INTERNATIONAL ECONOMIC & ENERGY WEEKLY

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP88-00798R000400190005-5
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 42
• Document Creation Date: December 27, 2016
• Document Release Date: June 21, 2011
• Sequence Number: 5
• Publication Date: October 3, 1986
• Content Type: REPORT

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Secret-
Intelligence 25X1
Directorate of
Weekly
International
Economic & Energy
Seeret
DI IEEW 86-040
3 October 1986
839
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International
Economic & Energy Weekly 25X1
1 Perspective-The Impact of Sanctions on South Africa
Nicaragua: Food Shortage Crisis
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The Maghreb: Population Problems and Political Stability
17 Mexico/US: Bilateral Commercial Talks
directed to Directorate of Intelligence
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Secret
DI IEEW 86-040
3 October 1986
Energy
International Finance
International Trade
Global and Regional Developments
National Developments
Comments and queries regarding this publication are welcome. They may be
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International
Economic & Energy Weekly
Synopsis
Perspective-The Impact of Sanctions on South Africa
Pretoria is moving on several fronts to circumvent current restrictions and blunt
the effect of new measures by implementing a wide range of clandestine export
strategies. Although South Africa will probably evade most trade sanctions, over
the long term they will cause greater inflationary pressures, somewhat slower
technological development, and shortages of financial and physical capital needed
to exploit South Africa's resources and reduce unemployment.
3 Nicaragua: Food Shortage Crisis
Nicaraguan consumers are suffering the worst food shortages since the 1979
revolution. While Managua probably will seek even larger food donations from the
Soviet Bloc, pressures are likely to mount over the long term as the Sandinistas
continue to consolidate control over the economy and add to production disincen-
tives.
11 The Maghreb: Population Problems and Political Stability
The countries of Maghreb face serious social problems as the demand of a large,
rapidly growing population clash with the meager financial resources available to
meet basic human needs. These problems almost certainly will lead to major
political challenges in these countries over the next decade.
17 Mexico/US: Bilateral Commercial Talks
After a year-long hiatus, Mexican officials have agreed to return to the negotiat-
ing table this month on a bilateral commercial agreement with the United States.
Although Mexico has made some headway in removing major trade irritants with
the United States in the past year, a number of problem areas remain.
Ottawa has decided to move tax reform to the top of its domestic economic agenda
to boost tax revenue and to make sure Canada is not disadvantaged by the
imminent restructuring of the US tax system.
Secret
DI IEEW 86-040
3 October 1986
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Perspective
International
Economic & Energy Weekly
The Impact of Sanctions on South Africa
reduce unemployment.
The intensive action in the United States, Europe, and Japan on economic
sanctions is a major issue in South Africa as government and businesses
concentrate on means for coping. Pretoria is moving on several fronts to
circumvent current restrictions and blunt the effect of new measures by imple-
menting a wide range of clandestine export strategies. Although South Africa will
probably evade most trade sanctions, over the long term they will cause greater in-
flationary pressures, somewhat slower technological development, and shortages of
financial and physical capital needed to exploit South Africa's resources and
sanctions on some South African exports.
The intensification of sanctions comes at a time of economic vulnerability. South
Africa's economic growth has slowed since the peak rate of 8 percent in 1980. Real
GDP grew by an average of only about 1 percent a year since then and fell 1 per-
cent in 1985. Furthermore, growth in net fixed investment has declined for the
past five years and may be negative for 1986 as business confidence has been hit
by internal unrest, external pressures, and low export prices. Moreover, we expect
South Africa's current account surplus will decline in the short term as a result of
long run.
Restrictions on the flow of financial capital to South Africa will have little direct
short-term impact because domestic demand for capital is low. Private-sector
investment has not recovered, despite an easy money policy pursued by the Reserve
Bank-interest rates are less than half what they were 15 months ago, and
decidedly negative in real terms. The inflow of foreign direct investment is
practically nil, so that bans on additional foreign investment will have little
practical effect. Nonetheless, technological development would be hindered in the
evading sanctions.
Sanctions against South African textiles, agricultural products, iron and steel, and
uranium are likely to be more effective because alternative suppliers are readily
available. In order to circumvent these sanctions the government has created a
Secretariat for Unconventional Trade within the Department of Trade and
Industry. In addition to helping exporters evade sanctions, the secretariat will offer
financial incentives and direct cash grants to exporters affected by increased costs
resulting from sanctions. Nevertheless, South Africa will probably suffer a loss in
export earnings because of a reduction in the volume of sales and the cost of
Pretoria is also concerned that, over the long term, markets once lost will not be re-
covered even if sanctions are later removed. Because all of the proposed trade
sanctions would reduce competition in the world market from South African
Secret
DI IEEW 86-040
3 October 1986
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products, there is some cynicism about the motives of those proposing or imposing
sanctions. For example, Canada and Australia have been singled out for hiding
protectionism under the garb of sanctions.
Paradoxically, there is considerable speculation within the South African business
community that sanctions may provide needed stimulus to the economy. Sanctions,
it is reasoned, will provide protection behind which new import-substitution
industries will be able to develop, and traditional industries will have less concern
about foreign competition. Realistically, however, any such advantages will at best
be limited and short term. Government policies have fostered the development of
import-substituting industries for years, and further steps in this direction will be
costly because of the small size of the market.
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Nicaragua: Food Shortage
Crisis
Nicaraguan consumers are suffering the worst food
shortages since the 1979 revolution. Record food
donations from the Soviet Bloc have not offset the
impact of plummeting real wages, lower agricultural
production, corruption, and failed Sandinista distribu-
tion policies. To deflect responsibility for the crisis,
Managua blames outside forces, principally the insur-
gency and the US embargo. Growing food-related
unrest, however, indicates that citizens are tiring of
excuses. While Managua probably will seek even
larger donations from the Soviet Bloc, pressures are
likely to mount over the long term as the Sandinistas
continue to consolidate control over the economy and
add to production disincentives.
Production Continuing To Decline
The regime is trying to boost production by encourag-
ing farmers to increase their workday-which has
plummeted to an average of two hours, according to
the US Embassy-and offering cash incentives for
production above quotas. Nevertheless, this year's
basic grain harvest is likely to be the worst in three
years and may fall 20 percent short of the govern-
ment's goals, according to official Nicaraguan
statistics.
Government policies, in our opinion, are the principal
cause of falling food production. The Sandinistas
began to take direct control over the agricultural
sector just after the revolution, when all properties
belonging to former President Somoza and his asso-
ciates-nearly 15 percent of Nicaragua's farmland-
were confiscated and reorganized into state farms and
cooperatives. The Land Reform Act of 1981 and
subsequent revisions legalized the expropriation even
of efficient private farms, and we calculate that
Managua has now increased its holdings to at least 60
percent of all arable land. Moreover, press reports
indicate that private farms in need of inputs are
routinely denied access to credit and foreign ex-
change. Such disincentives have discouraged indepen-
dent growers from investing in their enterprises
Government pricing policies also have contributed to
the decline in production. Managua controls all farm
input costs and forces producers to sell crops and
livestock to the state at set prices. As a result,
according to the US Embassy, official prices often do
not cover costs, and many producers are driven out of
business. To avoid bankruptcy, ranchers often smug-
gle their cattle into Costa Rica and Honduras, where
prices are 10 times higher, according to press reports.
Manpower and material shortages, poor weather, and
government incompetence have added to the problem.
severe labor shortages due to
at Corinto.
military conscriptions and forced relocation. In addi-
tion, the scarcity of hard currency has resulted in a
critical lack of seed, fertilizers, and spare parts. The
northwest was hit with floods in May that ruined
large supplies of stored foodgrains and drowned hun-
dreds of cattle. This was followed by a three-month
drought that destroyed the corn crops of many inde-
pendent farmers. blunders by
Sandinista managers this year include irrigation of
the wrong fields, failure to order poultry feed-
thereby starving 200,000 chickens, roughly 10 percent
of the total-and allowing crops to rot in the fields
while imported harvesting equipment sat on the docks
Dismantling Free Market Distribution
We believe the state-dominated distribution system
has compounded the shortages. The Sandinista policy
of ever-tightening controls is diverting food from state
stores onto the black market, where most Nicara-
guans cannot afford to shop. Moreover, food remain-
ing under government control is spread unevenly,
creating areas of chronic shortages.
Centralized distribution has been a Sandinista strate-
gy since 1979, when government agencies were given
sole authority to import, export, and wholesale basic
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DI IEEW 86-040
3 October 1986
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Soaring inflation and relatively inflexible wages have
combined to ravage the average Nicaraguan's pur-
chasing power. Government subsidies and commodity
price controls kept inflation in the 30 percent range
during 1980-84, despite a surge in the money supply
and declining production
Eventually, however, budget pressures forced
Managua to begin boosting official food prices and to
rely more on the printing press to pay its bills. As a
result, food prices increased four times, fueling an
overall inflation rate of 334 percent in 1985, and we
the new plan began to appear almost immediately,
however, when more than 10 percent of the population
went uncounted and did not receive cards.
Regime supply priorities dictate that military person-
nel and other government employees receive food
first, then peasants and factory workers, and finally
service-sector employees and others. In addition, gov-
ernment supporters in rural areas and war zones have
priority over city dwellers. Most of the population is
now living near subsistence level, but there are grow-
ing disparities. Most soldiers eat well, while
many Miskito Indians in the northeast
and residents in Managua's slums are near starvation.
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believe it may reach 500 percent this year.
After a 40 percent salary hike in 1979, the Sandinis-
tas virtually froze wages until 1983, when a new scale
provided some pay increases for low-skilled workers.
We estimate that average real wages fell by half
between 1979 and 1984, and
a further decline of 20 percent during 1985 despite
three wage hikes. For the average Nicaraguan con-
sumer, consumption has been driven down to 1960
levels.
foodstuffs. Over time,
Managua has tightened distribution controls by
undercutting retail markets with subsidized state-
owned outlets, closely monitoring wholesale and retail
price ceilings, and setting up a new agency to control
produce wholesaling.
In 1982 Managua started a program to control distri-
bution at the household level by issuing ration cards
for seven basic food items-rice, beans, corn, cooking
oil, salt, sugar, and sorghum-and guaranteeing fu-
ture supplies at subsidized prices. A more stringent
Cuban-style ration system was established in 1983,
and neighborhood Sandinista officials were charged
with distributing the cards and ensuring that official
prices were honored. Unable to deliver on its promises
of adequate supplies, Managua last April instituted a
third rationing plan that reduced the "guaranteed"
food items to rice, salt, sugar, and cooking oil, and
gave administrative control to the Ministry of Internal
Commerce, according to the US Embassy. Cracks in
Government mismanagement and corruption also
have been evident. Press reports indicate 250 metric
tons of produce recently rotted due to negligent
storage, and 10 tons of high-quality beef spoiled in a
government warehouse in May because the refrigera-
tion was turned off. Moreover, many government
employees in charge of food distribution are corrupt.
The US Embassy reports a Sandinista warehouse
employee was recently arrested for selling $600,000
worth of goods on the black market, and several
government price inspectors were arrested in August
for selling confiscated goods to, and accepting kick-
backs from, black-market vendors.
Corruption has blunted the benefits of record Soviet
Bloc food donations. The USSR has responded to the
crisis by delivering its planned 1986 wheat donations
early and by doubling the planned rice donation with
an emergency 45-day supply last spring. Moreover,
East Germany agreed last week to send 30,000 tons of
corn to help relieve the crisis. According to the US
Embassy, port records show Managua has been ex-
porting rice to earn hard currency, and Internal
Commerce Minister Ramon Cabrales is reportedly
getting rich off the scheme. In addition, the Embassy
reported in August that donated wheat probably is
being sold and that $1.5 million in oats and other
cereals have been exported to Honduras since 1981.
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Shifting the Blame
We believe recent public discontent has spurred
Managua to redouble efforts to blame others for food
shortages. President Ortega said in June that the
environmental policies of former President Somoza
had caused low production, and other Sandinista
officials have publicly blamed the recent drought on
US meteorological warfare, according to press re-
ports. Moreover, the regime has publicly exposed
some low-level corruption
Sandinista excuses have not placated the population,
however, and reports of civil unrest have surfaced,
according to the US Embassy. In June, a peasant mob
reportedly attacked a state truck loaded with corn and
made off with its cargo. In two other cases, mobs took
corn and Soviet rice during raids on state farms and
the port of San Juan del Sur in late July. Moreover,
two government market inspectors were killed in
separate incidents earlier this year when they tried to
enforce Sandinista policies, according to the US
Embassy. A third was attacked by a crowd standing
at a bus stop when he tried to arrest a woman for
selling beans.
Bloc aid.
We believe the food shortage crisis will continue to
worsen for at least the remainder of this year. Major
food donors-including the USSR and France-al-
ready have completed their scheduled deliveries for
1986, and domestic winter harvests are not likely to
fill the gap. As a result, more food disturbances are
likely, and the Sandinistas probably will respond with
tighter internal security and more appeals for Soviet
For the longer term, ideological priorities require the
state to gain control over the private sector, even at
the expense of food production and distribution. As a
result, the Sandinistas are not likely to implement the
reforms needed to increase production and improve
the flow of goods. Moreover, increasing Soviet Bloc
aid will probably, at best, only keep consumption at
minimum levels.
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The Maghreb: Population Problems
and Political Stability
The countries of the Maghreb ' face serious social
problems as the demands of large, rapidly growing
populations clash with the meager financial resources
available to meet basic human needs. These problems
are as apparent in leftist Algeria as in moderate
Morocco and Tunisia. In each country rapid popula-
tion growth undermines governmental efforts to main-
tain social stability, equity, and living standards for
the population and limits further social and economic
development. Z These problems almost certainly will
lead to major political challenges in these countries
over the next decade.
The Demographic Millstone
Maghreb: Population Dynamics, Million persons
1970-2000 a
The Maghreb's explosive population growth, currently
2.8 percent annually, is expected to continue-the
UN projects only a slight decline to 2.4 percent by the
year 2000. High population growth over the last 30
years has been largely a result of a steady decline in
mortality with no comparable change in the birth
rate. As a result, about 1.5 million people were added
to the population in the past year alone. The projected
population will be about 84 million at the end of the
century, almost triple the level in the late 1950s. We
estimate that even with population growth held to
only 2 percent annually-an optimistic assumption-
projected population in the region would reach 71
million by the end of the next decade.
Fertility control programs are not expected to signifi-
cantly alter these trends, because it would take two
decades under the best of circumstances to stabilize
lower birth rates. Although the governments of the
Maghreb have all begun to recognize the need for
population control, only Tunisia has allocated more
covers Morocco, Algeria, and Tunisia but excludes Libya, because
its small population and relative wealth make it atypical in the
region.
' Demographic data and projections are based on a contract study.
Rural
Urban
than a small share of its health budget to family
planning programs. Moroccan and Algerian officials
have publicly stated that their national economies can
accommodate twice the current population, but they
privately admit that rapid population growth is one of
their most urgent problems.
The rapid surge in population combined with poor
economic performance since 1980 has aggravated
unemployment. Regional GDP growth of 3.6 percent
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DI /EEW 86-040
3 October 1986
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Maghreb: Demographic Statistics, 1985 and 2000 a
Population (million persons)
23.64
22.28
7.29
37.26
36.21
10.38
Annual population growth
rate (percent)
3.0
2.8
2.3
2.8
2.5
2.0
Urban population
(million persons)
10.38
14.11
Annual urbanization rate
(percent)
4.3
Urban population as a share of
total population (percent)
44
67
Life expectancy at birth (years)
59
60
Population under 20 years
of age (percent)
56
57
Unemployment and
underemployment (percent)
25
25
Demand for physicians c
(number of physicians)
2,130
3,986
Literacy rate (percent)
28
35
62
58
65
Per capita GDP (US $)
490
2,230
1,136
NA
NA
Average annual GDP growth,
1981-85 (percent)
2.5
4.3
3.9
NA
NA
a CIA data.
b Projected.
Holding the current population-to-physician ratio constant;
11,100 per physician in Morocco, 5,590 per physician in Algeria,
and 4,800 per physician in Tunisia.
over the past five years was only marginally ahead of
population growth and down by almost half from the
previous five-year period, according to the IMF. As a
result, unemployment and underemployment have
risen steadily to an estimated 25 percent of the labor
force, more than double the 1980 level. Morocco will
need to provide 320,000 jobs per year for new entrants
over the next 15 years; Algeria, 275,000; and Tunisia,
80,000. We estimate that to accommodate the swell-
ing number of entrants into the job market, regional
GDP would have to grow at an unrealistically high
average rate of over 9 percent annually. Such a high
level of growth would be needed because the increas-
ingly capital-intensive development strategies of these
countries will create fewer jobs for a given increase in
The Maghreb is experiencing a growing gulf between
food production and demand, with limited prospects
for closing the gap. Roughly self-sufficient in food at
independence, IMF estimates show that the region
now imports over one-half of its food, and agricultural
imports account for 20 percent of total imports.
According to Moroccan and Tunisian Government
statistics, agricultural productivity has increased at
barely half the rate of population growth for the last
20 years. Poor government management, low farm
prices, and inadequate agricultural extension services
share much of the blame. We estimate that the cost of
annual food imports will grow by at least 40 per-
cent-$1 billion-by the year 2000 if agricultural
productivity is not improved.
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Rising Urbanization
The rapid increase in population and the limited job
opportunities in rural areas, along with improved
education, have fueled an enormous increase in ur-
banization. Over 53 percent of the Maghreb's popula-
tion is already concentrated in urban areas. Over the
years, city residents have become a key constituency
for political leaders who have consequently invested
heavily in urban improvements. Urban food subsidies,
modern services, and the protection of urban wages,
however, encourage rural-to-urban migration, creat-
ing added pressure for further investments.
Rapid population growth has eroded the old land-
based, family-oriented, traditional Islamic society of
the Maghreb faster than governments in the area
have been able to promote development of economi-
cally advanced and urban-based societies. The popu-
lar unrest fueled by this circumstance has been
aggravated by the economic slump of the past several
years. In all three countries unmet rising expectations
among the burgeoning, youthful population are be-
coming a major source of discontent, according to US
Embassy reporting. Studies by the World Bank con-
clude that Morocco's educational system is not geared
to providing the skills needed for technical and indus-
trial jobs and contributes, instead, to urban unemploy-
ment-a condition we believe also prevails in Algeria
and Tunisia. Social scientists of the region also say
that young people are increasingly blaming their
governments for mismanagement of the economy and
are vigorously resisting cuts in education benefits and
other subsidies required under economic austerity.
The US Embassy in Rabat reports that crime in
urban slums is rising at an alarming rate as a result of
the growing number of unemployed youth.
Rapid population growth and the erosion of tradition-
al Islamic values contribute to the appeal of militant
fundamentalism in all three countries. Although fun-
damentalism and leftist agitation have been fed by
rapid population growth, they have not reached dan-
gerous proportions. There are clear signs, however,
that these movements pose a potential threat.
We believe that Maghreb leaders will face growing
difficulty mobilizing the financial resources needed to
tackle the social and economic problems resulting
from population growth. An inadequate fiscal base
will make it especially hard to revitalize food produc-
tion. Most farmers cannot afford needed investments
in agricultural technology and expertise, and govern-
ment budget deficits will continue to curtail subsidies
for new equipment. We believe, moreover, that lead-
ers will be reluctant to dismantle inefficient govern-
ment organizations that control food production,
prices, and distribution because they provide an im-
portant source of patronage and political control.
Leaders also recognize that eliminating urban subsi-
dies would produce unrest in the cities.
Water will remain a key constraint to infrastructure
development. According to social scientists, many
existing sources of water are already overused, lead-
ing to saltwater encroachment, pollution of aquifers,
and reduced supplies. Demand for water will probably
double by the year 2000 with limited options for
expanding supplies, according to the World Bank.
Improving the efficiency of current water resources-
through methods such as emphasizing drip irrigation
and water-efficient crops-will require a significant
improvement in education and changes in traditional
farming methods. Development of new water re-
sources will entail even greater expense and require
significant foreign expertise to achieve.
The Maghreb region's harsh environment is likely to
increase the impact of these shortcomings. Less than
10 percent of the land is under cultivation and much
of the remaining land is in semidesert zones that
receive barely sufficient rainfall even in good years. If
the population projection of 84 million in the Ma-
ghreb by the turn of the century is correct, regional
agricultural productivity would have to increase by an
average of 8.2 percent annually-6.3 percent in
Morocco, 11.2 percent in Algeria, and 7.1 percent in
Tunisia-to achieve a balance between cereal produc-
tion and demand. In addition, the pressure for govern-
ment policies favoring irrigated agriculture will inten-
sify competition between rural and urban areas.
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Maghreb: Cereal Production Million metric tons
Gap, 1981-2000 a
Production
8 ob
Jf O
O
I I I I I I
0 1981 82 83 84 85 95 2000
aClA data. The data for 1986-2000 are projections.
bAssumes 4-percent average annual growth.
cAssumes 1.3-percent average annual growth.
dNo growth.
Although the Maghreb governments are committed to
reducing population growth, their leaders will contin-
ue to worry that promoting population control aggres-
sively could offend the traditional values of many of
their citizens. The governments' concerns with mini-
mizing that potential source of political unrest are
likely to hinder their population control programs for
some years to come.
Regional leaders are already well aware that demo-
graphic problems do not yield to quick fixes and that
the payoff from expensive and socially sensitive pro-
grams to lower population growth rates will not be
apparent for a decade or more. They are also likely to
continue to believe that their most immediate and
Maghreb: Per Capita Index: 1974-76 average.100
Cereal Production,
1981-2000 a
I I I I I
0 1981 82 83 84 85 95 2000
'CIA data. The average annual growth in production for each country
during 1981-85 is maintained for the projection in 1986-2000.
overriding concern must be to ensure political stability
and their continuance in power. That concern is likely
to exert sustained pressure on them to divert attention
and scarce resources from treatment of the root cause
of their demographic crisis-rapid population
growth-to treatment of its more politically pressing
symptoms, such as unemployment and urban slums.
In the meantime, the demographic crisis and the
increased social and economic problems flowing from
it almost certainly will continue to grow and to fuel
Islamic fundamentalist and leftist unrest. Political
leaders who fail to accommodate or co-opt either
fundamentalist or leftist aspirations are likely to have
increasing difficulty governing. Those leaders who
lean too far toward either fundamentalism or leftist
radicalism, however, will probably stir up opposition
from the other quarter. We doubt that any Maghreb
leader can arrive at a fully satisfactory resolution of
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these challenges. Fundamentalism and leftist radical-
ism point ultimately in very different political direc-
tions, and the underlying conflict between them
means that politics in the Maghreb countries will
become increasingly turbulent.
I
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Mexico/US: Bilateral
Commercial Talks
After a year-long hiatus, Mexican officials have
agreed to return to the negotiating table this month on
a bilateral commercial agreement with the United
States. The pact will provide a framework for trade
and financial dealings, consultation and dispute settle-
ment procedures, and guidelines for investment. Al-
though Mexico has made some headway in removing
major trade irritants with the United States in the
past year, a number of problem areas remain. The
most difficult are patents and trademarks, restrictions
on foreign investment, local content requirements, and
export performance requirements.
two weeks as a warning and could shut plants perma-
nently if violations continued. In addition, the new
law makes it easier to prove that patent and trade-
mark rights have been infringed by permitting firms
to present the products as evidence in court.
the proposal may provide
only nominal protection because of several loopholes.
Compulsory licensing and injunctions are in fact very
difficult to obtain in Mexico. Moreover, ambiguous
wording may allow "pirate" firms to interpret the law
to their advantage.
Giving Ground on Intellectual Property Rights
the Mexi-
cans are willing to move forward with changes in
patent and trademark laws.
The government also presented
draft amendments on the inventions and trademarks
law to the Mexican Senate in mid-September. If
enacted, these amendments would go far beyond
President de la Madrid's 1985 decision to overturn a
regulation prohibiting US drug firms from using
brand names and forcing them to disclose trade
secrets.
In large measure, the revisions
are primarily aimed at protecting pharmaceuticals
and biotechnology, but they also will cover other
products, such as chemicals, previously excluded from
patent rights.
Under the proposed patent law, manufacturers will be
able to obtain compulsory licensing that will prevent
other firms from copying their products and to seek
injunctions against companies suspected of breaking
the law. The draft law proposes some tough sanc-
tions-the government could close down plants for
Dim Prospects for Changing Investment Laws
Mexican willingness to negotiate on intellectual prop-
erty rights is not likely to be matched by a similar
attitude on foreign investment.
while at least some govern-
ment officials believe relaxing foreign investment
restrictions is critical to revitalizing Mexico's econo-
my, the protectionist bent of key members of the
Cabinet-as well as of business and leftwing opposi-
tion-make significant changes in foreign investment
rules unlikely.
In our opinion, a wariness toward foreign investment
and a desire to prevent multinationals from driving
local firms out of the market are likely to remain the
underpinnings of Mexico's investment policy. Despite
some steps taken two years ago to chip away at
administrative delays and to lower barriers on foreign
investment in priority sectors, the government has
authorized only a handful of US investments with
more than a 50-percent US share. Mexico also has
recently allowed 100-percent Japanese ownership of
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Several laws put into place in the 1970sform the core
of an investment strategy that has discouraged for-
eign investment and obliged the government to meet
most of its financing needs by borrowing abroad. The
most important constraint is Mexico's 1973 law
limiting the share of foreign investors in company
holdings to 49 percent, except for assembly plants.
The law affects not only new investments, but also
plant expansions, relocations, and new products.
Regulations weakening intellectual property rights
are powerful disincentives to foreign multinationals.
Under Mexico's technology transfer law, foreign com-
panies can expect trade secrets to be kept for only 10
years and may charge no more than 6 percent of sales
for royalty payments. In return, they must provide
scholarships, high-quality technology, improved tech-
nial aid, projects that enhance Mexican R&D, and
projects that promote import substitution and ex-
ports. The 1976 inventions and trademarks law-
currently being revised-made it easier for Mexican
firms to copy foreign products. The law prevented
firms from patenting a number of products, set a
maximum of 10 years for patent rights, and gave the
government a free hand to transfer patent rights to
another company if a patent was not used during the
first three years.
several plants. Nevertheless, we believe these moves
are in line with previously announced policies to allow
majority foreign ownership only in a limited number
of sectors where the Mexicans seek foreign technol-
ogy, such as electronics and chemicals, and subject to
numerous constraints. At the same time, Mexico has
imposed higher local content and export performance
requirements that hinder foreign investors. The gov-
ernment shows no signs of permitting majority foreign
ownership in politically sensitive sectors, such as
banking, insurance, and brokerage, where Mexican
firms would have difficulty competing with multina-
tionals.
The Mexicans reportedly are drawing up explicit
regulations on foreign investment to eliminate some of
the vagaries discouraging multinationals from invest-
ing in Mexico. The categories of acceptable and
unacceptable foreign investments in electronics, for
instance, currently overlap. If Mexico follows
through, the regulations could at least clear up uncer-
tainties and contradictions in the government's policy.
Concessions Mexico May Seek
Mexico is almost certainly coming to the talks with
the hope of making inroads into the US market. The
collapse of oil prices has prompted Mexico to diversify
and increase nonpetroleum exports, particularly to the
United States, its most important trading partner.
Last year's subsidies agreement went part of the way
toward achieving this goal by obtaining a US commit-
ment to assess whether US firms are injured by
Mexican exports before applying countervailing du-
ties and antidumping margins. In exchange, the Mex-
icans promised to phase out export subsidies.
Mexico City has moved further to encourage trade
since the signing of the subsidies agreement. It has
eased import licensing restrictions, lowered tariffs,
and joined the GATT. These steps will markedly
increase US exporters' access to the Mexican market
and improve protection afforded to US manufactur-
ers. Mexican officials probably view these changes as
bargaining chips for extracting additional agreements
from the United States, such as promises not to
impose new tariffs or nontariff barriers; a rollback of
US countervailing duties on Mexican exports; and
easier access for such Mexican goods as textiles, auto
parts, steel, meat, tuna, and sugar. Mexico may also
want to recover some of the tariff concessions it lost
during the last US review of the Generalized System
of Preferences.
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Secret
Opposition to a wide-ranging bilateral agreement
within the Cabinet is likely to place limitations on any
agreement and may cause the Mexicans to drag their
feet on negotiations. Secretary of Commerce Hernan-
dez advocates a framework agreement, but he proba-
bly will have a harder time selling it than GATT
membership or the subsidies agreement if it appears
that Mexico stands to gain little.
e believe that the
Mexicans would be willing to agree to consultation
and dispute settlement procedures and to fold intellec-
tual property rights into an agreement, but, if they are
pressed on foreign investment, they are likely to balk.
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Secret
Canada: Tax Reform
Picks Up Momentum
Ottawa has decided to move tax reform to the top of
its domestic economic agenda to boost tax revenue
and to make sure Canada is not disadvantaged by the
imminent restructuring of the US tax system. The
Mulroney government's proposals-which continue
its policy of shifting the base of taxation toward
consumption-would enhance Ottawa's ability to con-
trol the budget deficit and result in a small improve-
ment in Canada's foreign payments position. Despite
such benefits and the potential popularity of lower
rates, tax reform has traditionally been a contentious
issue in Canada, and Ottawa may be hard pressed to
implement a comprehensive reform package.
An important goal for Ottawa's reform effort is to
reverse the erosion of the federal tax system's revenue
yield since the mid-1970s. Despite numerous hikes,
tax revenue as a share of GNP is now about 1.6
percentage points lower than in fiscal year 1975. The
decline has occurred in all three major sources of
federal tax revenue:
Previous Tory Reform Efforts
Since assuming power in 1984, Prime Minister Mul-
roney's government has tried to stimulate investment
by creating a pool of liquid capital to support entre-
preneurial activity-a Tory attempt to break the
traditionally risk-averse nature of Canadian economic
behavior. The measures include a $360,000 lifetime
exemption on capital gains and increases in the ceiling
on contributions to pension funds. These steps lowered
the effective tax rate on savings and investment,
thereby shifting the base of the personal income tax
system toward consumption.
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Changes in the personal income and sales tax have
included measures to broaden the tax base and raise
rates. The Registered Home Ownership and Savings
Program deduction was abolished, and a minimum
income tax was introduced in order to dispel notions
that high-income Canadians too often use loopholes to
escape paying taxes. Revenue from the personal tax
system has also been raised through temporary sur-
charges and the partial deindexation of income tax
brackets to cover only increases in inflation above 3
percent. The federal government has increased the
sales tax rate sharply-raising it three times in the 25X1
? The personal income tax, which accounted for 42
percent of budgetary revenue in 1984, has fallen
because tax brackets have been indexed for inflation
since 1974, the allocation of portions of the tax to
the provinces, and the growing number of tax
exemptions.
? The corporate income tax, which contributed 13
percent of budgetary revenue in 1984, has suffered
the largest decline-more than 1-percentage-point
drop as a share of the GNP-due in part to the slow
growth of corporate profits over the past decade. In
addition, tax credits and loss carryover provisions
have halved the effective tax rate.
? Sales and excise tax receipts, which brought in 20
percent of budgetary revenue in 1984, fell in real
terms in the last decade because Ottawa exempted a
number of goods and cut the tax rate by at least 3
percentage points for most goods.
past two years-and lifted exemptions on a number of
goods including soft drinks and health products.
The principal aim of corporate tax reform already
implemented has been to foster an environment in
which investment decisions are guided more by eco-
nomic incentives than by tax considerations. Ottawa
has sought to broaden the tax base by eliminating a
number of deductions while lowering the statutory
rate applied to corporate income. In last year's bud-
get, Ottawa announced the phaseout of the invest-
ment tax credit and eliminated inventory adjust-
ments-with projected gains to the government of
$775 million over the next two years. Tax rates will
also be reduced over a three-year period. Although
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Secret
the system is designed to be revenue neutral-effec-
tive tax rates will remain near 18 percent-it will
generate increased revenue until broader tax reform
and lower rates are fully in place. Temporary surtaxes
have also been levied on corporate income, primarily
on larger corporations.
A Change in Direction
Ottawa's intention to go beyond its piecemeal ap-
proach and completely overhaul the tax system was
sparked by the move toward lower marginal personal
tax rates in the United States. The US tax reform
initiative, which Canadian officials fear would draw
people and investment to the United States, forced the
Tories toward comprehensive action. Tax reform is
now expected to be the centerpiece of the Tories'
domestic economic agenda over the remaining years
of their mandate.
A New Sales Tax. According to Finance Minister
Wilson, the keystone of the Canadian reform effort
will be the introduction of a VAT-style tax called a
Business Transfer Tax (BTT). The BTT is a broadly
based tax-covering both goods and services-that
will enable the Tories to eliminate the current federal
sales tax, remove the tax surcharges, and lower
personal tax rates. Press reports indicate a hallmark
of the BTT will be its administrative simplicity, which
suggests it will resemble a consumption-style VAT
and further shift the tax base toward consumption
activities. The primary attraction of the BTT, howev-
er, is its broad base-which means that the BTT need
only be set at 4 percent in order to collect as much
revenue as the current 12-percent federal sales tax.
Ottawa, which is struggling to control the budget
deficit, thus could raise substantial revenue with only
small hikes in the tax rate-rather than resorting to
highly visible surcharges that invite heated attacks by
business lobbies and the opposition. Because of its
broader base and lower rates, the BTT would also
contribute to a more efficient resource allocation as
compared with the current sales tax that is frequently
criticized for being inefficient and inequitable.
Corporate Reform. The continuation of corporate tax
reform probably will be a secondary component of the
government's program. The most important tax provi-
sion targeted for change is a reduction in the speed
with which firms are permitted to write off capital
costs. Changing this provision would fit well with
Tory philosophy of lessening the role of tax consider-
ations in investment decisions. Other aspects of corpo-
rate reform being considered include reducing the
time lag between when income is reported on financial
statements and when it appears in the taxable income
base, and integrating the corporate and personal tax
systems in order to ensure that all investment income
is taxed equally.
While any proposals for fundamental tax changes will
be carefully examined by the media and opposition
parties, the BTT seems likely to draw the most fire.
The very characteristics that make the BTT an
effective fiscal tool also open it to a number of
criticisms. Because the tax would cover a broad base,
a number of service industries and small businesses
would be subject to a sales tax for the first time.
While small business lobbies have supported minor
extensions to the sales tax base, the scope of Ottawa's
plans is certain to be criticized as excessive. Opposi-
tion from small business could be especially damaging
because the Tories look to such groups as a mainstay
of support.
The BTT is also likely to be criticized as a tax that
will fall disproportionately on low-income Canadians.
As a result, Ottawa probably will introduce refund-
able tax credits for low-income Canadians and ex-
empt some goods. The Tories are also likely to argue
that past initiatives, such as the implementation of the
minimum tax, have reduced the regressive nature of
the Canadian tax system.
Ottawa's desire to eliminate a large number of per-
sonal and corporate exemptions may also produce
significant opposition. Attempts to reform the tax
system in the past-such as the 1966 Carter Commis-
sion recommendations and a Liberal attempt in the
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Motivation for Corporate Tax Reform
Concern about the instability of the corporate tax
base has been the driving force behind efforts to
reform the corporate tax system. The Department of
Finance study reports that 60 percent of corporations
in 1981-the last year for which figures were avail-
able-paid no corporate taxes, although one-half of
these firms registered a profit. The primary factor
behind this disparity was the huge buildup of unused
investment tax credits, capital cost allowances, and
loss carryover provisions. According to the report,
firms had "stockpiled" an additional $10 billion in
writeoffs to be used in subsequent years-a figure 75
percent higher than revenue generated by the corpo-
rate tax in 1981. These tax credits have been a
continual source of instability in tax receipts, height-
ening the uncertainty attached to government budget
estimates. They have also exacerbated the already
large disparity in effective tax rates on different
industries, and hence increased the inefficiency
spawned by the corporate tax system. Past govern-
ment efforts to plug these revenue leaks have contrib-
uted greatly to the complexity of the Canadian tax
system.
Ottawa also believes that the buildup of unused
credits has hampered its ability to influence invest-
ments via tax incentives. Department of Finance
studies suggest that, because only about 30 percent of
investment is done by firms that can reasonably
expect to use tax incentives immediately, both the
value of incentives and Ottawa's ability to use them
as a policy lever are correspondingly reduced.
1981 budget-were scrapped after running into fierce
opposition from domestic interest groups. The Mul-
roney government thus far has not demonstrated
much resolve in pushing controversial proposals, and
will have to exhibit much more determination if a
comprehensive reform package is to be in place by
early 1988. Unless demonstrable progress on tax
reform is made next year, the prospect of national
elections-due in 1989 but widely expected in 1988-
will be a powerful constraint on any controversial tax
proposals.
Implications for the Canadian Economy
and the United States
Despite likely domestic opposition, the Canadian
economy would almost certainly benefit from the
changes Ottawa is considering. In the first place, we
think Ottawa is correct in fearing some negative
impact on investment unless its tax laws are changed
in response to US tax reform. In addition, the BTT
would enable the government to better control its
budget deficit that, combined with a continued rhetor-
ical commitment to deficit reduction, should begin to
restore its badly bruised reputation for fiscal compe-
tence. Such renewed confidence about Ottawa's eco-
nomic management in the international financial
community would strengthen the Canadian dollar,
allowing a lowering of interest rates that would boost
investment. Lower rates and the elimination of a wide
array of discriminatory tax incentives would also
provide greater scope for market forces to operate.
range of goods and services.
The tax reforms being considered probably would
slightly improve Canada's trade balance, including its
surplus with the United States. Critics of the current
sales tax point out that it actually discriminates
against Canadian goods: because of the way the tax is
applied, domestic products on average are taxed at a
rate one-third higher than imports. Canada's trade
balance could also benefit from the partial substitu-
tion of the BTT for personal and corporate income
taxes, because GATT rules permit the rebate of
indirect taxes on exported goods. Any benefit on this
score, however, is likely to be small at least in the
short run, especially if Ottawa sticks to its current
plan of having a low-rate BTT that covers a wide
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Safety Concerns Work on Poland's first nuclear power plant was halted for several months this
Delay Polish summer, probably because of the Chernobyl' disaster. Following the Soviet
Nuclear Power Program mishap, some 3,000 Poles petitioned parliament to suspend nuclear power plant
construction, and Polish scientists warned that planned safety systems were
inadequate. A parliamentary commission, citing limits on domestic coal produc-
tion and imports of Soviet energy, reiterated the importance of nuclear power but
promised that safety was a priority. Earlier this month, the Council of Ministers
ordered a review of blueprints for the plant, and Polish nuclear officials announced
that fire-prevention equipment and monitoring devices would be upgraded.
According to a regional party newspaper, Polish nuclear experts rejected poor-
quality cement deliveries and have noted quality problems with Polish steel and
electrical cable. Warsaw probably will have to seek additional technical assis-
tance-possibly from East Germany or the West-to address safety concerns and
alleviate materials shortages. Despite the delays and mounting costs of the plant,
plans for a second plant are moving forward. Nonetheless, officials do not expect
nuclear power to contribute significantly to Poland's energy supply before the year
2000.
Papua New Guinea's The first significant oil discovery in Papua New Guinea has been announced by
Oil Discovery British Petroleum and two Australian oil firms working in the area. Total potential
production from the discovery well is estimated at 6,000 b d
The
find, however, is located in the island's isolated, rugged interior-currently
accessible only by helicopter-which will hamper exploitation. Nonetheless,
a fourth international partner in the exploration reportedly committed up to
$1 million in late August for site preparations in advance of commercial produc-
tion. In addition to site preparation, a 250-
kilometer pipeline will be built to one or more tidewater ports. Because no plans for
a refinery have been announced, the discovery will probably not reduce Papua
New Guinea's total dependence on imported oil, but Port Moresby is likely to
encourage development efforts as a means of boosting export income.
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Secret
Proposals for At next week's meeting, the OECD's Export Credit Group will focus primarily on
OECD Export Credit strengthening the guidelines on the use of tied aid credits. Most participants,
Group Meeting including the formerly reluctant EC, appear willing to increase the minimum
grant element from 25 to 35-40 percent to lessen the use of tied aid credits as trade
promotion devices. The main area of contention is the method of calculating the
grant element. The EC and the United States have proposed using a differential
discount rate (DDR) system to better reflect the actual cost of providing aid.
Japan, however, has linked acceptance of the DDR system with the elimination of
all remaining export credit subsidies-a move the EC opposes. Because the DDR
system will most adversely affect low interest rate countries such as Japan, the EC
probably would agree to upper and lower limits on the DDR system so as to
partially offset its disadvantages, and obtain Tokyo's support. During this meeting,
most participants hope to devise an outline for a DDR system that would be
completed in December.
Moroccan Progress The IMF has approved the framework for a new $275 million 18-month standby
on New IMF Accord for Morocco on the condition that Rabat gets $100 million in new concessional bi-
lateral aid commitments for 1987. The Fund wants Morocco to obtain 12- to 15-
year money at no more than 4-percent interest from a group of donors including
the United States, moderate Arabs, France, and other West Europeans. The
bilateral funds would allow Morocco to undertake capital investment projects and
ensure a reasonable rate of economic growth while Rabat proceeds with its IMF
adjustment program. The Fund also expects commercial banks to contribute
another $250 million in new money during 1986/87. If donors cooperate,
negotiations on the standby will be concluded in October and a letter of intent
signed. Bilateral lenders may be more willing with assurances from the Fund that
the new loans will lead to an IMF accord. International bankers, on the other
hand, are miffed over Rabat's lax payments practices and may not be nearly as
forthcoming.
Tunisia Wins The World Bank approved a much-needed $150 million agricultural-sector loan
Additional Aid for Tunisia last week and Italy agreed to provide Tunis $100 million in trade
credits. Italy's aid is in addition to the $300 million already committed through
1987. Both actions follow Tunis's signing earlier in September of a letter of intent
for an IMF standby that could net Tunisia another $250 million over the next 15
months. Until now, Tunisian pleas for aid have gone largely unheeded. These new
commitments, however, only cover about one-half of this year's expected $470
million financial gap. Buoyed by IMF and World Bank support, Tunis will
probably redouble efforts to garner more bilateral aid. Tunisia's traditional
benefactors-particularly France-have not been forthcoming, largely due to the
country's uncertain political future, and may still not be willing to offer new
assistance. Unless oil prices sharply rebound, Tunisia will face even greater
financial needs next year.
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Secret
Hungarian Hungary is raising a $100 million loan to help bridge a widening current account
Borrowing Surge deficit, according to a Western press report. Budapest has enjoyed good access to
international credit this year, and its foreign debt has risen from $11.8 billion at
the end of 1985 to $13.9 billion in June. Hungarian officials recently told the US
Embassy that Budapest plans to borrow $2.5 billion in 1987, mostly to roll over ex-
isting debt. The readiness of bankers to lend to Hungary despite the poor domestic
economic performance and continued deterioration of its external accounts this
year may reflect a lack of better lending opportunities elsewhere. Although
Hungary's foreign debt currently appears manageable and large reserves provide a
cushion, the steady rise in the debt will make Budapest increasingly vulnerable to a
change in the lending climate. Unless Hungary can move further with its economic
reforms and improve trade performance, Budapest is likely to have increasing
difficulty maintaining the confidence of the banks.
US Trading Partner Despite the sharp depreciation of the dollar this year, foreign trade surpluses with
Surpluses Still High the United States have increased for nearly every major US trading partner. For
Despite Dollar Drop some partners-notably West Germany, Japan, and Italy-bilateral surpluses
continue to grow in spite of declines in the value of the US dollar against their cur-
rencies ranging from 15 to 30 percent. Only France has registered a small decline.
At the same time, the surpluses of major partners such as Canada, South Korea,
and Singapore-whose currencies have changed little against the dollar-are
likely to increase, adding to the US trade imbalance.
West United France Italy Japan South Singapore Canada
Germany Kingdom Korea
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Secret
French Views on Philippe Jurgensen, the Director of External Economic Relations in the French
the GATT Meeting Trade Ministry, told the US Embassy that France is pleased with the results of the
Punta de Este meetings and believes that the negotiations provide a good basis for
the new trade round. Jurgenson stated that US flexibility was a very important el-
ement in the successful outcome and that the French Government looked forward
to continued bilateral discussions and cooperation. Paris was disappointed with the
failure to address Japan's rights and obligations, and intends to continue to
pressure the Japanese for more balanced trade. According to Jurgenson, France
plans to raise this issue as often as possible in the negotiations and to bring up
Japan's trade imbalance in other relevant forums including the OECD and the
Sherpa meetings preparing for the economic summit. Despite Jurgenson's opti-
mism, France will continue its hard line on agricultural trade.
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Global and Regional Developments
Soviet Grain Moscow has not purchased the remaining 3.8 million metric tons of wheat called
Agreements Unfulfilled for in the third year of its long-term agreement (LTA) with the United States,
which ended 30 September, and it probably will fail to fulfill similar agreements
with Argentina for coarse grains. The Soviets are required to make minimum
annual purchases of 4 million tons each of US wheat and corn. Despite the US of-
fer of subsidized wheat, Moscow has shunned US grain in favor of cheaper
Canadian and French wheat.
Soviet purchases of Argentine coarse
grain-currently estimated by trade sources at 0.7 million tons-fall far short of
the 4-million-ton minimum stipulated by the LTA. Shipping delays, problems with
quality, and lagging Argentine purchases of Soviet goods contributed to the slow
sales. Although Soviet purchases of Canadian grain reached 6 million tons-
exceeding the 5-million-ton average called for under Moscow's agreement with
Ottawa-the Soviets successfully demanded concessions on quality standards.
Moscow continues to prefer other sellers despite the US subsidy because of their
greater willingness to accept stringent Soviet quality demands. Meanwhile, ample
world stocks and new harvests continue to depress grain prices already at 12-year
lows, further reducing Soviet incentives to fulfill current agreements.
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Developed Countries
Canada's Dome Dome Petroleum officials are meeting with the company's lenders this week in
Petroleum Switzerland in an attempt to convince them to extend the 28 October deadline for
Maneuvering To Avoid rescheduling Dome's $4.4 billion debt and for making payments to unsecured
Liquidation creditors. The financial press reports, however, that at least one Swiss bank is
unwilling to postpone payments, a position that would force Dome into default. To
counter this threat, Dome is prepared to go to court and request protection under
Canada's Companies Creditors Arrangement Act-similar to US Chapter 11
bankruptcy. The Act would require Dome to file a reorganization plan and
separate its lenders into categories for purposes of repayment, but would prevent
the banks from forcing Dome to liquidate its assets. Dome almost certainly
believes this threat, along with its earlier claims that unsecured creditors will lose
all of their investment should it be forced into receivership, will convince the banks
to give it another four months to negotiate a rescheduling agreement.
Quebec May Reduce Confronted by a $2 billion budget deficit, Quebec's Liberal government is
Stock Market considering modifying the Quebec Stock Savings Plan (QSSP), which allows
Tax Incentives province residents to reduce their income taxes by investing in Quebec-based
companies. The seven-year-old program-created by the former Parti Quebecois
government-has raised over $3.5 billion in new capital for Quebec companies,
and is extremely popular with Quebec taxpayers, who face the highest provincial
income taxes in Canada. The deduction, however, has cost the province $436
million in lost tax revenues, and market analysts fear that QSSP stocks are often
overvalued because investors in search of tax writeoffs frequently pay little
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attention to the actual prospects of the firm. To boost revenue, Quebec is
considering lowering the maximum deduction, decreasing the share of investment
that may be written off, and eliminating all deductions for large-asset "blue chip"
stocks. Because public support for the program is so strong, however, the
government will have to move cautiously even on the limited reforms now
contemplated.
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British Current Britain's current account suffered a record $600 million deficit in August because
Account Deteriorates of rising imports and slumping exports. For the first eight months the current
account was roughly in balance, making London's forecast of a $5 billion surplus
for the year unattainable. Nonoil imports rose by 6.6 percent in volume terms and
by 0.7 percent in price, while export volume was down by 7.8 percent and export
prices up by 1.9 percent. Oil earnings also fell, reflecting the decline in oil prices
and Britain's position as a net oil exporter. Officials noted that the August trade
figures did not necessarily represent a trend and are expressing hope that a pickup
in world trade will improve the current account for the remainder of 1986. The
pound's depreciation since the beginning of the year should also help make British
goods more competitive. As long as British exporters continue to face high real
wage increases, however, any improvement in the trade picture due to a pound de-
preciation is likely to be transient.
Dutch The Hague's recently announced 1987 budget combines spending cuts and tax
Unveil Austerity increases to counteract the 50-percent fall in natural gas revenues. Although the
Budget for 1987 budget deficit will still rise from 6.1 to 7.1 percent as a share of GDP, without the
austerity measures it would have soared to 9.9 percent of GDP. To offset the
projected $5.4 billion revenue loss, the government will cut expenditures $2.3
billion-the first cut in total spending in 30 years-by reducing departmental
budgets, freezing public-sector wages, and delinking social security benefits from
private-sector wage hikes. The Hague also plans to increase revenue by $2.9 billion
by raising the VAT and energy excise taxes-the first tax increase in three
years-and selling state holdings. While the budget cuts will dampen economic
growth-forecast at 1.5 percent next year-continued low inflation and falling
unemployment should cushion the negative impact.
Belgian Collective Representatives of Belgium's trade unions, business federation, and small busi-
Bargaining Agreement nesses have reached a tentative national collective bargaining agreement, the first
such voluntary accord since 1975. Included in the deal is the first real wage
increase since 1981 when the government imposed wage and working hour
reductions and a requirement to increase hiring. The agreement, which still must
be approved by the governing boards of the three groups, gives preference to
raising lower wage levels and gradually increasing the monthly minimum wage. In
addition, it calls for labor and management to work for greater job creation. Some
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estimates claim the agreement will create 10,000 jobs, though critics charge the
government's austerity budget will more than offset this by leading to between
20,000 and 30,000 job losses. Brussels welcomed the accord because it avoids a
confrontation with private-sector unions at the same time the government is facing
opposition to its austerity measures from the public-sector employees.
Peruvian Economic Although Lima is still trying to maintain a dialogue with its creditors, President
Policy Becomes Garcia has not made any financial concessions since the IMF declared Peru
Increasingly Isolationist ineligible for new loans in August. Peruvian officials failed to offer commercial
bankers any payment on $600 million in interest arrearages during talks last
Friday, and Peru has fallen some $25 million in arrears with the Inter-American
Development Bank, leading to a halt in loan disbursements from that institution.
Consequently, the World Bank is the only major remaining source of medium-
term loans for Peru. With little new foreign investment and weakening exports,
President Garcia is trying to spur economic growth with consumer demand. This
past weekend, Garcia announced wage increases of 25 to 100 percent for Peruvian
workers, telling his audience he expected the increased spending power to support
6-percent GDP growth this year and next. Although his approach will produce
short-term economic growth, the failure to offer investment incentives will
eventually lead to strains on the limited industrial capacity, a rise in inflationary
pressures, and a sharp economic slowdown.
Paraguayan President Stroessner has implicitly acknowledged the gravity of Paraguay's
Economic economic crisis by announcing an ambitious stabilization plan last week. The
Reform Program reforms include investment and export incentives, tighter fiscal policies, and a
partial currency devaluation. The Embassy comments, however, that Asuncion has
yet to implement the program and that the devaluation does not apply to cotton
and soybean sales, which make up 80 percent of Paraguay's legal exports, or to
petroleum, the country's largest import. The program is intended to help the
credibility of Asuncion's economic management and to prompt the loan disburse-
ments that multilateral development banks have withheld since last year because
of Paraguay's overvalued currency. The partial devaluation, however, will spur
inflation and double the cost of debt service while the other provisions do nothing
to move Paraguay's underground economy-estimated at one-half of all economic
activity-into the open, taxable market. Stroessner's longstanding belief that
devaluations are politically destabilizing probably prevented a more sweeping
exchange rate reform.
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Kenya's Widening Kenya's record grain harvests and high fixed prices paid to farmers may yield
Budget Deficit some political benefit to President Moi but are driving the government's budget
deficit far above planned levels, according to US Embassy reporting. Kenyan
economic planners, reacting to the 1984 drought and donor advice, have regularly
raised agricultural producer prices so that farmers now receive a premium of about
43 percent above world market prices for both corn and wheat. These incentives,
combined with favorable weather and the government's timely supply of agricul-
tural inputs, produced a record grain harvest for the 1985/86 crop year and are ex-
pected to produce an even better harvest in 1986/87. The Embassy reports,
however, that continuing financial support to the government's grain-marketing
parastatal is the major factor behind a likely increase in the 1986/87 budget
deficit to 7 percent of GDP from the original target of 4 percent.
Effect of Lower A leading Soviet economist has delivered the most authoritative statement yet on
CEMA Oil Prices Moscow's plans to deal with declining CEMA oil prices-which are based on a
on Eastern Europe five-year moving average of world oil prices. Oleg Bogomolov, head of the Soviet
institute for research on CEMA, recently acknowledged that Moscow will find it
difficult to balance trade with its allies as the value of Soviet energy exports falls.
He said Moscow will have to look for new items to export. If world oil prices aver-
age $15 per barrel over the next few years, the value of Soviet energy exports to
Eastern Europe could drop by 22 billion rubles over the 1986-90 period.
Bogomolov's statement indicates the USSR is hoping to increase exports-
probably of manufactured goods-rather than accept lower imports from Eastern
Europe. Greater Soviet deliveries would reduce the cost to Eastern Europe of
contributing to Moscow's modernization program.
Increased East East European imports from the West increased substantially in the first half of
European Imports 1986, reversing the trend of the past five years when financial pressures limited
From the West imports. Imports were about 16 percent greater than in the first half of 1985.
Exports, on the other hand, increased by only 3 percent, and the midyear balance
of trade for the region fell from a $2.1 billion surplus in 1985 to about $154 mil-
lion. Nearly all countries have increased purchases of capital equipment and
industrial materials, but Poland's largest increase was in consumer goods. East
European planners apparently have shifted priorities from building up financial
reserves to addressing domestic economic needs. The regimes probably are using
lower debt service costs and generally better access to Western credit to finance
ambitious modernization programs. To improve economic performance and avoid
renewed debt problems, however, planners must do better at channeling Western
imports into competitive industries. Poland's imports of consumer goods casts
doubt on Warsaw's claims it will use new Western credits to concentrate on items
needed by its export industries.
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Hungary's Poor Trade The National Bank of Hungary devalued the forint last week by about 8 percent
Results Lead to against major Western currencies to help stem deterioration of Hungary's hard
Devaluation currency trade balance. This action follows a 3-percent devaluation in February,
which proved too small to improve the country's trade performance. The National
Bank initially resisted further devaluation for fear of fueling inflation, but a $375
million first-half trade deficit apparently convinced Budapest that the step was
necessary to maintain the confidence of international lenders. The IMF has urged
Budapest to adopt a more flexible exchange rate policy instead of relying mainly
on tax incentives and preferential credits to promote exports. The new devaluation,
coupled with the slower issuance of import licenses, may dampen imports, but it is
unlikely to stimulate exports very much. Until Hungary abolishes producer
subsidies and converts to a more market-oriented pricing system, exporters will be
largely shielded from the effects of exchange rate changes.
New East East Germany and the USSR this week began commercial operation of a new rail
German-Soviet ferry srvice between Mukran, East Germany, and Klaipeda, Lithuania. The new
Rail Ferry Link ferry service will help ease congestion in East European rail networks and speed
commercial deliveries. The 11,700 DWT ferries carry up to 103 rail cars. When all
six ships are in operation in 1989, the East Germans expect them to carry 5.3 mil-
lion metric tons of freight per year-compared with 8.5 mmt of total bilateral
seaborne trade estimated for 1985. The link will also reduce transport costs by up
to 80 percent The project will also lessen
vulnerability of supply lines to political instability in Poland-a particular concern
when the project was begun in 1982. It also will, to a limited extent, enhance the
Soviets' ability to deliver military materiel in peacetime and could be used to move
supplies and possibly units from the western USSR in wartime.
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China's Chinese imports of integrated circuits for the last two years have caused
Microelectronics domestically produced electronic components-generally higher priced and of
Industry Depressed lower quality-to pile up in inventory. Moreover, the import of duplicate
production lines has created excess capacity for some products. Because of sluggish
sales, credit restrictions, and a delay in the State's funding allocations for the
current five-year plan, many Chinese electronics factories are suffering from a
shortage of operating funds. With greater responsibility over their own profits and
losses as a result of economic reforms, some enterprises have been forced to stop
paying bonuses, close production lines, lay off workers, or sell surplus equipment.
At the national level, Beijing has begun to supervise imports of production lines
more closely, and also is considering a 100-percent tariff on imported integrated
circuits to protect the domestic industry. Sales of US and other Westen microelec-
tronics production equipment will probably be slowed because of Beijing's actions.
In addition, imports of some integrated circuits-primarily for consumer goods-
will probably drop sharply, cutting primarily into Japanese sales. But China
remains unable to produce sophisticated, high-quality components, and will
continue to rely on imports for many of the integrated circuits needed outside of
the consumer goods sector.
New Competitor Beijing will reopen its Bank of Communications this month in Shanghai.
for China's Banks Established in 1908, the Bank of Communications was prohibited from conducting
banking activities in China after 1949. Its Hong Kong branch, however, has
continued to operate and is now one of the largest PRC-held commercial banks in
Hong Kong. We believe Beijing intends competition from the Bank of Communi-
cations to force China's state-owned, specialized banks to operate more efficiently.
China's four specialized banks now operate exclusively in the agricultural, urban,
construction, and foreign exchange sectors. The new bank will compete with them
to provide comprehensive banking services to all these sectors, according to senior
Chinese banking officials. The bank's financial strength and experience in the
rough-and-tumble Hong Kong market will make it a tough competitor. It will
probably make its first move in the foreign sector, where the state-owned Bank of
China also faces competition from a new branch of China International Trust and
Investment Corporation.
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