for some time.
Nonoil exports also face bleak prospects. Egyptian
industry is dominated by public-sector enterprises
whose low productivity, orientation to the home
market, and dependence on government pricing
Secret
Policy Options
Given the bleak prospects for most of Egypt's
traditional foreign currency earners and the unlike-
ly development over the next several years of new
sources of revenue, we believe that Egypt's foreign
payments position will become untenable without a
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combination of major cuts in import growth and
significant increases in external assistance. Even
with some moderation in import growth,2 Egypt
will experience an unsustainable deterioration in its
foreign payments position. Cairo will continue to
explore various policy options to help reduce its
payments deficits and avoid crippling import cuts.
Non-US Financial Assistance. The Gulf Arab
states are in the midst of their own financial crisis
because of falling oil revenues and would not be
inclined, we believe, to provide the additional aid
Egypt will require. Moreover, a policy shift de-
signed to attract Gulf assistance, such as a deem-
phasis of the Camp David accords, would jeopar-
dize current US assistance levels of about $2.3
billion annually and leave Cairo no better, and
possibly worse off, than before. Financial assistance
from Libya or the Soviet Union would require an
even more fundamental political reorientation and
would not, in our judgment, provide anywhere near
the level of funding Egypt would lose by abandon-
ing its relationship with the United States.
Debt Rescheduling. The Mubarak government's
only viable option with regard to civilian debt relief
appears to be in multilateral rescheduling of long-
and medium-term liabilities under IMF auspices.
An IMF standby agreement would come at consid-
erable cost. In exchange for new lines of credit and
extended repayment terms on bank-syndicated and
bilateral loans, Egypt would have to adhere to strict
financial and monetary guidelines, including much
more rigorous subsidy reforms and more rapid
movement toward a unified exchange rate. Such
adjustments, however, would almost certainly force
substantial increases in consumer prices and proba-
bly provoke political unrest.
Accelerated Reform. From an economic perspec-
tive, a substantial self-initiated acceleration of eco-
norn,ic reform is the most effective option available
to Egypt. It is, however, no more palatable than an
'We have assumed for purposes of analysis that the government
will be willing and able to limit import growth to 5 percent per year
over the balance of the decade.
17
Secret
Egypt:
Estimated Foreign Debt,
December 1985
Billion US $
Civilian
24.0
Medium- and long-term
16.5
Short-term
7.5
Military
7.0
US FMS debt
3.7
Total
31.0
IMF standby agreement, from Cairo's political
viewpoint. Current plans envision a five-to-seven-
year period for the elimination of most subsidies, a
pace that will yield few dividends in the near term.
To Egyptian policymakers, however, a speedup in
reform over the next one to two years entails too
many political risks with no tangible economic
benefits. Accelerated price increases, reform of the
bloated bureaucracy, divestment of inefficient pub-
lic-sector industries, and exchange rate unification
are all recognized by the leadership as inherently
important goals. They are aware, however, that
such adjustments would initially entail large jumps
in living costs and displacement of workers before
there is any visible improvement in the economy.
Outlook
We believe that the Mubarak government lacks
confidence in its ability to survive during a period
of rigorous economic adjustment. Egypt's low- and
middle-income urban population already see their
economic status eroding and would regard a rapid
reduction in subsidies as intolerable. Moreover, a
strong consensus within Egyptian society holds the
government responsible for providing affordable
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goods and services to the public. These attitudes act
as powerful constraints to any accelerated reform
effort.
The government's gradualist approach to economic
reform has some major drawbacks. By delaying
needed price adjustments or by stretching them out
into increments acceptable to the general public, a
sense of urgency is lost and much of the shock value
of reform is dissipated. Cairo's excessively cautious
approach to reform provides little incentive for
consumers, producers, and investors to shift gears
and adopt new modes of behavior that might result
in increased productivity and investment. Instead,
it is business as usual for most Egyptians, despite
the burden of price hikes. Finally, by not providing
incentives (for example, higher wages, increased
access to consumer goods) and by attempting to slip
price increases through in a furtive manner, the
regime confirms in the minds of most Egyptians
that reform can only be injurious to their long-term
economic well-being.
Nevertheless, in the absence of large increases in
US aid, Cairo probably cannot delay much beyond
1987 the introduction of an IMF standby agree-
ment. A Fund-supported program, while onerous
and politically dangerous, would provide the gov-
ernment with some means of deflecting criticism
from itself. It and an accompanying rescheduling
agreement would also provide immediate economic
relief. Moreover, given recent experiences in IMF
standby agreements, the positive benefit of resched-
uling would remain intact even if Egypt, at a later
date, fell out of compliance.
Implications for the United States
We believe that Egypt will push hard for FMS debt
rescheduling. The $3.7 billion in military debt
obligations owed to the United States will require
annual payments of about $550 million over the
next several years. The Egyptians are $470 million
in arrears on these payments and are constantly
pushing up against the one-year arrearage limit
that could trigger a Brooke amendment cutoff in all
US assistance. Cairo has requested debt relief in
Secret
past meetings with US officials and will almost
certainly press harder for forgiveness, or substan-
tial rescheduling, during the next year. Egypt's
special military relationship with the United States
and shared concerns over the role of the Soviets,
Libyans, and Iranians in the Middle East will
undoubtedly be cited by Cairo as justification for
FMS relief.
The Mubarak government also will strongly argue
for conversion of more Economic Support Funding
(ESF) into cash transfers, as well as an increase in
total ESF, which currently is $815 million annual-
ly. During the current US fiscal year about $300
million of ESF for Egypt has been allocated by the
United States for balance-of-payments support; the
remainder is distributed as project assistance
through USAID. Cairo will probably attempt to
persuade US officials to convert more project assis-
tance into grants, citing as justification the cash
grant status of all ESF under US assistance to
Israel. The Egyptians have long maintained that
the United States promised aid parity with Israel.
Egyptian officials may also cite growing political
and social tensions caused by the large US presence
in Egypt and argue the desirability of lowering the
US profile by channeling more project assistance
directly into Egyptian hands
In addition to regular ESF, Egypt is receiving from
the United States $500 million in supplemental
grant assistance?all of which will be disbursed
during the current Egyptian fiscal year (1 July-30
June). Our analysis of Egypt's 1985/86 budget
suggests that Cairo has already incorporated this
amount into the capital transfer and investment
portions of its budget, leading us to believe that the
Egyptians assume this one-time funding, or the
equivalent in new ESF, will be made available to
them on an annual basis after 1986.
Given current financial trends, Egypt could easily
require, in the absence of an IMF standby program
and a rescheduling agreement, an additional $1
billion in balance-of-payments support by 1987.
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This would necessitate a more than threefold hike
in US aid designated solely for payments support
and, in the absence of any general aid increases,
would require converting most current US assis-
tance, military and civilian, into cash grants. An
IMF-supported standby program for Egypt un-
doubtedly would ameliorate, to some extent, the
need for greater direct financing but would proba-
bly entail additional costs for the United States in
the form of supporting the IMF program and
deferring loan obligations.
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Latin Debtors: Increasingly
Competitive Labor Costs
The five largest Latin American debtors 1?often
as part of IMF-supported programs?have under-
taken austerity measures that have resulted in
generally falling labor costs since 1981. According
to our estimates, Latin American labor costs have
fallen 14 percent in domestic terms and 48 percent
in US dollar terms between 1981 and 1984. We
expect existing and growing labor surpluses in the
debtor countries to continue to restrain realwage
increases throughout this decade. Low labor costs
should attract some labor-intensive investment as it
has in the East Asian NICs,2 but we believe that
political and economic uncertainty in the Latin
American debtor countries probably will constrain
significant private investment that could help fuel
economic expansion.
Austerity Drives Domestic Wages Down
Before the debt crisis, real labor costs were increas-
ing at an average annual rate of 4 percent in
domestic currency terms in what are now the five
largest Latin American debtors. Since the onset of
the debt crisis in 1982, these countries have imple-
mented various austerity measures, often as a part
of debt rescheduling agreements with the IMF and
other financial institutions. Debt-related policies
have dramatically reversed the previous trend. In-
creases in nominal wages actually lagged increases
in inflation in four of the five largest Latin Ameri-
can debtors between 1981 and 1984; we estimate
that real domestic labor costs fell 14 percent on
average during this period.
Although complete data for 1985 will not be
available for several months, we believe that real
wages fell in four of the five largest debtors last
year. Brazil had the only increase for 1985; hefty
' The five largest Latin American debtors are Brazil, Mexico,
Argentina, Venezuela, and Chilel
The East Asian newly industrializing countries (NICs) are Hong
Kong, Singapore, South Korea, and Taiwan
21
Trends in Real Hourly Manufacturing Labor
Costs: Large Latin American Debtors
and East Asian NICs, 1974-84
1984 US S
3.0
0.5
1 1 1 I 1 1 1 1 1 1 1
East Asian
NICs a
Large Latin
debtors b
0 1974 76 78 80 82 84
. The East Asian NICs include Hong Kong, South
Korea, Singapore, and Taiwan.
b The large Latin American debtors include Argentina,
Brazil, Chile, Mexico, and Venezuela.
307839 1-86
hikes in minimum salaries, a trend toward quarter-
ly pay adjustments, and major wage concessions
resulting from large-scale strikes in the Sao Paulo
industrial belt led to an average real wage increase
that exceeded 10 percent in cruzeiro terms. Vene-
zuela and Mexico will report mild declines for
1985. Venezuela has focused more on increasing
employment than on increasing real wages, and
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Labor Compensation Costs
Labor compensation costs are used rather than
earnings comparisons because they better reflect
the true cost Qf employing labor, and, therefore,
the competitiveness of labor inputs in manufac-
tured goods production. In contrast to earnings,
this broader definition includes items such as:
unemployment insurance costs, contributions to
pension plans, all bonuses and special payments,
pay for time not worked (that is, holiday, vacation,
and sick pay), payment in kind (that is, housing
allowances) and payroll taxes that are paid by the
employer but that do not necessarily benefit the
worker directly.
Mexico has continued its attempts to control infla-
tion by suppressing real wage growth. Argentina
and Chile will show the most severe declines for
1985; both economies continue to be stalled by
their high dependence on depressed commodity
revenues in the agricultural and mining sectors,
respectively.
Dollar Labor Costs Decline
Even More Dramatically
Because movements in real exchange rates in-
creased the value of the US dollar against all of the
largest Latin American debtor currencies during
the past four years, the debtors have enhanced their
labor cost competitiveness vis-a-vis the OECD
countries by even more. We estimate that the US
dollar labor cost of employing manufacturing labor
in Latin America fell by 48 percent between 1981
and 1984, with the real average hourly cost falling
from the equivalent of $2.83 in 1981 to $1.48 in
1984. We estimate that three-fourths of this de-
cline was due to real depreciation of the debtor
currencies against the US dollar with about one-
fourth due to the fall in domestic labor costs.
Although currency devaluations were not undertak-
en specifically to lower relative labor costs, that has
been perhaps its most significant result.
Secret
Prospects For
Low-Wage-Induced Investment
Low labor costs have been a key element in attract-
ing foreign investment and in producing competi-
tive manufactures for export in the highly praised
development of the East Asian NICs. These Asian
countries had US dollar labor costs that were 41
percent lower than the five largest Latin American
debtors four years ago, which provided a large
incentive for labor-intensive producers to invest in
Asia. The East Asian NICs have now lost that
labor cost advantage over the largest Latin Ameri-
can debtors. Asian labor costs were 20 percent
higher than the average Latin American debtor
costs in 1984, and the Latin American debtor
advantage continues to grow.
Cost and supply factors regarding the labor force
should have attracted greater labor-intensive in-
vestment from both domestic and foreign sources,
but other considerations have acted to prohibit the
Latin American debtors from fully realizing the
benefits of their competitive labor position. Among
the deterrents to new investment are rampant
inflation, high real interest rates, stringent price
controls, restrictive exchange controls, erratic tax
policies, and protected domestic markets. All of
these factors tend to raise, and more important to
make unpredictable, the costs related to doing
business in the Latin American debtor countries.
Although current trends are slowly swinging to-
ward a more favorable business environment,
abrupt turnarounds in the past have made investors
wary, and they will withhold their capital until they
are convinced that new favorable changes are more
than transitory. Brazil and Mexico have both made
moves away from their better-than-average adher-
ence to austerity programs in favor of more growth-
oriented policies. Argentina has implemented an
aggressive plan to control inflation, but many ob-
servers believe that it may soon be abandoned.
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Individual Country Trends
Mexican real wages plummeted the most severely
among the largest debtors between 1981 and 1984;
manufacturing labor costs fell by 28 percent. The
US Embassy reports that organized labor offered
the ruling PRI, during the 1982 elections, its
cooperation in holding down wage hikes in return
for increased representation of labor leadership in
government. The Mexican workers received assur-
ances that certain basic commodities would be
subsidized and held at low prices although wages
would not keep up with inflation.
Chile realized a 20-percent decline in real domes-
tic labor costs between 1981 and 1984. Chile has
yet to fully recover from the domestic banking
crisis and the drop in international copper prices
that contributed to the economic recession that
began mid-1981. Labor legislation that had effec-
tively created a real wage floor was removed in
1982 because government officials believed that
wage inflexibility was reducing product competi-
tiveness, increasing unemployment, and aggravat-
ing the recession.
Labor costs fell 18 percent in Brazil's manufactur-
ing sector from 1982's peak by 1984. The govern-
ment of Brazil passed a salary decree law in 1983,
as part of an austerity program agreed upon with
the IMF, that indexed labor costs well below the
cost of living, according to the US Embassy. In late
1984, officials began attempts to preserve worker
purchasing power with a new salary law that called
for wage indexation equal to inflation and for
semiannual adjustments.
Venezuela's real domestic labor costs fell 18 per-
cent between 1978 and 1984. During this period,
real manufacturing wages rose only in 1980 when a
large general increase was mandated by the gov-
ernment, but the subsequent rise in consumer
prices offset most of the nominal increase in wages.
Falling real wages reflect the more general deterio-
ration in nonpetroleum-sector performance in Ven-
ezuela. This deterioration in large part is due to
inept government policies that were adopted be-
tween 1979 and 1983 that kept the bolivar overval-
ued while liberalizing import procedures.
While Argentina's manufacturing labor costs have
yet to reach I975's peak levels, it was the only
debtor to have rising real wages in 1983 and 1984.
The military appeared to be making an effort to
improve its image with the Argentine public prior
to the transition to a popularly elected civilian
government in 1983, and Raul Alfonsin made good
on his campaign promise to raise real wages in
1984.
Real Wage Outlook
We believe that the labor cost competitiveness of
the largest Latin American debtors will continue to
expand throughout the decade:
? Increasing labor reserves will restrain labor cost
increases, preventing domestic real wages from
recouping the losses incurred with the onset of the
debt crisis until after the end of the decade. These
reserves are already large with unemployment
rates generally well into the double digits and
underemployment rates even higher. Moreover,
rapidly expanding labor forces will ensure an
ample supply of labor in the future.
23
? Depreciation of domestic currencies by the Latin
American debtors against their OECD trading
partners will probably continue in an attempt to
stimulate even more exports and to reduce capital
flight.
Falling labor costs have boosted the competitive-
ness of Latin American exports. We expect, howev-
er, that interventionist government policies and
powerful labor unions will attempt to prevent fur-
ther declines in domestic purchasing power, which
in some cases may already be at subsistence levels
for many workers. As a result, we believe that
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Largest Latin Debtors:
Real Manufacturing Labor Costs,
1974-84
Hourly Labor Cost
(1984 US 8)
Average Annual Growth
(percent)
1974
1976
1978
1980
1982
1984
1975-81
1982-84
Argentina
1.87
0.91
1.03
2.41
0.63
0.91
-1.6
-18.3
Brazil
1.74
2.08
2.33
1.96
2.32
1.23
3.2
-17.2
Chile
0.81
0.72
1.06
1.48
1.21
0.81
11.6
-22.6
Mexico
3.46
3.88
3.33
3.74
2.15
1.81
2.9
-24.7
Venezuela
3.61
3.72
4.05
4.43
4.27
2.64
2.6
-15.1
Group average
2.30
2.26
2.36
2.79
2.12
1.48
3.0
-19.4
Asian NIC average
1.13
1.24
1.52
1.65
1.69
1.77
5.9
1.9
United States
12.13
12.66
13.18
12.38
12.41
12.59
0.3
0.7
Largest Latin Debtors:
Changes in Real Domestic
Manufacturing Labor Costs,a
1975-84
Average annual percent
1975-81
1982-84
Argentina
-3.4
3.9
Brazil
6.0
-3.2
Chile
11.7
-7.1
Mexico
2.0
-10.3
Venezuela
0.3
-4.3
Group average
4.1
-4.9
Asian NIC average
7.6
7.1
United States
0.2
0.7
a Measured in national currencies.
future increases in labor cost competitiveness will
derive primarily from real devaluations of Latin
American debtor currencies.
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Somalia:
Uncertain Prospects
For Economic Reform
Somalia made limited progress toward improving
its ailing economy in 1985, but major problems
remain including a growing external debt, contin-
ued high current account deficits, and slippages in
implementing the 1985 IMF reform package. Al-
though the economic stabilization effort continues,
enthusiasm for economic reform in 1986 probably
will be tempered by continuing opposition from
many of President Siad's supporters in the govern-
ment and military. Because Siad's overtures to
Libya and the Soviet Union have netted him only
limited assistance thus far, we believe he will come
to terms with the IMF in 1986 to avoid jeopardiz-
ing essential Western and Arab aid.
Economic Slide
The Somali economy has not recovered from the
severe drought of 1974-75 and the Ogaden war
with Ethiopia in 1977-78. The war resulted in a
steady inflow of refugees and an end to Soviet
financial and technical assistance. As foreign aid
grants declined, Mogadishu substantially increased
government expenditures in 1978 and 1979 leading
to high budget deficits. Government domestic and
foreign borrowing to finance these deficits pushed
the inflation rate higher and widened the current
account deficit.
Mogadishu undertook some reforms in 1981-83 to
accommodate IMF standby arrangements, but
heavy short-term borrowing and high interest rates
kept current account deficits high. Efforts to estab-
lish a medium-term economic program in late 1983
and early 1984 were abruptly postponed, and Siad
rejected a new IMF agreement to appease support-
ers who stood to lose financially if effective reform
measures were enacted. A Saudi ban on livestock
imports from Somalia because of disease, and the
1983-84 drought, exacerbated Mogadishu's eco-
nomic and financial situation. In 1984, the inflation
rate topped 90 percent?nearly three times the
25
average of 1981-83?the budget deficit increased
from 3.3 percent of GDP in 1983 to 6.9 percent in
1984, and the foreign payments situation worsened
drastically.
The 1985 Reform Program
In response to mounting economic pressures, Siad
introduced an ambitious reform package in Janu-
ary 1985, along with another IMF standby agree-
ment. The new package aimed to increase economic
growth from 2.3 percent in 1984 to 4 percent in
1985, to dampen inflation from 92 percent to 20
percent in 1985, and to reverse the financing gap
from a $139 million deficit in 1984 to a surplus of
$18 million.
The linchpin of the program was a devaluation of
the Somali shilling. The government allowed the
shilling to float for most private transactions and
devalued the official rate by about 50 percent
between January and May 1985. The government
also eliminated most controls on trade and pay-
ments, including licensing for most import and
export transactions. The program also sought a
substantial rise in revenues by liberalizing imports.
The government undertook to reduce the civil
service sector and to strengthen controls on expen-
ditures.
Limited Successes and Deep Problems
The economic reform efforts have had mixed re-
sults. Despite a shortfall in government revenue,
Somalia probably came close to meeting the 1985
targets for the budget deficit and for banking
system credit to the government, according to IMF
data and Embassy reporting. Although inflation
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Somalia: Economic Indicators,
1980-85
Real GDP Growth
Percent
Central Government Deficit
as a Share of GDP a
Percent
10
Inflation Rate
Percent
100
Exchange Rate b
US $ per shilling
0.20
0.15
remained in excess of IMF targets, it is down by
more than one-half to about 40 percent, according
to IMF estimates. Exports were expected to in-
crease by 60 percent because of favorable weather
conditions, efforts to diversify export markets, and
the lifting of the Saudi ban on noncattle livestock.
Furthermore, real GDP probably grew by about 4
percent during 1985?close to government tar-
gets?according to IMF estimates.
Despite these modest gains, difficulties remain.
External debt mounted steadily?to an estimated
$1.5 billion?and the IMF projects a $68 million
foreign payments deficit for 1985, due in part to
lower than expected aid donor receipts and high
debt servicing requirements. According to the Em-
bassy, external arrears totaled an estimated $61
million for 1985, up from a previous IMF estimate
of $27 million. Mogadishu also has fallen behind in
its repayments to the IMF and is seeking a short-
term US bank loan to pay its arrears to the Fund.
Exchange rate adjustment continued to be a major
point of contention between the Fund and Mogadi-
0.10 shu in 1985. The government ceased making
monthly adjustments to the official rate in mid-
0.05 ? May, leaving the official rate about double the
free-market rate. The government continues to
resist unification with the market rate because it
fears the potential negative effects on the budget
Outstanding External Debt Debt Service Ratio
Billion US S Percent
100
80
60
40
1980 81 82 83 84 85c
1980 81 82 83 84 85c
a Includes external grants.
b Average exchange rate for year except for 1985,
which is the yearend exchange rate.
c Estimated.
307838 1.85
Secret
and inflation, but also because officials are unwill-
ing to relinquish control over the allocation of
foreign exchange and the benefits of the cheap
official rate, according to the Embassy. The two
sides have yet to reach an agreement on when or if
unification will take place.
Mogadishu also continues to avoid taking effective
steps to reform the public sector. Under the 1985
program, the Somalis were to classify existing
public enterprises into three categories: those to be
phased out of operation, those to be privatized or
converted into joint ventures, and those to remain
in the public sector. According to the US Embassy,
however, the Somalis dragged their feet?probably
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Somalia:
Current Account Trends, 1980-85
Million US $
1980
1981
1982
1983
1984
1985 a
Current account balance
?136
?83
?177
?150
?146
?172
Merchandise trade balance
?268
?195
?300
?272
?425
?471
Exports
133
175
171
90
41
65
Imports
401
370
471
362
466
536
Net services
?68
?69
?54
?45
?78
?58
Private and official transfers
200
181
177
167
357
357
a Estimated.
fearing losses of patronage and control?and are
attempting to keep in the public sector all business-
es that benefit top Somali officials and their friends
and relatives.
Disappointed Expectations
of Western Aid
Siad launched the 1985 program with the hope that
the IMF, the United States, and other donors
would quickly come to his aid. Senior government
and party officials over the past year, however,
have increasingly criticized his failure to acquire
sufficient Western assistance to reverse the coun-
try's economic and military decline, in return for
adopting reforms and providing the United States
with military access
Those officials who opposed the 1983-
84 reform program and IMF agreement and profit-
ed from the corruption the previous system allowed
are again pressing Siad to reimpose socialist eco-
nomic policies.
To counter mounting criticism, Siad is seeking to
improve relations with the Soviet Union and Libya
in hopes of gaining additional aid and limiting
military and political support for Somali dissidents.
At the same time, he has become increasingly
critical of Western donors, particularly the United
27
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States but also the IMF, blaming their "stinginess"
for Somalia's woes. So far, Libya has provided
some $20 million for a joint agricultural project,
but the Soviets have replied to his overtures with
political conditions that are unacceptable to Siad,
according to US officials. Nonetheless, he probably
believes renewed contacts with Moscow and Tripoli
will give him some leverage in the difficult negotia- 25X1
tions over Western aid and Somali economic re-
form in 1986.
Outlook
We believe that, while Mogadishu's commitment to
reforms is far from certain, Siad is well aware that
the economic crisis will worsen if he does not take
some action. The country's underlying structural
deficiencies? high import dependence in combina-
tion with reliance on a few export products and
markets, and low productivity of investment?will
probably persist for many years, requiring contin-
ued foreign assistance to keep the economy afloat.
Debt service for 1986, including arrears, will be
$224 million?almost twice the projected level of
exports, according to the Embassy.
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Siad probably will face increasing pressure to reject
an IMF stabilization package in 1986, especially if
donor assistance continues to fall below Somali
expectations. More government leaders, however,
are increasingly aware of the economic situation
and the need for an IMF agreement, according to
the Embassy. We believe Siad?with little viable
alternative?will accept an IMF agreement to pro-
mote the flow of aid from Western and moderate
Arab sources, but will test the tolerance of the IMF
by delaying the unification of the exchange rates,
the full payment of arrears, and other reforms. We
concur with the Embassy assessment that the So-
malis, fearing the potential economic consequences,
are less likely to enter an agreement if the IMF
insists upon a unified foreign exchange rate rather
than a modified dual system.
We believe Siad will persist in his criticism of the
West to counter his domestic critics, and he will
seek ways to mitigate the effects of economic
adjustment on his favorite supporters. We do not
believe Siad will risk a break with the West,
however, given Somalia's strong need for economic
and military aid and the low probability that the
Soviet Union and Libya will respond sufficiently to
his overtures
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Western Involvement
in Libya's
Oil Industry
Iranian Alternatives
to Khark Island
Briefs
Energy
Western Oil Companies in Libya
Equity Share in
Libyan Operations
(percent)
Current Crude Liftings
(thousand b/d)
United States
OASIS
Conoco
16
64
Marathon
16
64
Amerada Hess
8
32
W.R. Grace
12
14
Occidental
37
46
Total
220
Western Europe
Elf a, France
49
2
Wintershall, West Germany
49
2
VEBA a, West Germany
35
21
OMV a, Austria
12
15
AGIP a, Italy
50
80
Total
120
a Includes total or substantial government ownership.
Khark Island remains Iran's only export terminal for onshore oil production,
despite Tehran's claim it has completed another export facility at Ganaveh.
Satellite photography shows that work at Ganaveh is continuing but is not
finished. Press reports from Bahrain indicate that, because of extensive
damage, Khark may be abandoned when the new outlet is complete. The
Ganaveh export terminal probably will not be finished before February and
will add about 2 million b/d in export capacity. The reopening of Khark's sea
island berths 11 and 12 and the recent simultaneous use of four T-jetty berths
seen in photography suggest it is highly unlikely that Iran will abandon Khark
for the new, smaller terminal.
29
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Mauritanian Oil
Hopes Waning
Mauritania is not likely to become an oil producer any time soon, despite some
initial optimism by US oil companies exploring in country. According to US
Embassy reporting, OXOCO's recently concluded onshore seismic studies in
southwestern Mauritania proved favorable, but the company decided that the
soft world oil market made exploitation of the fields uneconomic. The
Secretary General of the Mauritanian Ministry of Mines and Industry believes
Texaco has also decided to postpone drilling its offshore concession?despite
promising seismic results?because of the company's legal battle with Penn-
zoil. AMOCO also appears to be dragging its feet on exploring potentially
lucrative onshore and offshore fields. Although the Secretary General main-
tains AMOCO is interested in exploiting the concessions, a date for negotiat-
ing an agreement has not yet been set.
International Finance
Japan Debates Finance Ministry and Central Bank officials last week publicly opposed any
International attempt to modify the floating exchange rate system for "the foreseeable
Monetary Reform future," according to the Japanese press. Vice Finance Minister Oba noted
that Finance officials would not support a target zone system in which major
currencies would be allowed to fluctuate within a well-defined band, even if
proposed by aides to Prime Minister Nakasone. We believe these statements
are primarily intended to discredit any recommendation by Nakasone's special
trade policy advisory group for reform of the international monetary system.
Nakasone has said he will put forth some of the group's recommendations?
due in March?at the Tokyo Economic summit in May.
Secret
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Costa Rican IMF San Jose may need another waiver to stay in compliance with the IMF
Program Facing stabilization program it signed this July. Political realities during the presiden-
Problems tial campaign have prevented full and timely implementation of promised
tariff reforms. This is also holding up the second tranche of a World Bank
loan. Moreover, a deterioration in Costa Rica's trade balance is further
undercutting San Jose's ability to meet quarterly foreign reserve targets.
Anticipating higher tariffs, Costa Rican manufacturers apparently have
stepped up imports in recent months. Export earnings are down because coffee
exporters are witholding sales, expecting higher prices in the wake of the
continued Brazilian drought. According to Embassy sources, Costa Rican
officials claim further import cuts are impossible before the 2 February
elections. As a result, the new administration scheduled to take office in May
is likely to be faced with clamping down on the economy or lobbying the World
Bank and IMF for a relaxation in program targets.
Progress on Guinea's
IMF Agreement
Bangladesh Signs IMF
Standby Agreement
On 12 December Guinea signed a letter of intent with the IMF detailing a ma-
jor reform program that Guinea hopes will be the basis for a standby
agreement to be negotiated in coming weeks, according to the US Embassy.
The most significant reforms include a major devaluation, an increase in rice
and fuel prices, reform of the banking system, rationalization or abolition of
state enterprises, reduction of the civil service, and various budgetary reforms.
President Conte, who has moved cautiously to liberalize the Guinean economy,
is likely to meet resistence to imposing austerity measures on what is already
one of Africa's poorest economies.
Bangladesh and the IMF signed a standby agreement for about $200 million
in December. Agreement in principle was reached last June, but final signing
was delayed because of disagreements between Dhaka and the Fund over the
scope and pace of economic reforms. According to the US Embassy, Dhaka
has now agreed to increase public utility taxes, phase out fertilizer subsidies,
and depreciate the taka. Dhaka also pledged to maintain ceilings on domestic
credit and public external debt to reduce inflation and foreign exchange
outlays. The IMF loan comes at a time when Bangladesh's financial reserves
have declined to about $300 million, equal to about one month's imports.
President Ershad, however, may backslide on some austerity measures to
enhance his popularity as part of ongoing efforts to schedule national elections
with the participation of opposition parties.
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Global and Regional Developments
EC Bans Livestock
Hormones
Canada To Impose
Tariffs on EC Beef
EC agriculture ministers have approved a total ban on the nontherapeutic use
of growth hormones in livestock effective 1 January 1988. The action is in re-
sponse to consumer pressures and an attempt to curb overproduction of meat.
Although not directed specifically against EC trading partners, the ban will
apply to imports as well as domestic meat and thus threatens US exports of
beef and beef products. The United Kingdom, a major user of hormones,
opposed the ban, citing a lack of scientific evidence of harmful effects. The ban
will likely be difficult to enforce, and, until the specific enforcement mecha-
nisms are worked out by EC veterinary officials, the exact impact on US beef
exports cannot be predicted.
Ottawa is expected to satisfy the domestic complaints of unfair competition by
levying countervailing duties on EC beef imports. In 1984, Ottawa used its
Meat Import Law to impose quotas on beef imports, but dropped the
restrictions after the EC threatened retaliation against Canadian foodstuffs.
Ottawa invoked the law again in 1985 but immediately suspended the
restrictions, pending an investigation of EC beef imports by a government
panel. The study will be completed by mid-January, and senior Canadian
officials recently stated that the panel almost certainly would find the EC
guilty of unfair trade practices. While the duty rate has yet to be determined,
the influential Canadian Cattlemen's Association is arguing that a level of 43
to 57 cents per pound is needed to offset EC export subsidies. Ottawa,
however, is likely to impose substantially lower rates because the EC subsidies
are only about 25 cents per pound.
Bonn and The Hague The West German and Dutch Governments have decided to provide $185
To Aid Semiconductor million in subsidies to the joint Siemens/Philips project to develop by 1989 a
Project next generation of memory chips. Bonn's share will be $125 million. The
project's prospects were unclear last summer when Toshiba came out with
samples of a 1-megabit chip and Siemens decided to purchase Toshiba's
design. Siemens remains committed, however, and both firms optimistically
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contend that the microelectronics gap between West Germany and Japan will
be closed if they can meet their target date. Siemens is also interested in using
megabit chips to improve the competitiveness of the company's telecommuni-
cations and factory and office automation equipment.
Tin Council To When the International Tin Council (ITC) reconvenes Tuesday after a three-
Consider New week hiatus, the main topic of discussion will be the latest proposal put
Proposal forward by ITC creditors. The plan calls for the establishment of a new
company controlled by creditor banks and London Metal Exchange (LME)
brokers to assume the debts as well as the assets of the ITC bufferstock. It also
would allow for the orderly disposal of the ITC's tin inventory?about 85,000
metric tons, including outstanding contracts?over a three-year period to
minimize price distortions. For ITC members, this proposal is preferable to
earlier solutions because it limits ITC's liability to roughly $300 million
instead of the potential $1.3 billion debt of the bankers' original proposal. The
growing concessions in favor of the ITC reflect the relatively weak bargaining
position of the creditor banks and LME brokers. Although more palatable to
ITC members, the plan probably will not receive immediate approval because
members remain divided on responsibility for the ITC debt. In the meantime,
the LME?facing growing pressures?meets Monday to decide when to
resume tin trading.
Vienna Agrees
To Finance
Hungarian Dam
India and USSR Sign
Trade Agreement
Austria has agreed to provide substantial financial and technological support
for construction of the controversial Nagymaros dam, part of a joint Czecho-
slovak-Hungarian hydroelectric complex on the Danube. The Austrian Gov-
ernment will guarantee bank loans covering nearly 90 percent of the estimated
$440 million cost, and Austrian companies will perform 70 percent of the
construction. To repay the loans, Hungary will deliver 1.2 billion kilowatt
hours of electricity annually to Austria?two-thirds of its share of the
complex's output?for a 20-year period, starting in 1996 when work is
scheduled to be completed. After dragging its feet since 1977, Budapest agreed
to proceed last year in response to pressure from Moscow and Prague.
Austrian participation will alleviate some concerns about the project's costs
and will free Budapest to channel resources to more productive energy
investments. The meager potential return for Hungary?less than two percent
of its current electricity requirements?could revive criticism from domestic
environmental groups.
India and the USSR signed an agreement late last month that calls for an in-
crease of up to 100 percent in bilateral trade over the next five years. It
extends the longstanding arrangement under which India pays for its imports
in nonconvertible rupees and provides more favorable credit terms for
purchases of Soviet machinery and other equipment. The agreement does not
indicate any major change in the composition of trade. India apparently used
its threat to open its market even more to Western capital and technology to
wring concessions from the Soviets. The target of doubling trade is not likely to
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be reached. Moscow probably will not increase its exports of crude oil and pe-
troleum products, which make up more than 70 percent of Indian imports from
the USSR. The Indians probably will be reluctant to accelerate purchases of
Soviet capital goods significantly because of dissatisfaction with their quality.
South Korea Eyeing South Korean companies are considering investment opportunities in the
Caribbean Basin Caribbean Basin in order to export apparel and other manufactured goods to
Investment the United States and Western Europe. Although the Caribbean Basin
Initiative does not include textiles and apparel, there are only limited quota re-
strictions on textiles from this region. About two dozen apparel makers from
South Korea, Hong Kong, Taiwan, and Singapore have opened factories in the
past two years in the Caribbean Basin. Most recently, a South Korean firm is
deciding whether to open a plant in Costa Rica to manufacture textile bags
and luggage./
China and Japan
To Renew Long-Term
Trade Agreement
South African
Miners Fired After
Wildcat Strike
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10 January 1986
Beijing and Tokyo have resolved serious differences over future Chinese crude
oil export commitments, enabling them to renew their long-term trade
agreement for another five years. According to press reports, Japan will
increase the minimum quantity of Chinese crude oil it imports by 10 percent to
176,000 b/d through 1990. Japan had resisted Chinese proposals for a
significant increase in the oil import commitment level to help offset China's
growing trade deficit with Japan, which was over $5 billion in 1985. This
compromise is unlikely to reduce the bilateral deficit, however, because the
Japanese already have been buying about 60,000 additional b/d of Chinese
crude on the spot market for the past several years. Nonetheless, Beijing
probably will use the agreement to placate students and other domestic critics
who have recently protested Japan's trading practices.
Operations in the world's second largest platinum mine, located in nominally
independent Bophuthatswana, shut down on 6 January after its South African
owners, Impala Platinum Holding Ltd, fired 20,000 miners engaged in a
wildcat strike over wages and better working conditions. Since the shutdown
platinum futures prices for April delivery have soared. While the mine closure
has also renewed concern that tensions in southern Africa might disrupt future
metal supplies, it is unlikely the closure will be prolonged. In the absence of a
labor settlement, replacement workers can readily be drawn from the vast pool
of unemployed blacks in Bophuthatswana and South Africa. Meanwhile, mine
officials claim that platinum stockpiles will prevent any break in consumer
supplies.
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Japanese Economic
Policy Dilemma
Japanese Develop
Ceramics Welding
Technology
Ottawa Announces
Plan for Minimum
Income Tax
National Developments
Developed Countries
Prime Minister Nakasone this week called for a coordinated international
effort to lower interest rates to spur economic growth in industrial nations. We
believe the timing of Nakasone's plea reflects his growing concern over the
impact of high domestic interest rates on the sluggish Japanese economy.
Private Japanese forecasters project a further slowdown in 1986?an election
year?because of reduced demand for Japanese exports. The Prime Minister
may be out in front on this issue, however. The Bank of Japan so far is
unwilling to cut interest rates unilaterally for fear that Japanese purchases of
US securities would accelerate, thus weakening the yen. The near-zero growth
budget approved by the Cabinet at yearend, moreover, gives Tokyo little room
to boost the economy by fiscal measures over the next few months. Even if the
Bank of Japan cuts interest rates?perhaps matching a cut in the US discount
rate?we believe the impact would at most temper the economic slowdown
because credit is readily available now for the larger firms.
technicians at the Government Industrial
Research Institute in Osaka have developed a capability for rapidly welding
ceramics. The technology has been demonstrated for silicon nitride and silicon
carbide, which are two of the three most promising ceramic materials (along
with zirconia) for many high-temperature engine and tooling parts desired for
commercial and military applications. We doubt that the welding technology
will be commercialized soon principally because the critical long-term reliabil-
ity of the welds has yet to be demonstrated. Whether or not this particular ce-
ramics welding technology ultimately proves practical, it represents a concep-
tual breakthrough in joining ceramic parts.
Ottawa expects to raise $320 million in 1986 from its new minimum tax on
personal income, but we believe the figure will be substantially less. Basically a
flat rate tax with fewer deductions, the new levy greatly complicates Canada's
income tax system because high income persons must now perform calcula-
tions under both the old and new systems and pay whichever is greatest. Tax
experts have also criticized provisions that raise the effective tax rate on
Canadian dividends by 50 percent at a time when equity investment is a major
concern. In addition, the new tax strikes previously exempt capital gains,
breaking the government's earlier promise of a $500,000 lifetime capital gains
exemption. Finally, critics claim the tax will not raise the expected revenue be-
cause of its tax-averaging provision.
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New Life for Moroccan
Efforts to Purchase
French Aircraft
New Moroccan
Tax Reforms
Peru Pursues
Nationalist Foreign
Investment Approach
Less Developed Countries
France has reopened negotiations with Morocco on a roughly $450 million deal
involving 24 Mirage 2000 aircraft. Paris's latest offer calls for a 30-percent
cash payment up front, another 30 percent payable one year later, and the re-
mainder to be financed on a commercial basis. Rabat's counterproposal offers
25 percent down and 25 percent due one year later, with the remainder
financed commercially.
The Moroccan Government in December pushed through parliament the first
phase of its IMF-supported tax reform program. The new value-added tax,
scheduled to go into effect in April, is slated to replace two fraud-ridden
turnover taxes on goods and services. Implementation could well be delayed,
however, due to the parliament's concern over the technical complexity of the
new tax and, in particular, its potential inflationary impact. The US Embassy
believes the VAT, which has been in preparation since 1981, will be more or
less revenue-neutral. Nevertheless, local retailers may well use the tax as an
excuse to hike prices. Some government officials fear that any increase in
inflation, coming on top of an already falling standard of living, could provoke
unrest. "
President Garcia's decision to take over a US oil firm as an apparent first step
in implementing his nationalistic foreign investment policies will further sour
already shaky relations with Washington and is likely to discourage new
foreign investment. On 27 December Garcia announced the takeover of an
offshore US oil company that had failed to accept Lima's requirements for
additional exploration, profit sharing, and new tax arrangements prior to the
26 December deadline. In a press conference on 29 December, Garcia said he
intended to review the profit-sharing practices of a US copper firm and large
local companies. The nationalization of the US oil company probably will
complicate negotiations with the two remaining US oil companies over issues
such as the amount of reinvestment and repayment of revoked tax credits. The
copper concession?which produces 70 percent of Peru's copper annually and
survived the 1974 nationalizations?is also vulnerable because its contract is
subject to renegotiations soon.
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Troubles
Secret
A holiday truce has ended a strike against the Standard Fruit Company until
at least mid-January. The government probably will then come under renewed
pressure from labor and management alike to improve the competitiveness of
banana exports?Honduras's largest foreign exchange earner. Some 4,000
banana workers, joined by thousands more in solidarity strikes, walked off the
job in mid-December when Standard announced the layoff of 100 workers.
The strike reportedly brought industrial activity to a near halt in three
northern Honduran cities. Both sides are calling the government's reluctance
to intervene irresponsible. Standard wants access to more advantageous
exchange rates through establishment of an official parallel market and
elimination of banana export taxes. While opposed to the layoff, union leaders
fear that the government's failure to respond to the company's requests may
force Standard to close its Honduran operations, according to the US
Embassy. Although the government last year provided some relief on export
taxes, it has consistently resisted pressures from international lenders and
donors to liberalize exchange controls and effectively devalue the lempira.
Recent Embassy reporting indicates that the new government, scheduled to
take office on 27 January, also is committed to resisting devaluation.
Trinidadian Efforts Port-of-Spain's recent devaluation of the local dollar and proposed new
To Revamp Oil-Based investment code will help to revitalize the country's economy over the long
Economy term, but the devaluation is causing problems for its Caribbean trading
partners. Trinidad and Tobago has been attempting to diversify away from the
still-dominant petroleum sector-25 percent of GDP. An overvalued exchange
rate, high local wages, and restrictive government policies traditionally have
limited foreign investment in Trinidad's manufacturing sector, which currently
contributes only 7 percent of the country's GDP. The proposed investment
code would permit full foreign ownership of assets, eliminating the previous
joint venture requirements. Moreover, the 33-percent devaluation will help to
stem the heavy losses of foreign exchange reserves, which dropped 65 percent
to an estimated $500 million in 1985. Although the devaluation exempts
essential foodstuffs and a few other imports, inflation in this import-dependent
economy in 1986 probably will surpass the 7-percent rate in 1985. Moreover,
labor unions will probably win wage increases that would partially offset
improved international wage competitiveness caused by the devaluation. The
devaluation already is putting pressure on other Caribbean Community
(CARICOM) countries dependent on the Trinidadian export market. Difficul-
ties are most pronounced in Barbados, Port-of-Spain's largest CARICOM
trading partner, which is struggling to resist a similar devaluation.
Growing Pressure
on Nigeria's President
Discontent within the military threatens to divert President Babangida's
regime from following through on economic reforms required by the budget
for this year. Babangida has announced an austerity budget for 1986 that
includes periodic devaluation of the currency, divestiture of government-owned
businesses, and an immediate 80-percent cut in petroleum subsidies. He also
announced that debt payments would be limited to 30 percent of foreign
exchange earnings. This amount will cover only about one-half of this year's
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obligations, according to the US Embassy. Babangida's crackdown on the
armed forces last month may have preempted challenges to his rule, but it
highlights the widespread disaffection in the military. The austerity measures
and external factors probably will result in another year of economic
stagnation. Western bankers are likely to cut trade credits in reaction to the
debt-service limit, forcing Lagos to import on a cash basis. Declining oil
revenues probably will offset projected savings on debt servicing, which will
leave Nigeria without the means to finance economic growth or to ease the
painful effects of cuts in the budget and in subsidies.
Indonesian Declining oil revenues?and falling export prices for commodities?are com-
Unemployment plicating Jakarta's efforts to deal with severe urban unemployment, unofficial-
Worsening ly estimated in excess of 20 percent. According to US Embassy estimates,
Indonesia's economic downturn?along with technological changes taking
place in industries such as semiconductors?led to 75,000 to 100,000 layoffs in
1985, with further retrenchments expected this year. The Manpower Ministry
forecasts economic growth this year of 2 percent?far less than the estimated 5
percent needed to absorb the 2 million entering the work force. To complicate
matters, President Soeharto announced sharp new budget cuts last week, a
move that rules out fiscal policy as an economic stimulant. In lieu of a more la-
bor-intensive development strategy, we believe Jakarta's near-term options for
handling the growing unemployment problem are limited to continuing
technical training programs, labor export, transmigration, and reliance on the
informal sector to absorb excess capacity in the labor market. As a result,
unemployment and underemployment very likely will continue to grow.
Thailand Worried
About US Farm Bill
Sri Lankan Insurgents
Threaten Tea Exports
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The rice export promotion provisions of the US farm bill will very likely
heighten bilateral trade tensions, according to the US Embassy. Bangkok fears
that the new policy will enable US rice exporters to regain the market share
lost to Thailand in the early 1980s?and that cheaper US rice will drive down
world rice prices. Thailand already is feeling the pinch of softening world
demand for commodities. Its rice exports fell by over 11 percent in 1985 from
4.6 million metric tons in 1984, contributing to a 5-percent drop in total export
earnings last year. Another export setback will add to Prime Minister Prem's
political problems as exporters and farmers clamor for financial relief, and
Prem's political rival, General Arthit, uses the country's economic difficulties
as a pretext to continue maneuvering to replace Prem.
Tamil insurgents claim to have contaminated an undetermined quantity of Sri
Lankan tea exports with potassium cyanide, according to the US Embassy.
The government has alerted factory owners, buyers, and shippers but has so
far not taken any additional security measures. Damaging the tea-export and -
production centers?located in Sinhalese-dominated areas?would represent
the most serious economic attack by the Tamils so far. Even if the insurgents
fail to take such action, their threat may deter tea buyers. Tea exports account
for 25 percent of Sri Lanka's export earnings.
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Soviet Aid to Vietnam
To Increase
Soviet Interest
in Japanese
Machine Tools
Communist
A Soviet Foreign Ministry official says the USSR will double its aid to
Vietnam in the next five years. In July the Vietnamese press reported such an
overall increase. It had been left unspecified in the joint communique issued
during party Chairman Le Duan's visit to Moscow in June. In November the
Vietnamese reported that oil exploration assistance would be quadrupled. The
Soviets probably calculate that this will bring some tangible economic returns
as Vietnamese oil production comes on line. The aid promised in June was tied
to Vietnamese undertakings to increase production and export of raw materials
to the USSR, and a good part of it will apparently go to the oil sector. Soviet
Foreign Ministry officials also say the increase is meant to indicate that
improved Sino-Soviet ties will not affect military aid to Hanoi and that, while
a negotiated settlement on Cambodia is desirable, Vietnam can well afford to
continue the war if pushed too hard for concessions.
According to recent Tokyo press articles, the Soviets are interested in
purchasing large amounts?at least $200-250 million?of Japanese equipment
and technology for motor vehicle production. This includes pressing machines,
metal and plastic molding machines, and three-dimensional computer aided
design (CAD) equipment?the same as that recently purchased by General
Motors. This equipment is intended for the Tolyatti and Moslcvich car plants,
two other unnamed car plants, and the Kama River Truck Plant. The
equipment would be in addition to at least $725 million worth of Western
design and production technology ordered since early 1980 for the Soviet
industry. The high price offered for this technology indicates that the Soviets
will continue to modernize their automotive industry with vast quantities of
sophisticated Western equipment. The Japanese expect the Soviets to use the
CAD equipment to upgrade styling on autos intended for export markets. We
believe most of the equipment destined for car plants probably will be used to
produce new front-wheel-drive cars aimed at export markets.
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