(UNTITLED)

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP86T01017R000707510001-0
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 5
• Document Creation Date: January 12, 2017
• Document Release Date: March 3, 2011
• Sequence Number: 1
• Publication Date: December 2, 1986
• Content Type: MEMO

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South America: Mixed Outlook for the Southern Cone Economies
Summary
Publicity about the successes of Argentina's Austral Plan and Brazil's Cruzado
Program is obscuring emerging economic problems in each country. Both Buenos Aires
and Brasilia are promising to make adjustments to keep their economic programs on
track, but we are skeptical about the ultimate success of current policy initiatives. In
contrast, Chile's quiet commitment to free-market policies has enabled the country to
grow although its dicey political situation could cause economic setbacks in the future.
I
Argentina's Economic Regrouping
The bloom has faded from President Alfonsin's Austral Plan, which initially brought such
success in arresting Argentina's hyperinflationary spiral. Basking in the Plan's initial success,
Alfonsin failed to implement structural reforms--eliminate the deficit, spur private investment,
reform capital markets--necessary to lay the foundation for long-term, non-inflationary
growth As a result, the official inflation index rose at an annualized rate of
about 70 percent during the first half of 1986, heightening inflationary expectations. Instead
of spurring new capital formation, consumer spending increased, triggering a short-term
boom, especially for durables. The economy grew by 3 percent during the first half of 1986
compared to an equal drop during the same period in 1985, but new investment remained
stagnant. After recording a double-digit jump in inflation last August, Alfonsin was jolted
This memorandum was requested by Dr. Michael L. Mussa, Member of the Council of
Economic Advisors. It was prepared by the 25X1
South America Division, Office of Africa n Latin American Analysis. Comments and queries
regarding this memorandum my be directed to Chief, South America Division, 25X1
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Buenos Aires is now beginning a fresh attack on deeply embedded economic problems.
Last week Alfonsin announced plans to insulate state-owned enterprises from political
pressures that create operating inefficiencies, placing the firms within a semi-autonomous
holding company, headed by a senior executive from the private sector. He also pledged to
reorganize public-sector wage schedules and cut government employment through a
voluntary retirement program. Moreover, he recently replaced his populist Central Bank head,
who had resisted efforts to impose monetary discipline, with a technocrat committed to tight
These moves will facilitate Argentina's efforts to shore up its current account position,
i
h
_Wul way
t
the IMF for a $1.2 billion standby agreement and a $350 million compensatory fin
ancing w
facility to help cover a current account deficit caused by agricultural export losses.
Successful IMF negotiations will facilitate upcoming discussions with commercial bankers for
debt rescheduling and around $1.5 billion in new lending. Argentina will need the new money
to cover a projected current account deficit of $3.2 billion in 1987, up from about $2.8 billion
this year, caused in part by continued weakness in the international grain
market--highlighting its inability to diversify exports--and increased demand for imports. F
Notwithstanding Alfonsin's new-found commitment to revitalize the ec
ono
my, in our
judgment the opposition of major interest groups will work against implementation of the 25X1
sw
i
eep
ng, market-oriented reforms needed for long-term growth in Argentina. 25X1
Radical Civic Union party will continue to oppose - sect w 25X1
any large-scale pu
pu
blic-sector r w
rk
,
o
er
lay-offs, as well as efforts to reduce state control and regulation of the economy. Such
sentiment, in our opinion, will hinder moves to either reform the largest money-losing state
enterprises or sell them to the private sector. Additionally, nationalist fervor will hamper the
opening of the economy to foreign competition and increased participation of overseas
capital. 25X1
In the Argentine political context, we expect Alfonsin to more readily accommodate
these interest groups as the November 1987 gubernatorial and congressional elections near.
Based on recent experience, anti-inflationary, tight money policies will probably give way,
starting next spring, in an effort to lower real interest rates and increase public spending to
improve Radical party electoral prospects. Such policy backsliding would also cut against
efforts to reform the economy because it would refuel budget deficits and discourage
private-sector investment. Over the longer term, public support for Alfonsin's policies would
shrink making difficult the tasks of effectively managing the move of the capital from Buenos
Aires, overseeing trade integration with Brazil, and facilitating the diversification of the
Argentine agricultural economy to expand its industrial export base.
Brazil's Economic Outlook Turns Sour
Brasilia's nine-month old Cruzado Plan is unraveling in the face of highly expansionary
economic policies that have fueled a runaway economic boom and inflationary expectations.
Burgeoning consumer demand sparked by real wage hikes, reduced unemployment, and the
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rush to buy before the price freeze is lifted will result in the second consecutive year of
Brazilian economic growth in excess of 8 percent . Inflation--as measured
by the official price index--is down sharply to a monthly eve of about 1.5 percent since the
anti-inflation program was implemented, but disguised inflation, manifest by shortages of
consumer and producer goods alike, is on the rise. Although several critical industrial sectors
are operating at full capacity, the US Embassy reports that businessmen are increasingly
r
l
t
e
uc
ant to invest in sorely-needed plant expansion.
As Brasilia attempts to reduce shortages by increasing imports and diverting exports to
the internal market, its strong external payments position is eroding. We estimate that the
trade surplus probably will drop to about $10.5 billion in 1986--only $1.5 billion more than
interest payments--from $12.4 billion last year. With foreign investment at a 15-year low and
new borrowing at a near standstill, Brasilia is drawing down reserves rapidly to meet its debt
servicing obligations. Cash reserves probably will drop 50 percent this year to under $4
billion by yearend, according to our calculations.
The immense popularity of the price freeze is likely to continue to limit the Sarney
administration's ability to respond to growing economic distortions. For example, the recently
announced selective price hikes meant to reduce demand sparked violent demonstrations and
cost Sarney considerable public and political support. The extent of the disapproval probably
will thwart him from implementing further adjustments needed to dampen demand and spur
new investment necessary to alleviate supply bottlenecks. Consequently, we believe growth
almost certainly will slow next year, while inflationary pressures build and the payments
accounts continue to deteriorate. Because of the Brazilian public's hostility toward the IMF,
Sarney is unlikely to enter any agreement that involves a conventional Fund program. We
believe that Brasilia is still reluctant to implement the free market reforms--reducing budget
deficits, paring back state enterprises, opening the market to foreign competition--necessary
to lay the foundation for noninflationary, long-term growth. Instead, Brazil probably would try
to secure a new debt agreement that significantly reduces its payments, threatening a partial
int
erest moratorium in an effort to bully its creditors.
Chile's Free Market Approach
Despite Chile's publicized political problems, its commitment to free market economic
public investments in infrastructure--devasted by earthquake in 1985--andin export
promotion will likely spur Chile's economic growth by over 4 percent this year. Growth may
nudge real wages up and lead to a nearly 2 percent drop in unemployment with rural areas as
the chief beneficiaries. Meanwhile, careful budgeting by Chile's economic team could shear
almost 1 percentage point--to 1.7 percent of GDP in 1986--off the non-financial budget
deficit, thereby lessening inflationary pressures. Moreover, the economic team will also slow
inflation from last year's 26 percent by implementing a moderate money ex ansion policy and
b
l
i
y s
ow
ng the peso devaluation rate, according to Embassy reporting.
Despite stagnating world commodity prices, Chile's current account deficit will likely
decline this year. Chile's trade surplus could jump by a fourth to $1 billion with a 10 percent
rise in exports leading the gain, reflecting the success of its promotion policyF___1
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LAX"I
l Additionally, tougher import barriers, such as a price floor on wh
t
ea
and other
agricultural imports, will consolidate the gains in the trade account. Meanwhile, falling world
interest rates and strong incentives to convert debt-to-equity--more than $700 million in
debt will be converted to equity this year--will probably save Santiago $200 million in foreign
exchange. The unanticipated boon in its external accounts has helped Santiago add over $100
million to its gross reserves, pay off its Bank of International Settlement loan, and reduce
short-term dollar loan holdings of the Central Bank. 25X1
Chile's economic team believes it can achieve similar results in 1987 and 1988 by
maintaining its present monetary and fiscal policies and continuing efforts to obtain foreign
investment for its chief export industries--mining, forestry, fish, and fruit products.
Nevertheless, these hopes hinge on Chile's receiving development bank lending and
commercial bank funds needed to cover its chronic financing gap Chile's 25X1
creditor nations could again try to apply pressure for a political transition by threatening to
stall multilateral project loans necessary to support the country's structural adjustment. The
other major risk in the outlook involves President Pinochet's pressing his economic team for
more populist economic policies in hopes of assuaging political discontent and improving his
popularity. In this scenario, negotiations with commercial bankers for $65&ini$$icm in new
loans or debt service concessions for 1987-1988 could be brought to a standstill. In either
case, economic growth and Chile's commitment to free market principles would suffer. 25X1
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SUBJECT: South America: Mixed Outlook for the Southern Cone
Original - Requestor
1 - D/DCI-DDCI Executive Staff
1 - DDI
1 - O/DDI
1 - NIO/ECON
1 - NIO/LA
1- NIC/AG
1 - PDB Staff
1 - C/PES
1 - DDI/CPAS/ILS
1 - D/ALA
2 - ALA/PS
1 - ALA Research Director
5 - CPAS/IMC/CB
1 - C/ALA/SAD
1 - C/ALA/SAD/BR
1 - C/ALA/SAD/SC
ALA/SAD/BR~ I (2 Dec 86)
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