INTERNATIONAL ECONOMIC & ENERGY WEEKLY

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• Publication Date: February 6, 1987

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International
Economic & Energy
Weekly (u)
6 February 1987
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DI IEEW 87-006
6 February 1987
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International
Economic & Energy Weekly (u)
6 February 1987
iii Synopsis
1 Perspective�OPEC: Following the Saudi Lead
3 Indonesia: Countdown to Rescheduling?
7 China: Reassessing the Role of Foreign Technology
11 Mexico's Parastatals: The High Price of Domestic Politic,
15 Jordan: A Gamble on West Bank Development
19 Briefs Energy
International Finance
International Trade
Global and Regional Developments
National Developments
Comments and
directed to
ueries re arding this publication are welcome. They may be
Directorate of Intelligence, telephone
Seat(
DI IEEW 87-006
6 February 1987
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International
Economic & Energy Weekly (u)
Synopsis
1 Perspective�OPEC: Following the Saudi Lead
Recent production cuts by OPEC, combined with public announcements of
support for higher prices from many non-OPEC producers, have buoyed price
expectations. Although considerable doubt remains whether OPEC can sustain
compliance with the accord over the next several months, we believe that Riyadh
will tolerate some moderate cheating and rally enough OPEC sup ort for the
agreement to keep prices above last year's $15 per barrel average
3 Indonesia: Countdown to Rescheduling?
We believe Indonesia will reschedule some of its $40 billion foreign debt in 1987
unless there is a sufficient increase in world oil prices. The timing of rescheduling
negotiations with commercial creditors probably will be dictated more by Jakarta's
schedule for parliamentay and presidential elections than by the deteriorating
state of the country's external finances.
7 China: Reassessing the Role of Foreign Technology
After several years of rapidly�and haphazardly�increasing its imports of
Western technology, Beijing is reassessing the role of foreign technology in China's
industrial modernization effort. Nonetheless, total expenditures on foreign tech-
nology will continue to rise and market opportunities for foreign suppliers remain
bright in some sectors.
11 Mexico's Parastatals: The High Price of Domestic Politics
Although pressure to divest the largely inefficient parastatals has mounted in the
last year with the dramatic decline in oil prices and the burgeoning of the federal
deficit, President de la Madrid has for the most part responded with only vague
promises to open the sector to private control.
15 Jordan: A Gamble on West Bank Developmen
King Hussein's first formal economic development program for the West Bank and
Gaza is intended to improve the quality of life, and, more important, to establish
Jordan�in place of the PLO�as the representative of Palestinians in the two
occupied territories. Without rapid and visible progress on the program, Jordan
risks losing its bid to become the Palestinian's major negotiator in the peace
process.
iii
--Secret�
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Economic & Energy Weekly (u)
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Perspective OPEC: Following the Saudi Lead
OPEC has reduced oil output substantially following its decision in December to
limit production and raise prices. These production cuts by OPEC, combined with
public announcements of support for higher prices from many non-OPEC
producers, have buoyed price expectations. The average world price for crude oil
has risen by $3 per barrel since December to about $18 per barrel
OPEC output has declined by about 2 million b/ o about (b)(3)
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million b/d since December, with the Saudis accounting for more than one-half of
the decline. Riyadh has canceled its netback contracts and switched entirely to a
fixed-price basis. Moreover, the former Aramco partners recently agreed to
purchase 1.25 million b/d at official Saudi oil prices through June,
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Other OPEC members are following the Saudi lead,
hey reportedly have phased out market-related pricing schemes and
are changing fixed prices. Most have also reduced output, although some
countries�Kuwait, the UAE, and Nigeria, for example�are apparently still
producing above their quotas
Nevertheless, considerable doubt remains whether OPEC can sustain compliance
with the accord over the next several months. Some customers are likely to search
for lower priced supplies before purchasing oil at higher, official prices. Although
OPEC members have been able to sell oil at these prices initially, many customers
have balked at signing longer term contracts. OPEC producers could come under
pressure to offer discounts when companies renew contracts amidst a seasonal
decline in oil demand. Also, continued overproduction by Kuwait and the UAE
and higher Iraqi output could prompt other members to begin producing above
quotas. Baghdad may be able to increase exports by as much as 850,000 b/d in
several months because of pipeline expansion projects in Turkey and Saudi Arabia.
Finally, over the course of the year non-Communist oil demand growth is expected
to be below last year's 2-percent increase, which could complicate the group's
efforts to sustain higher prices.
Saudi Arabia's production policies will be crucial to the accord. In our view, its
near-term strategy is to stabilize prices near $18 per barrel, a level Riyadh believes
will still ensure a longer term market for its oil. Last year, lower oil prices reversed
market trends and raised OECD dependence on Persian Gulf oil supplies from 16
percent of total consumption in 1985 to 20 percent
This price support strategy is risky, however, because continued budget deficits
may force a sharp drop in Riyadh's liquid reserves�now estimated at about $50
billion. For example, if Riyadh holds government expenditures at last year's level
1
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of about $40 billion, the Saudis would need to boost exports by an additional 2 mil-
lion b/d at prices of about $18 per barrel to balance the budget. But world demand
is unlikely to increase by this amount for at least two to three more years, and Ri-
yadh cannot be sure other producers would allow it to capture the bulk of this de-
mand.
Widespread cheating by other OPEC members or faltering oil demand could cause
the Saudis to abandon their current strategy and boost output to generate
increased revenues. It is more likely, however, that Riyadh will tolerate some
moderate cheating and rally enough OPEC support for the agreement to keep
prices above last year's $15 per barrel average. Under these conditions, prices,
while remaining volatile, would probably average in the $15 to $18 per barrel
range for the year. Stricter compliance or an escalation of the Iran-Iraq war could
push the average price above $18.
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Indonesia: Countdown to
Rescheduling?
We believe Indonesia will reschedule some of its $40
billion foreign debt in 1987 unless there is a sufficient
increase in world oil prices. The timing of reschedul-
ing negotiations with commercial creditors probably
will be dictated more by Jakarta's schedule for parlia-
mentary and presidential elections than by the deteri-
orating state of the country's external finances. In our
judgment, the Soeharto government will delay any
rescheduling request until after the parliamentary
elections are completed in April 1987. From the
regime's perspective, this would allow time for some
of the public's concern about the government's ability
to manage the economy to dissipate before it stage-
manages the election of President Soeharto to a new
five-year term in March 1988
Rescheduling Jitters
Anemic export revenues are making it difficult for
Indonesia to sustain economic growth, generate em-
ployment opportunities, and restrain its foreign debt,
which we estimate reached $40 billion by January
1987. Since 1981, the country's external accounts
have reeled following oil price declines amounting to
about $18 per barrel through the end of 1986. In
addition, prices for Indonesia's primary commodity
exports�rubber, tin, palm oil, and copper�have also
fallen. As a result of the drop in export revenues,
Jakarta recorded cumulative current account deficits
exceeding $20 billion in just five years�an estimated
$6 billion in 1986 alone.
The deficit last year was financed through a variety of
sources, including about $1 billion in commercial
credits, approximately $3 billion in foreign develop-
ment assistance, and the rest from drawdowns in
international reserves�which totaled about $10.5 bil-
lion last April�and new private borrowings. Accord-
ing to our estimates, if Indonesian oil prices average
$14 per barrel and the prices of other commodity
exports stay depressed, Indonesia could suffer a $4-5
billion current account deficit in 1987.
3
Assessing the Likelihood of Rescheduling
On the basis of a variety of techniques to evaluate a
country's repayment ability, we believe that, at cur-
rent low oil prices, debt rescheduling is only a matter
of time for the Soeharto government. One such
methodology is logit analysis, an econometric tech-
nique quantifying the likelihood that Indonesia will
seek multilateral debt relief rising from declines in
oil prices and export revenues. Judging from prior
rescheduling cases for 19 countries, including Indone-
sia, covering the period 1979-84, we believe that a
rescheduling probability above 40 percent warrants
serious concern. In Indonesia's case, the probability
reached this level in 1986, and is projected to reach
50 percent this year.
Liquidity analysis�which measures liquid assets
and access to commercial credit versus current pay-
ments�indicates Jakarta began to encounter liquid-
ity problems after oil prices peaked in 1981 at
roughly $35 per barrel. The problem worsened steadi-
ly as service payments on external debt rose faster
than Indonesia's cash and credit account. The prob-
lem started to become especially acute in 1986
following the sharp decline in world oil prices early
last year. Our analysis suggests that, unless Jakarta
can come up with quick and cheap sources of foreign
credit, or unless there is a sustained turnaround in oil
prices, the government could be forced to reschedule
its foreign debt before the end of 1987.
Many US commercial banks are already reluctant to
make additional financing available because of Indon-
esia's dire short-term economic prospects, despite the
recognition that Jakarta is publicly committed to
repaying its debt to foreign commercial banks. For its
part, the Soeharto government in recent months has
been making a concerted effort to ingratiate itself
with foreign bankers by repaying as many short-term
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Indonesia: Foreign Debt Situation, 1977-86a
Total Debt b
Billion US $
45
36
27
18
9
0
1977 78 79 80 81 82 83 84 85 86c
a Yearend data.
b Includes long- and short-term debt. Short-term debt includes
short-term trade financing and short-term borrowing by the
Note scale change
Debt Service
Billion US $
3.5
2.8
2.1
1.4
0.7
0
1977 78 79 80 81 82 83 84 85 86 c
central bank and commercial banks to finance
international reserves.
c Estimated.
loans as possible. this is to
enhance future borrowing power in international cred-
it markets. At the same time, some foreign bankers
are concerned that Jakarta is not moving vigorously
enough to avail itself of standby credits from the
IMF. According to US Embassy reporting, however,
it is very doubtful that the government could secure
$3 billion in standby credits that US banking sources
believe necessary to restore Indonesia's previously
excellent access to new commercial borrowings. The,
bankers believe that IMF standby loans, and the
economic policy adjustments they would entail, would
send a positive signal to the financial community and
help bolster Indonesia's sagging commercial credit
rating
If Jakarta Reschedules
As Indonesia's largest commercial creditors, with
about $7 billion outstanding, Japanese banks probably
would take the lead in a rescheduling and provide
S'ecret
311759 1.87
fairly reasonable terms if their recent financial deal-
ings with Jakarta are any guide. Through the end of
1986, Japanese banks had been willing to provide new
credits to Jakarta even though it was apparent that
Indonesia's economy was deteriorating. Even if these
banks were not inclined to treat Indonesia leniently in
rescheduling negotiations, we expect they would be
under pressure from Tokyo to do so. The Japanese
Government is sensitive to the long-term economic
importance of Indonesia as a vital and relatively
secure source of strategic resources�especially oil
and gas; last year, for example, Indonesia provided
about 15 percent of Japan's oil requirements. All told,
we believe, Tokyo would view a rescheduling exercise
as a unique opportunity to strengthen Japan's overall
economic relationship with Indonesia and perhaps
push Jakarta to make some economic policy changes.
4
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US commercial banks, with about $3 billion in loans
outstanding to Indonesia, would have to decide wheth-
er to go along with an accommodating Japanese
approach or, as in recent debt reschedulings with
other LDCs, be hard bargainers. For its part, we
believe that Jakarta, in exchange for favorable treat-
ment from US banks, might be willing to offer some
concessions in other areas of the bilateral economic
relationship, such as easing foreign investment regula-
tions and redtape.
Indicators To Watch
As Jakarta wrestles with its financial problems, there
are a number of indicators that, in our judgment,
could signal that a rescheduling is at hand:
� Substantial activity and deep discounts in the sec-
ondary market for Indonesian medium- and long-
ns.
last November an international banker re-
ported that such a market was growing. He noted
that most Indonesian loans are being swapped for 83
to 85 cents on the dollar, and estimates this could
drop to 70 to 75 cents per dollar early this year.
� Demands by bankers for a sharp decrease in loan
maturity and a sharp increase in interest spreads
above the London interbank offer rate (LIBOR) for
new loans.
several international bankers have indicated
that they would not increase their outstanding loans
to Indonesia on any terms.
� Imposition of the exchange controls that have been
rumored in Jakarta since the 31-percent devaluation
of the rupiah last September.
despite repeated goverlimenL announce-
ments to the contrary, Jakarta is considering anoth-
er devaluation soon along with exchange controls to
halt the drain on its international reserves.
� Increased capital flight, which would also compel
the government to impose foreign exchange con-
trols.
some bank depositors were shifting
their funds overseas for fear that Jakarta might
5
freeze bank deposits.
Chinese businessmen�some con-
nected with Soeharto and his family�are getting
their money out of the country before another
devaluation is announced.
� Significant drawdowns in international reserves and
commercial credit lines.
rumors are circulating within
the international financial community that draw-
downs of credit lines are "substantial."
The Political Dimension
The government's current economic difficulties coin-
cide with a particularly sensitive period for the Soe-
harto regime. Despite its public optimism, the govern-
ment is undoubtedly aware that oil prices could
remain depressed for at least several more years. We
believe the regime, therefore, must weigh the conse-
quences of doing nothing in the hope that oil prices
will firm soon, or move decisively to remedy the
present financial crisis. Among other things, a major
goal would be to restructure principal and interest
payments on official debt�which we estimate at
about 30 percent of government budget expendi-
tures�to avoid further budget cuts in economic and
social services. Whatever Jakarta's policy response, it
will be made with elections on the horizon. Parliamen-
tary elections this April will set the stage for the
presidential election in March 1988 and Soeharto has
already said that he intends to run for a fifth five-year
term. Because of the election timetable, we believe
Jakarta will probably move to reschedule some of its
foreign debt soon after the April elections. This will
allow time for some of the public's concern about the
deteriorating economic situation and the govern-
ment's ability to manage the economy to dissipate
before the presidential election, which Soeharto is
assured of winning.
Secret�
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China: Reassessing the Role of
Foreign Technology
After several years of rapidly�and haphazardly�
increasing its imports of Western technology, Beijing
is reassessing the role of foreign technology in China's
industrial modernization effort. Growing concerns
about the costs of foreign technology, its disappointing
impact in a number of economic sectors, and the
disruptions it has caused in some fledgling domestic
industries have led to tighter controls over the acquisi-
tion of foreign technology�both equipment and
know-how�as well as closer scrutiny of its use. These
changes will probably, over time, contribute to a
strengthening of Chinese industrial capabilities and
export competitiveness. Nonetheless, total expendi-
tures on foreign technology will continue to rise and
market opportunities for foreign suppliers remain
bright in some sectors.
Emerging Problems
Three main concerns have prompted Beijing's
reassessment:
� The decline of foreign exchange holdings. Dupli-
cate and unnecessary technology imports contribut-
ed to the dramatic drop in China's foreign exchange
holdings from $17 billion in December 1984 to
$10.3 billion in September 1986. Chinese traders,
for example, imported more than 100 color televi-
sion production lines and dozens of washing ma-
chine and refrigerator assembly lines. Many of these
deals committed China to massive expenditures of
foreign exchange well into the future for compo-
nents needed for assembly.
� Disappointing results from using imported equip-
ment. Widely publicized Chinese reports last year
indicated that only a fraction of the imported
equipment was being used effectively�even in pri-
ority areas such as computers, microelectronics, and
scientific instrumentation.
7
China: Technology Imports by Central
Authorities, 1981-86 a
Billion US $
0.6
0
1981
83
84
85
a Data reflect contracts signed, not actual shipments. Data on
technology purchases by provincial, municipal, or semi-
independent trade authorities are spotty.
b Projected, based on data for the first six months.
86b
311809 2.87
� The harm to Want industries. Many factories are
strapped because their products cannot compete
with lower priced, higher quality imported goods
while purchases of duplicate production lines have
created additional surplus production capacity. Chi-
nese press reports have also been critical of the fact
that many of the foreign-equipped production lines
have kept China dependent on imported compo-
nents.
New Initiatives
To correct these problems, Beijing aims not to curb
total expenditures on foreign technology, but rather to
reduce unnecessary purchases and find ways to in-
crease the benefits from the technology it must im-
port. Beijing still believes that foreign technology can
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provide a cost-effective shortcut to the country's
industrial and technological advancement. Beijing
also views foreign technology as vital to its export
competitiveness as well as its goal of eventually
substituting domestic products for imports.
Beijing, however, is seeking a middle ground between
the import legislation adopted by Brazil and India to
protect their infant electronics industries from foreign
competition and the liberal policies of Taiwan and
South Korea, which have nearly eliminated govern-
ment controls over technology acquisition in order to
speed industrial development and export growth. Beij-
ing has implemented a combination of direct adminis-
trative controls, economic levers, and worker and
manager incentives to control the purchase and im-
prove the use of foreign technology, and to encourage
greater use of domestic technologies. Beijing has, for
example:
� Centralized import decisionmaking, and charged
industrial ministries with checking domestic avail-
ability and ensuring that imports are not redundant.
� Issued regulations linking equipment purchases to
transfers of know-how, and offered preferential
treatment to foreign partners that help China pro-
duce for export.
� Encouraged trade corporations and factories to seek
the advice of technical consultants and to make use
of feasibility studies.
� Raised tariffs and cut domestic prices to shore up
sales of domestically produced goods.
� Sponsored technology exhibits and fairs to make
Chinese buyers aware of indigenous technologies
that could substitute for foreign ones.
More Bang for the Import Buck
We expect China's progress in rationalizing technol-
ogy import decision making and in improving technol-
ogy utilization to be gradual. Bureaucratic bound-
aries�both provincial and ministerial�will continue
to result in duplicate or unnecessary purchases. More-
over, basic infrastructural weaknesses�including
shortages of technical personnel, energy supplies, raw
materials, spare parts, and funds�will continue to
hinder technology absorption. Nonetheless, we believe
that China will, over time, substantially reduce the
ecret
Beijing Debates Technology Import Policies
In the aftermath of Hu Yaobang's dismissal, Chinese
reformers and conservatives will probably intensify
their debate over a wide range of issues related to
economic policy. China's "open door" to Western
technology could become one of the focal points for
challenges to recent reform policies.
Throughout 1986, even when reformers generally had
the upper hand, Chinese officials expressed a variety
of opinions on the relative merits and drawbacks of
foreign technology, as well as on the policies most
likely to yield maximum economic benefits from
technology introduction. The debate has centered on
several issues:
� To make or buy needed technologies.
� To centralize import decision making or to increase
the factory voice in the decisionmaking process.
� To regulate imports by administrative means or
through greater use of market mechanisms.
� To direct purchases toward mature sectors such as
textiles and machine building or to high-tech indus-
tries such as electronics.
� To purchase state-of-the-art or less advanced, but
more easily assimilated, items
We believe that a push this year by conservative
Chinese leaders would result in greater use of indige-
nously developed technologies and equipment, closer
central supervision and greater use of administrative
mechanisms to regulate technology imports, and
stronger emphasis on less sophisticated but possibly
more easily assimilated technologies for established
industries. Soviet technology would probably meet
the requirements of many Chinese conservatives. Re-
formers, however, will also try to promote their
policies, which include greater use of market mecha-
nisms to regulate technology import choices and to
encourage effective technology use, greater involve-
ment by factory-level decisionmakers, and emphasis
on imports of sophisticated Western technology for
high-tech industries.
8
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Sceret
incidence of duplicate imports and the purchase of
equipment China can supply domestically. Some suc-
cesses are already evident. Last year, for example,
China's Ministry of Machine-Building Industry can-
celed 88 im ort projects that did not meet the new
criteria.
We also believe Beijing will improve the match
between imported technology and the needs and capa-
bilities of users, gradually boosting the economic
payoffs to factories introducing foreign technology.
Import decisions made by central agencies such as the
State Economic Commission or the Ministry of For-
eign Economic Relations and Trade will begin to
reflect what these agencies have learned from surveys
undertaken in 1986 about why past import projects
succeeded or failed. Factories will make better use of
imported technology as they gain experience using
feasibility studies to guide both equipment selection
and related adjustments in factory conditions, re-
source supplies, and training. Managers will probably
become increasingly sensitive to the benefits of tech-
nology introduction�and the costs of poor technology
use�as a result of factory management reforms
adopted in recent years. Political uncertainties in
Beijing following Party Chairman Hu Yaobang's
ouster last month have put related changes in labor
and price policy on hold, and will limit the effective-
ness or delay the widespread implementation of mana-
gerial reforms.
We believe the sectors likely to benefit most from
improved use of foreign technology are textiles, food
processing, household appliances, consumer electron-
ics, packaging, metallurgy, printing, and plastics.
Because Beijing is aggressively promoting exports�
and has tied the use of foreign technology to the
promise of export earnings, rather than solely to
improved production for the domestic market�we
expect Chinese goods in these sectors to be increasing-
ly competitive in international markets. Foreign tech-
nology will help China improve quality control and
upgrade packaging, factors that have limited China's
penetration of many export markets.
Consequences for Technology Suppliers
Despite Beijing's attempts to cut back duplicate pur-
chases, many foreign technology suppliers will find
9
improved opportunities to sell to China during the
next five years. Overall spending on foreign technol-
ogy is slated to increase, accelerating in the latter
years of the 1986-90 Plan. The focal areas for tech-
nology imports will be the energy, transport, telecom-
munications, raw materials processing, textile, light
industry, machine-building, and electronics sectors.
We also expect China to make greater use of foreign
experts to conduct feasibility studies, consult on tech-
nology import needs, and provide managerial and
financial advice. We believe Chinese buyers will also
look for ways to acquire foreign technology without
making large outlays of foreign exchange�for exam-
ple, buying used equipment or the rights to dated
technology processes, or leasing equipment instead of
purchasing it outright.
Beijing's new policies will probably create additional
layers of bureaucracy, prolonging negotiations with
foreign suppliers. Foreign technology suppliers also
will face greater pressure to engage in cooperative
production projects, such as joint ventures and license
agreements. The ability of foreign firms to secure
government-backed concessional financing�already
a decisive factor�w11 become increasingly impor-
tant
Beijing will continue to find Western technology�
especially from Western Europe and the United
States�more desirable than that from the Soviet
Bloc, in our judgment:
� The market position of West European technology
suppliers will remain strong, but will probably de-
cline slightly from 1985 levels, which were most
likely skewed by a small number of large contracts
awarded to West German and French firms.
� We expect the US share of China's technology
imports at least to stabilize�and probably to in-
crease�over the next five years. US firms will
benefit from policies linking equipment purchases to
cooperative production, but will face keen competi-
tion from European firms, which often include
attractive financing with their bids to supply equip-
ment and production technology.
� Japan's share of China's technology purchases will
probably continue to erode, as China's central trade
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China: Sources of Technology Imports by
Central Authorities, 1983 and 1985 a
Percent
1983
Total=US $ 0.6 billion
Other 18.3
France
0.7
West Germany
9.5
United States
30.5
Japan
41.0
a Data reflect contracts signed, not actual
shipments.
1985
Total=US $ 3.0 billion
Other
20.6
France
10.8
West Germany
26.7
United States
Japan 23.3
18.6
corporations enforce Beijing's instructions to direct
imports away from Japan�a policy first formulated
in 1985 out of frustration with a ballooning bilateral
trade deficit and the relatively low level of Japanese
investment. Japanese sales figures will also begin to
reflect China's suspension of imports of consumer
goods production lines through 1990 and the effect
of the yen's appreciation.
Beijing considers Soviet technology generally to be
inferior, and�unless there are sharp shifts in the
direction of economic and foreign policy in Beijing
following Hu Yaobang's resignation�the Soviet
Union will remain a relatively minor source of the
foreign technology China seeks. China will receive
311810 2.87
Soviet equipment and assistance in at least two dozen
projects under a bilateral technical cooperation agree-
ment signed in July 1985, however. Most are in the
energy or heavy industry sectors; Beijing welcomes
Soviet assistance for the former because its technol-
ogy�particularly in coal and electric power�is rela-
tively advanced, and for the latter because it is a
sector that Western investors generally avoid. Most of
the joint projects under consideration involve renova-
tion of sites built with Soviet help in the 1950s.
10
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Mexico's Parastatals: The 1-pi�g11
Price of Domestic Politics
The Mexican Government uses its system of state-
owned enterprises, or parastatals, to great advantage
to create jobs, administer subsidies, exert leverage
over private business and organized labor, and keep
the political system functioning relatively smoothly.
These political benefits, however, come only at a
substantial economic cost: excessive spending, massive
debt, unnecessary inventory accumulation, reduced
international competitiveness, and higher inflation
spurred by the sector's generous labor contracts.
Although pressure to divest the largely inefficient
parastatals has mounted in the last year with the
dramatic decline in oil prices and the burgeoning of
the federal deficit, President de la Madrid has for the
most part responded with only vague promises to open
the sector to private control. the
onerous conditions attached to many sales, the domes-
tic liquidity crunch, and the poor state of most public-
sector firms' ledgers have choked off privatization
efforts and probably will continue to do so through the
end of de la Madrid's term in 1988. In addition, new
lenient foreign financing agreements have dulled
much of the fiscal incentive for reform. Any piece-
meal progress de la Madrid is able to make could
provide limited opportunities for US business in the
near term, but, at the same time, Mexico City is likely
to squeeze US banks for further concessions on
parastatal debt.
A Problem Sector
US Embassy reporting indicates that, without key
market forces, operational inefficiencies are rampant
in many parastatals, quality control often is lacking,
and modern management techniques are sometimes
ignored by supervisors and middle-level managers
who owe their positions to political factors rather than
business acumen. Among examples reflected in
Mpress reporting are the following:
11
Mexico's Controlled Parastatal Sector:
Operating Surpluses and Deficits,8
1981-86
Million US $
18
15
12
9
-3
Pemex b
Other
-6
1981 82 83 84 85 86c
a Those enterprises subject to congressionally
approved budget.
b The national oil company.
c Estimated.
manufacturer
�in trying to persuade Mexico City to allow a
100-percent control of a DINA plant as
overall effort to restructure the parastatal
and bring an end to heavy annual losses
the director has identified a history of
poor Mexican management as the company's major
problem, and believes that US management tech-
niques can help produce a profit.
311775 2-87
DINA, the state-owned truck
� Engineers at the electric power parastatal, CFE,
reportedly fear that the country faces brownouts or
blackouts unless various spare parts are received
soon. For example, many turbines already have been
shut down and "cannibalized" for spare parts to
keep other units running.
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inefficiency and over-
staffing in Mexico's steel sector allows the public
sector to produce only 70 tons per worker compared
with the 170 tons that workers produce in Mexico's
private steel firms.
� The state-owned sugar company, AZUCAR, has
announced that it has no plans to scale back its
operations or work force even though there is a
massive surplus of sugar in the country.
� Despite heavy subsidization, we have found that
government food stores, CONASUPO, sell their
goods at prices only slightly lower than their pri-
vate-sector competitors. In addition, press reports
indicate that CONASUPO store managers employ
high degrees of discretionary pricing with little
regard to market conditions.
� Generous labor agreements at AeroMexico and
Mexicana, Mexico's state-owned airlines, reportedly
were scaring off potential private-sector investors,
although there are rumors that Mexicana soon will
be sold. Meanwhile, Mexican pilots publicly blamed
poor maintenance for recent airline disasters.
Dim Prospects for Improvement
De la Madrid is now faced with a dilemma: financial-
ly, he finds it nearly impossible to allow the parastatal
sector to maintain its size; politically, he finds it
equally difficult to scale it back. In recent years, the
oil revenues and heavy foreign borrowing that masked
the losses incurred by most parastatals have been
harder to come by, and the subsequent strain on
government coffers has been intense. We believe the
President recognizes the need for a contraction of the
state-run system, but he lacks the political capital
required to take decisive steps in that direction. As a
result, he has largely backed off on his promises to
divest the sector and is now placing more emphasis on
making "priority" state-owned firms more efficient.
In his 1 September 1986 State of the Nation speech,
de la Madrid announced that his government would
take steps to prevent nonstrategic and lower priority
Mexico: Debt Profile, 1986
Total=US $ 97.5 billion
Percent
Nationalized banks
5.0
Private
sector
18.5
Parastatals
32.5
Federal
government
44.0
311776 2.87
enterprises from depleting the Mexican budget so that
the strategic and priority enterprises might be saved.
This formulation apparently was intended to indicate
that his government would continue to operate some
firms, but was willing to divest others. The list of
sacrosanct firms was divided into the following
categories:
� Those put under exclusive state jurisdiction by the
Constitution, including petrochemicals, electric util-
ities, railroads, the nuclear industry, post, telephone
and telegraph, and public banking.
� Essential social services such as social security,
public housing, and CONASUPO.
� Priority enterprises that, among others, include
steel, fertilizer, sugar, and shipbuilding.
The President also stated that 205 parastatals have
been transferred, liquidated, merged, or sold, and that
some 261 others are in the process of being divested.
According to de la Madrid, there now are about 700
parastatals, compared with 1,155 in 1982. The US
Embassy reports that it has been unable to confirm
12
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the numbers cited by the President, and points out
that the inclusion of the caveat "among others" in the
last category is a typical Mexican Government loop-
hole.
Last May's closing of the Fundidora Steel complex
was a bold gesture by de la Madrid, but we believe
that the political fallout from the move will hinder
further progress. Moreover, we are skeptical of recent
government announcements that the number of paras-
tatals has been reduced:
� In their announcements, Mexican officials refer to
the number of parastatals whose sale or liquidation
have been "authorized," rather than actual transac-
tions, which are far fewer.
� Although some firms have been eliminated, our
analysis of government data reveals that the sector's
total output and employment levels actually have
increased.
We conclude that the de la Madrid administration is
convinced the political benefits the parastatals gener-
ate make them worth their economic cost. Thus,
despite the President's relatively conservative market-
oriented economic philosophy and his promises to
Mexico's creditors to privatize the sector, his hands
are tied by a system that rests on the ruling party's
monopolistic control of economic resources. As the
economy deteriorates, de la Madrid now depends
more than ever on the state-run sector to buy him
time by delaying or softeijg the impact of austerity-
driven economic reforms.
Outlook
Between now and the end of his term in 1988, we
believe de la Madrid's administration will enjoy a
temporary respite from its immediate financial prob-
lems as a result of the lenient IMF agreement signed
in September 1986 and the $12 billion financial
bailout by the country's creditors. Rather than use
this break to begin economic reform, however, we
believe the Mexican leadership will direct most of the
money toward foreign interest payments and, with an
eye on national elections in 1988, domestic spending
that favors the ruling party's major constituencies. In
our view, the leverage for change does not exist:
domestic advocates of reform are without strength
and foreign creditors have lost the influence they once
13
The Fundidora Closing
The closing in May of the Fundidora Steel Company
in Monterrey, the country's third-largest city, result-
ed in significant political costs in addition to immedi-
ate financial losses. The company�one of the three
largest state-owned steel complexes that comprise the
SIDERMEX conglomerate�clearly was a financial
disaster. In 1985 alone, according to press reports,
Fundidora lost $48 million and increased its total
outstanding debt to $380 million. Workers responded
angrily with large-scale demonstrations to the clos-
ing, which eliminated some 10,000 jobs directly and
will affect another 60,000. Layoffs are costly to the
government: under Mexican law, severance pay covers
three months' salary and an additional 20 days'
salary for each year of service.
I--Fundidora employees would receive sufficient
severance pay to support their families for six to eight
months. Beyond that, their prospects look bleak.
Because of inefficiency and overcapacity, Mexican
steel is uncompetitive in international markets, while
the slowdown in economic activity has reduced do-
mestic demand for steel. Moreover, private business
in the area is in no position to absorb any of the newly
unemployed, according to US consular officials in
Monterrey.
For its part, Mexico City points to the decision to
close the steel plant as evidence that it is taking the
painful steps needed to reform the economy. We
believe there is some validity in drawing a parallel
between the closing of the plant and the decision in
1985 to allow IBM 100-percent ownership of a Mexi-
can subsidiary. In both cases, Mexico City acted
while intense negotiations with creditors were taking
place amidst increasing pressure to adopt economic
reform. Although financial realities were more press-
ing in the Fundidora decision than in the IBM case,
we believe that the timing of the decision was influ-
enced by the creditor negotiations. More important,
rather than signaling similar moves elsewhere, we
believe that the negative political fallout from the
closing dampened the administration's resolve to
eliminate other inefficient state firms.
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held by agreeing to new loans and new terms on old
debt without conditioning them on reform.
Implications of these domestic economic and political
strains for the United States over the near term will
be limited largely to adverse effects on US firms
doing business with Mexico's parastatals and to US
commercial creditors that have lent them money.
Payment delays and declining markets can be expect-
ed for US businessmen, but investors may find new
opportunities if Mexico puts some of the smaller, less
politically sensitive parastatals on the market. Mexico
City will be hard pressed to honor parastatal debt
obligations once the current financial rescue package
expires. US bankers will increasingly be pushed to
offer concessions and creative solutions for their par-
astatal loan exposures. Banks also are concerned
about the status of outstanding debt to a parastatal
that is sold. In most cases, creditors view foreign
governments as better risks than private firms and
fear that the new owners may shirk their responsibil-
ity to repay old debts
As oil prices remain depressed, Mexico's population
balloons, and rapid urbanization continues, the ruling
party will find it increasingly difficult to continue
satisfying its constituencies by relying on parastatals.
Over the long term, we believe these pressures will
force de la Madrid's successors to search for new
means to buffer the pain of austerity policies. A
number of alternatives may be pursued, but the most
likely scenario of a muddle-through approach carries
risks: given the mounting strains, the eventual trauma
associated with economic reform will be more pro-
nounced the longer the adjustment is postponed. The
Mexican reluctance to reform, in our view, will
accelerate the erosion of the economy and contribute
to broader problems that will spill across the US
border. For example, we expect illegal emigration to
increase, because we do not believe that the public
sector can absorb the increments in the labor force. In
addition, as long as the parastatal sector fails to
contract, US banks will face increasing pressure for
further loans or face payment suspensions
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--Seent_
Jordan: A Gamble on West Bank
Development
King Hussein's first formal economic development
program for the West Bank and Gaza is intended to
improve the quality of life, and, more important, to
establish Jordan�in place of the PLO�as the repre-
sentative of Palestinians in the two occupied territo-
ries. Severe cash shortages, PLO opposition, and
skepticism on both banks, however, challenge Jordan's
ability to implement the plan. Without rapid and
visible progress on the program, Jordan risks losing its
bid to become the Palestinians' major negotiator in
the peace process.
Hussein Bets on Development
Rather than engage in head-to-head political competi-
tion with the PLO, Hussein has opted for a long-term
strategy designed to capitalize on disarray within the
PLO and its problems providing economic and social
support to the Palestinians. Hussein hopes that by
providing economic and municipal development aid he
can reestablish a Jordanian political presence among
the Palestinians in the West Bank and Gaza. Ulti-
mately, he believes improving economic conditions is
the best way to win Palestinian acceptance of Jor-
dan�and not the PLO�as the representative in
negotiations with Israel, according to the US Embas-
sy.
The development program, which Jordanian planners
expect to have a price tag of about $1.3 billion
through 1990, focuses on social projects that will give
maximum benefit to the general populace. About
three-fourths of the planned investments are ear-
marked for education, social welfare, and construc-
tion, according to the US Embassy. Spending in these
areas is designed to improve the quality and skills of
the West Bank and Gaza work force and to stimulate
employment opportunities.
No Cash in Hand
The key obstacle to the development plan's success is
Jordan's inability to pay the bill. Worker remit-
15
Jordan: West Bank and Gaza
Development Plan, 1987-90
Cumulative total=US S 1.3 billion
Percent
Housing and
infrastructure
42.7
Industry
6.2
Agriculture
17.1
Social
development
2.8
Health
9.5
Education
21.7
311756 2.87
tances�Jordan's most important source of foreign
exchange�tourism, and merchandise exports contin-
ue to perform poorly, saddling Jordan with the prob-
lem of financing another foreign payments gap this
year. Foreign exchange reserves of about $360 mil-
lion�the equivalent of less than two months' imports
at current rates�are woefully inadequate to cover the
revenue shortfall. Despite holding expenditures at last
year's level, the 1987 budget calls for a deficit of at
least $188 million, according to the US Embassy.
Without foreign assistance, Jordan has no hope of
making the development plan work. As a result, senior
Jordanian officials are scrambling to obtain critically
needed financial aid, according to US Embassy re-
ports. Last September, Prime Minister Rifal traveled
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to West Germany, France, and the United Kingdom
seeking money for the plan, followed the next month
by a stop in Kuwait. Emphasizing the importance the
government places on the program, King Hussein
subsequently visited Middle Eastern and West Euro-
pean capitals to make a pitch for funds. Jordan's drive
to attract international financial support for the pro-
gram culminated in November at the Development
Conference held in Amman.
Donor response has been unenthusiastic. Although
participants at the Development Conference gave
guarded endorsement to the concept of Jordanian aid
to the West Bank and Gaza, nearly all countries
evaded financial commitments to Amman. The US
Embassy reports several EC members, particularly
France, Spain, and Greece, continue to believe that
funneling aid through Jordan would compromise their
neutrality on the legal status of the occupied territo-
ries. Some European countries probably are also
concerned about the possibility of Arab retaliation.
The EC Commission has, instead, elected to channel
part of its $3.1 million commitment directly to the
West Bank and Gaza�a decision that Amman vehe-
mently opposes. Only the United Kingdom has
pledged direct assistance�about $7.3 million through
1990�which London intends to disburse with mini-
mal fanfare to avoid political controversy that might
jeopardize implementation of its projects. West Ger-
many intends to follow the UK lead, but German
assistance is only at the planning stage.
A greater disappointment for Jordan has been the
tepid response from its traditional Arab benefactors.
Saudi Arabia, Qatar, and Oman�some of Jordan's
most important donors�sent only low-level represen-
tatives to the Development Conference and have not
committed additional funding beyond their scheduled
payments agreed to at the 1978 Baghdad summit.
Even the Baghdad grants are likely to decline this
year to about $450 million from the 1986 total of
$560 million. Saudi Arabia also still is insisting that
Jordan pay $195 million for Saudi oil deliveries in the
second half of 1985.
Views From the West Bank and the PLO
Yasir Arafat has denounced Jordan's development
plan, declaring it would lead to a de facto normaliza-
tion of relations between Amman and Tel Aviv,
according to Palestinian media reports. He has cau-
tioned Arab countries not to support the plan, con-
tending that such assistance would prolong the Israeli
occupation. Arafat instead has called for adherence to
the Baghdad summit resolutions, a clear signal for a
return to the PLO-Jordan Joint Committee as the
official conduit of development funds to the occupied
territories. For now, Arafat probably wants to avoid
risking a more direct confrontation with Jordan and
concentrate on reconciling with rival Palestinian fac-
tions in Syria and Lebanon
Most Palestinians apparently are willing to accept
Hussein's money, but even the staunchest supporters
of the plan are skeptical of long-term Jordanian
objectives and capabilities. Many Palestinians object
to Jordan's veiled strategy to supplant the PLO as the
legitimate representative of the Palestinians in the
occupied territories
Views From the East Bank and Israel
Israel, in principle, supports the development pro-
gram, including quality-of-life improvements for the
Palestinians. Tel Aviv much prefers an increase in
Hussein's moderate influence to the PLO's continued
sway in the occupied territories. Reflecting its com-
mon interests with Jordan, Israel has cracked down on
PLO militants, closed radical newspapers, and deport-
ed some activists, according to the press and US
Embassy reporting. Much to Jordan's irritation, how-
ever, Israel has attempted to link itself publicly to the
implementation of the development plan. Moreover,
Tel Aviv has insisted on a strong hand in vetting
proposed development projects and would veto any
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initiative that threatens Israeli economic and security
interests in the occupied territories.
Although most key officials in the Jordanian Govern-
ment support the plan, some East Bank political
conservatives argue that the country's scarce financial
resources should be used at home and are pressuring
Amman to abandon the plan. Moreover, they have
allies in the government who share their concerns
about the security implications of closer ties to the
occupied territories, according to the US Embassy.
An Uncertain Payoff
Jordan's chances are not good that it will be able to
keep the development plan on schedule or gain politi-
cal advantage in the territories at the PLO's expense.
Any failure to make rapid and coordinated progress
will make Jordan appear too weak to represent Pales-
tinian interests. So far, Amman has allocated only
about $25 million for the plan. These funds, however,
will help quiet criticism from many Palestinian lead-
ers on the West Bank who are complaining about the
lack of discernable progress, according to the US
Consulate in Jerusalem.
Foreign donors will continue to be tightfisted. The
Arab states will be most reluctant to provide assis-
tance to a perceived Jordanian-Israeli strategy to
circumvent the PLO. Riyadh told Hussein its own
cash problems preclude more aid to Jordan for now,
according to the US Embassy. Other Arab oil states
are echoing the same theme. As a result, we estimate
total Persian Gulf aid in 1987 will continue last year's
decline and fall to about $540 million from $600
million in 1986. EC members also probably will drag
their feet until they are certain they can avoid
negative political fallout.
The best we believe Jordan can expect is enough
money to start a few small projects that demonstrate
to the Palestinians the program is still a viable
solution to improve their standard of living. This
might give the Jordanians some breathing room to
line up additional funding, especially from the EC.
Jordan also is likely to launch an aggressive public
17
relations campaign, touting existing projects in an
effort to maintain Palestinian confidence in the pro- (b)(3)
gram. Still, Amman has promised much and faces an
uphill battle to maintain the momentum of the pro-
gram. New money probably will come too late to give
Jordan the opportunity to make much headway on
large projects this year.
Regardless of the financial outcome, Jordan cannot
discount the prospect that the PLO will take counter-
measures to undermine the plan if Arafat or local
supporters believe they are losing political ground.
The Embassy reports some evidence that pro-PLO
Palestinians are taking notice of the threat the Jorda-
nian strategy presents to Arafat and themselves. A
PLO counteraction almost certainly would include
increased violence and acts of intimidation against
any Palestinian participants in the development plan.
Jordan knows the constraints on US foreign aid this
year and, as a result, will look to the United States for
support principally on the diplomatic front. Amman
believes that a US lead could spur EC countries to
boost their assistance to the development effort. Jor-
dan also will look to the United States to continue to
intercede on its behalf with the Israelis and perhaps
the Saudis. If Hussein's plan is unsuccessful, Amman
may well lose the opportunity to create a Jordanian-
Palestinian negotiating team that eliminates the
PLO�and thereby forfeit the chance to remove a
major obstacle to the peace process.
Secret
(b)(3)
(b)(3)
(b)(3)
(b)(3)
(b)(3)
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�s
Briefs
Energy
Results of Saudi
Oil Minister's Trip
Iranian Attempts
To Protect
Refinery Operations
Saudi Oil Minister Nazir's recent visits to Egypt, the USSR, Norway, and the
United Kingdom as an OPEC emissary strengthened perceptions of solidarity
among oil producers and helped reestablish Saudi Arabia as the primary architect
of OPEC's oil policy. Nazir succeeded in gaining commitments for production cuts
from most countries he visited, but the cuts were minor and OPEC still must
hammer out policies to achieve stability in the international oil market. Non-
OPEC oil production, including cuts by Norway and Oman, will be pared by less
than 200,000 b/d. Even proposed cuts by Egypt, Mexico, and the USSR are
probably more the result of technical constraints, declining capacity, seasonal
fluctuations in consumption, or interest in scoring propaganda points. London
reiterated its longstanding policy of not cooperating with OPEC. Renewed
competition among oil producers�especially within OPEC�is still likely as oil
demand declines during the spring and summer. With little prospect for additional
non-OPEC cuts, growing pressure on government revenues will put OPEC's
solidarity to the test. The Saudis may have to make stronger overtures to non-
OPEC oil producers and put pressure on the other OPEC members�particularly
Iraq�to abide by the OPEC agreement.
Since April 1986, Iraqi air attacks have damaged all six of Iran's operating
petroleum refineries, substantially reducing the production of petroleum prod-
ucts�especially heating and motor fuels. Refining output for 1986 reached its
lowest level in September when total daily production dropped to 130,000 b/d, or
20 percent of capacity. By January 1987, however, much of the damage had been
repaired and imports needed to satisfy national demand were down to a near-
normal 200,000 b/d. The Iraqi attacks have apparently forced Tehran to construct
walls around some of the critical refining components such as the furnaces,
distillation towers, pump and control buildings, steam plants, and major pipeline
bundles. Walls have also been built around gas storage tanks, the bases of stacks
and flares, and around some administration buildings.
wall construction is continuing. Although the walls will
provide some protection for refinery workers and components such as pump and
control buildings, they offer little protection for other critical components such as
furnaces and distillation towers. Iran is also constructing crude oil storage tanks at
the Esfahan and Tabriz refineries that will increase storage capacity at the two re-
fineries to a 10-to-15-day supply in the event pipeline supplies were cut off.
However, given the high vulnerability of oil storage tanks to air attacks, Iraq could
probably easily negate Iran's effort.
19 _--Seeret---
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Secret
Vietnam Plans
Oil Exports
Ethiopian Oil
Discovery Reported
Secret
Officials from Japanese trading firms expect that later this year Vietnam will
begin exporting crude oil produced from its joint venture with the Soviets off the
southern Vietnamese coast, The
Japanese officials project initial exports of about 40,000 b/d, with increased
volumes expected if the world price of crude stabilizes between $16 and $18 per
barrel. They say the crude oil will be shipped to Singapore in exchange for refined
petroleum products from the Middle East. Vietnam is counting on these oil exports
to spearhead the recovery of its economy; it is deeply in debt, depends on the
USSR for economic and military aid, and is isolated from Western assistance
because of its occupation of Cambodia. Tests by Western oil firms in the 1970s in-
dicated that recoverable amounts of oil in the area might be only 20,000 to 40,000
b/d. Even at the higher estimate, the exports would only marginally benefit the
Vietnamese economy, although Hanoi's dependence on Soviet aid would be
reduced.
Soviet drilling teams in Ethiopia claim to have discovered the country's first
commercially exploitable oil deposit in the Ogaden.
the claimed potential of the field is 1.5 billion barrels of oil and petroleum
byproducts. The Soviets have been drilling in the area since 1983. Ethiopia is now
totally dependent on imports of Soviet oil, and a field of this size could eventually
make Addis Ababa self-sufficient. Moscow, however, may have exaggerated the
field's potential in order to please Ethiopian leader Mengistu, who has been
disappointed with Soviet oil exploration efforts. News of the find almost certainly
will heighten tension with neighboring Somalia, which has long claimed the
Ogaden and still supports sporadic guerrilla operations there.
20
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Secret
International Finance
Japanese Banks
Accept New
Debt Proposal
Philippine Request
for New Financing
Facility Rejected
Japanese banks have agreed in principle to a
Finance Ministry proposal that would have far-ranging implications for Japan's
relations with troubled LDC debtors. Under the proposal, the Japan Center for
International Finance (JCIF)�now a private clearinghouse for up-to-the-minute
country risk information�would purchase new LDC loans from Japanese banks at
a discount. The banks, in turn, could claim the discount as a tax loss while still
earning interest on the loans. Moreover, the banks would receive a taxable
dividend from the JCIF if the LDC repays the principal. In addition to the near-
term tax benefits, individual banks are apparently attracted to the proposal
because it spreads risks of LDC loans among financial institutions. It also transfers
some risk to the government because both Tokyo and the banks will provide capital
to the JCIF, although the amounts have yet to be decided. For its part, the Finance
Ministry hopes the proposal will spur lending to high-risk LDCs as well as give To-
kyo more leverage over such lending, including deciding which countries will be
permitted to receive the discounted loans.
The Consultative Group of key bilateral and multilateral aid donors refused in late
January to endorse a $7 billion "growth facility" requested by the Philippines to
finance economic recovery. It did agree to provide $1.5 billion in new economic as-
sistance this year�$500 million less than Manila sought. Manila probably will
continue to seek support for the facility, arguing that it is necessary to meet
development goals. Under the proposal, Manila's major aid donors and commer-
cial banks would provide matching funds. Although the aid donors are receptive to
the concept of shared funding, they contend that private banks would only lend to
the Philippines once political and economic conditions stabilized. Philippine
officials, however, claim that commercial banks would consider the facility if the
Consultative Group gave its approval first.
Mexico's Mexico City and IMF officials seem likely to settle on a first-quarter target
First-Quarter growth rate that will enable the Mexicans to draw on a $500 million contingency
IMF Target fund. According to the terms of Mexico's agreements with the Fund and
international bankers, commercial banks will disburse the contingency fund if an
index of manufacturing production grows more slowly during the first quarter of
1987 than a target negotiated with the IMF.
If the contingency fund is released, as
is likely, the de la Madrid administration is constrained to allocating the money to
public-sector investment projects identified by the World Bank.
21 Seeret
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Ecuador's New
Debt Problems
Sudan and the IMF
Kuwait's New
Investment Policy
Threat to Zambian
IMF Program
elle
Ecuador may be headed for a confrontation with its major creditors over terms for
rescheduling its debt and growing international concern about its uncertain
political future. The Central Bank claims Quito cannot pay $30 million in interest
due this month to foreign banks. President Febres-
Cordero may default rather than exhaust his country's foreign exchange reserves,
according to sources of the US Embassy.
Under Febres-
Corder�, Ecuador has been one of the most financially responsible nations in
honoring its foreign debt obligations. Quito appears to be dragging its feet on its
monthly interest payments now, however, to obtain better terms in negotiations for
a rescheduling package of $300 million. Ecuador's current cash reserves�
estimated to be $144 million�are probably sufficient to cover Quito's interest
payment this month, but future payments may be in jeopardy.
Sudan has made a token payment of $6.7 million on its arrearages to the IMF,
seeking to improve relations before its annual Article IV consultations in
February. The payment will enable Sudan to participate in new SDR allotments,
but is not sufficient to reinstate Sudan's eligibility to borrow from the general
fund�Sudan is still approximately $585 million in arrears. The Sudanese Finance
Minister may be building false hopes within the Cabinet and the public that
wrinkles between the IMF and Sudan are being ironed out. The IMF claims no de-
cisions are planned for the coming meeting and no change in the Fund's relations
with Sudan is likely.
The Kuwait Investment Company is selling off some of its dollar-denominated
securities because of concern about the US budget deficit, depreciation of the
dollar, fear of renewed inflation, and uncertainty about US tax legislation.
Kuwait, however, probably will continue to keep
much of its estimated $50 billion in foreign securities investment in US dollars�at
least 35 percent�because of the security and size of US financial markets while it
continues to diversify its investments in the West as well as in the Third World and
Communist Bloc. Because the Kuwait Investment Company has a reputation
among the Persian Gulf states for prudence, its move away from the dollar�if dis-
covered by other Gulf investors, especially Saudi Arabia�might cause them to
alter the composition of their own foreign investment portfolios.
President Kaunda announced last week that he will end Zambia's year-old system
of determining foreign exchange rates through a weekly auction�the centerpiece
of an ambitious IMF-supported economic reform program that also included
significant relaxation of price controls and improved producer incentives. What
system will replace the auction is still uncertain, but according to Embassy and
press reporting, the exchange rate apparently will be fixed at 11 cents per kwacha,
a significant appreciation from last week's auction rate of 7 cents. According to
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--Secrat__
Embassy reporting, the decision to change the exchange rate system was made by
a limited circle of senior advisers without consultations with the IMF and World
Bank. Riots in December triggered by IMF-recommended increases in food prices
probably heavily influenced Kuanda's decision. The departure from using a
market-based system to determine the exchange rate will clearly jeopardize
external financing. Disbursement of about $200 million under an existing IMF
standby agreement already is threatened by the country's inability to pay arrears
before the end of February, when new payments become due. Kaunda's new Prime
Minister, who has additionally assumed the finance portfolio, will seek to schedule
another consultative group meeting later in the year, convene a Paris Club
meeting, and pursue negotiations with bilateral donors.
Eastern Europe's Eastern Europe's syndicated loans from Western banks dropped to $1 billion last
Foreign Borrowing Down year from $3.3 billion in 1985 despite favorable conditions, but borrowing by
creditworthy countries in the area probably will revive this year. Bulgaria,
Czechoslovakia, East Germany, and Hungary�the region's creditworthy coun-
tries�sought fewer syndicated loans in 1986, in some cases because they had
borrowed heavily two years ago to restructure debts. In addition, they resorted
increasingly to less publicized and less costly bank-to-bank loans. Cash-rich
Japanese banks became the dominant lenders, partly because they offered more
attractive rates than US and West European banks. Eastern Europe's troubled
debtors�Poland, Yugoslavia, and Romania�remained out of the syndicated loan
market in 1986. Many banks, pessimistic about receiving payment on existing
loans, are hesitant to offer them new money. Borrowing by East European
countries probably will increase this year, although not to 1985 levels, because of
reduced hard currency earnings and continuing debt obligations. Banks may raise
rates or limit additional exposure if borrowers' creditworthiness deteriorates or if
East-West tensions rise.
Hungarian Financial
Problems
Hungary's hard currency current account deficit in 1986 reached $1.5 billion, and
GDP stagnated, according to a source of the US Embassy. The source implied
Budapest will seek assistance from the IMF if the financial situation does not
improve. Hungary probably will avoid a liquidity crisis in the short term because it
has encountered only mild resistance to its recent borrowing efforts and its foreign
exchange reserves remain substantial. Budapest is likely to come under increasing
pressure to seek IMF assistance this year, however, to convince Western bankers it
is acting to resolve its economic troubles. The IMF has been dissatisfied with the
slow pace of Hungary's reform efforts and probably will demand tougher
adjustment policies and broader reforms. Negotiations could prove difficult
because the regime fears greater austerity would lead to domestic unrest
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eeret
International Trade
Key LDC Debtors'
Poor Trade
Performance in 1986
Most key debtors recorded substantial export declines in 1986. Oil exporters' were
hard hit by the sharp drop in oil prices. Lower commodity prices and reduced grain
sales cost Argentina nearly $2 billion in export earnings while high domestic
demand in Brazil reduced the quantity of goods available for export, lowering
export earnings by more than $3 billion. The Philippines-the one exception-
benefited from a modest rebound in prices for traditional exports such as coconut
products. For the debtors as a group, import cutbacks in 1986 did not match
export declines. As a result, the cumulative trade surplus was cut nearly in half,
aggravating financial woes and further delaying sustained economic recovery. In
fact, Argentine efforts to boost real GNP growth led to an import surge. Mexico
and Nigeria slashed imports in response to lower oil exports, and Brazil was forced
to cut imports in order to limit reductions in its trade surplus.
Key LDC Debtors: Exports and
Imports, 1985-86 a
Billion US $
(except where noted)
Exports
Imports
Balance
1985
1986
Change 1985
(percent)
1986
Change 1985
(percent)
1986
Net Change
Total
90.4
67.6
-25
53.0
47.8
-10
37.4
19.8
-17.6
Argentina
8.4
6.9
-18
3.8
4.6
21
4.6
2.3
-2.3
Brazil
25.6
22.4
-12
13.2
12.9
-2
12.4
9.5
-2.9
Ecuador
2.9
2.1
-28
1.6
1.7
6
1.3
0.4
-0.9
Mexico
21.9
15.8
-28
13.5
11.4
-16
8.4
4.4
-4.0
Nigeria
12.8
6.5
-49
8.5
5.5
-35
4.3
1.0
-3.3
Philippines
4.6
4.7
2
5.1
4.7
-8
-0.5
0
0.5
Venezuela
14.2
9.2
-35
7.3
7.0
-4
6.9
2.2
-4.7
a 1986 figures are estimated.
Secret 24
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---Sectet,
Global and Regional Developments
Airbus Competition
With US Aircraft
Kuwaiti-Soviet
Petroleum Cooperation
The West European aircraft consortium Airbus Industrie is trying to win over the
airlines that were the first customers for the new McDonnell Douglas MD-11
long-range wide-body aircraft. According to the US Embassy in Stockholm,
Airbus Industrie has offered a 25-percent discount on its new A340 long-range
aircraft to entice Scandinavian Airlines to switch its order. The US Embassies in
Rome and Bangkok report similar offers to Alitalia and Royal Thai Airlines�
including free use of substitute aircraft between the MD-11 delivery date in 1990
and that of the A340 in 1992. These initiatives are causing governments and
airlines to reevaluate their choices. The apparently successful marketing of the
MD-11 has forced the consortium to adopt this aggressive strategy of trying to re-
verse the purchase decisions of the airlines. The design and development costs of
the A330/A340 would add another $2.9-3.1 billion in subsidies to the $7.5 billion
provided by member governments in support of Airbus Industrie since its inception
in 1970.
Kuwaiti and Soviet officials will meet in Moscow early next week to continue talks
on joint energy projects. The discussions, the first since September, will center on
oil swap arrangements, technical production cooperation, and development of joint
ventures in Iraq, the USSR, Greece, and Morocco, according to the US Embassy
in Kuwait. The talks follow an agreement signed last summer between the two
states to expand economic cooperation. Potential deals would provide an important
outlet for Kuwait's oil industry during the oil market slump and help the
government balance its relationship with the United States. Moscow probably
views economic cooperation as an effective way to improve Soviet-Kuwaiti
relations, to obtain access to Western oil technology and Kuwaiti financing, and to
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improve their image in the Arab world. Although immediate progress is unlikely,
enhanced economic ties between Moscow and Kuwait could encourage other Gulf
states to expand ties to the Soviet Union
Major Chinese
Chinese
Investments in
Hong Kong
Economic Problems
Spur Omani-UAE
Border Agreement
--Seeret---
6 February 1987
Beijing is paying $256 million for a 12.5-percent share of Hong Kong's Cathay Pa-
cific Airways, according to press reports. The deal is the third major investment in
Hong Kong made by the China International Trust and Investment Corporation
during the past year. Since last January, it has bought out a failing bank and in-
vested in Hong Kong's second cross-harbor tunnel project. Beijing is making these
large, well-publicized investments to demonstrate it intends to maintain Hong
Kong's vibrant capitalist economy. China now estimates that its total investment
in Hong Kong exceeds $5 billion, a 25-percent increase since the Chinese-British
accord was signed in 1984. Cathay Pacific probably hopes the investment will give
it access to Chinese cities beyond Shanghai and Beijing, which it now serves. It
wants to compete with a new Hong Kong airline, which is owned by entrepreneurs
with close ties to China and is already serving several secondary Chinese cities.
Oman has traded territory for cash to end a longstanding border dispute with the
United Arab Emirates and to relieve growing economic problems
Oman ran a budget
deficit of about $1.4 billion last year because of a decline in oil revenues, according
to the US Embassy in Muscat
Oman and the UAE
probably agreed not to publicize the deal to avoid renewed Saudi pressure to settle
their border disputes and because of Muscat's concern about a domestic backlash.
Oman has managed its economy fairly well over the past five years, but the
additional cash will relieve pressure resulting from lost revenues. Despite its
economic troubles, Muscat is unlikely to agree to a similar arrangement with
Riyadh, whose border claim overlaps up to 200 kilometers
National Developments
Developed Countries
26
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New Bank of
France Governor
After earning wide respect for his handling of the LDC debt crisis during an eight-
year term as IMF head, Jacques de Larosiere returned to Paris in January 1987 to
become governor of the Bank of France (BOF)
de
Larosiere will probably try to make the BOF�traditionally only an administrative
arm of the Treasury�a more independent institution.
De
Larosiere's efforts to increase BOF independence may also be constrained as the
government slows reform in anticipation of the 1988 presidential election. In the
interim, de Larosiere may be able to use recently instituted interest-rate-based
monetary policy as a tool for more day-to-day operating control. Nonetheless, we
expect de Larosiere will eventually become an influential voice, particularly in
international monetary policy.
Danish Wage The unexpectedly swift agreement on a four-year wage pact will help improve
Agreement labor relations. The unions achieved their main goal in obtaining a 37-hour
workweek�to be phased in over a four-year period�without a reduction in
compensation. In addition, labor won some wage increases and the right to reopen
negotiations halfway through the contract period. Management is pleased because
employers will have four years of labor stability in which to modernize their
facilities. The conservative government is also pleased because the private-sector
settlement facilitated a public-sector agreement and helped maintain its thus far
successful efforts to balance the budget. Government officials are hailing both
agreements, but Danish economists are more skeptical: some say that the
settlement will cause a 5-percent deterioration in Danish competitiveness in 1987
and add to the current account deficit. Economists are more sanguine that future
productivity gains�coming from a surge in investment�will offset the pact's
damage to overall competitiveness.
Nicaragua Allows
Repatriation of
Oil Refinery Profits
6 February 1987
Less Developed Countries
Nicaragua recently signed an agreement permitting the US-owned oil refinery in
Managua to reDatriate earnings blocked since 1981, (b)(3)
Under the new accord�reached after 18 months of negotia- (b)(3)
tions�Managua agreed to release $40 million in embargoed profits. Past earnings
are to be paid off over 12 years in $2 million semiannual installments, although the
agreement permits the payments to be rolled over at maturity if the refinery is un-
able to export enough fuel oil to cover the costs. In addition, the refinery's owners
are promised a minimum of $5 million in annual earnings repatriation for 1986
and future years. While the agreement limits the refinery to a very low return, if
honored by the Sandinistas the deal probably would be sufficient to keep the
owners from abandoning the operation and forfeiting their investment.
(b)(3)
awl
(b)(3)
(b)(3)
(b)(3)
(b)(3)
(b)(1)
(b)(3)
(b)(3)
28
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The Downside of
Peru's Economic Boom
Labor Strife
in Suriname
GDP grew a robust 9 percent in 1986, according to official estimates, but the econ-
omy may soon begin overheating, causing President Garcia problems with business
and labor. Lima expects 6- to 7-percent growth in 1987, although local private
forecasters foresee only about 5 percent as the economy slows later in the year. Af-
ter seeing inflation fall from 160 percent in 1985 to 60 percent last year, the gov-
ernment expects another sharp drop to 40 percent this year. Local independent
forecasters, however, project inflation in the 50- to 100-percent range. We expect
several factors to push inflation to the upper end of this range, including the
relaxation of price controls, a planned series of devaluations, and a budget deficit
that the Central Bank anticipates will reach nearly 12 percent of GDP this year�
double the share it held during the first nine months of 1986. Production costs will
probably rise as firms approach capacity, leading to demands for greater price
concessiops. Once labor sees inflation pick up, unions probably will increase strike
activity to press Garcia to make good on his promise of a 6-percent real wage in-
crease in 1987. Inflationary pressures added to worsening foreign payments
problems could undermine confidence in Garcia, forcing major policy readjust-
ments
Attempts by disgruntled bauxite workers to close the US-owned Suralco refining
facilities on Monday and periodic sabotage by insurgents may prompt the
company to pull out of Suriname. The police dispersed workers, but a US official
reports the refinery was damaged extensively. Workers were angered after the
company laid off at least 500 workers last week when sabotage of powerlines by
the rebels forced closure of the smelter. According to the US Embassy, the
company, which accounts for 50 percent of Suriname's hard currency earnings,
has demanded major financial concessions from the Bouterse regime to stay in
Suriname. This is the first significant labor strife in Suriname since 1984, when
militant bauxite workers won tax concessions from the Bouterse government.
Continuing insurgent activity, coupled with labor violence, probably will cause the
company to cease operations for an extended period�or possibly to close down
entirely�even if it receives additional concessions.
29
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Communist
Damage to Soviet
Winter Grains
Record cold temperatures early last month caused moderate to severe damage in
major winter grain regions of the USSR. Soviet press reports and weather data in-
dicate that cycles of intense freezing and thawing caused severe ice crusting in the
southern Ukraine and in parts of the northern Caucasus. The prolonged cold
period occurred after a very dry fall in the Ukraine�a vital grain-producing
area�thus preventing optimal winter grain development. Winterkill as a result of
plant freezing or suffocation averages 18 percent a year in the USSR, but
probably will be greater this year. Even if the weather is normal for the rest of the
winter, the harvested winter grain crop�which usually is about 60 million metric
tons�may be reduced by as much as 4 million tons. High levels of soil moisture
this spring will spur growth and partially compensate for losses, but damaged
areas can be replanted only with spring crops, which yield less than winter grains.
Even so, if at least average weather conditions prevail through the spring grain-
growing season, the overall harvest could equal last year's 210 million tons
Rapid Growth in A sharp increase in bilateral trade last year has increased Romania's economic
Soviet-Romanian Trade dependence on the USSR and may undermine its attempts to pursue a noncon-
formist foreign policy in coming years. Total bilateral trade for the first three
quarters of 1986 grew 30 percent, as compared with the same period in 1985, ac-
cording to sources of the US Embassy in Bucharest. Romanian exports of food and
agricultural products accounted for much of the gain and contributed to dire food
shortages in Romania this year. They were largely in payment for the increase in
Soviet oil deliveries, which rose from 42,000 b/d in 1985 to 129,000 b/d in 1986.
The Soviets reportedly also agreed to more favorable trade terms for 1987 by
raising prices for Romanian agricultural and food goods and by lowering prices for
Soviet raw materials. The Soviets' new willingness to increase oil deliveries and to
give Bucharest better price terms reflects their satisfaction with the rapid rise in
Romania's deliveries of foodstuffs and their desire to increase trade within
CEMA. The expanded trade relationship with the Soviets undermines Romania's
longstanding effort to diversify its international trade to help maintain its
relatively independent position in the Soviet Bloc. Some additional increases in
trade are likely this year and could eventually give the Soviets additional leverage.
East German
Economic Growth
Slows in 1986
According to official statistics, national income growth slowed last year�to 4.3
percent versus more than 5 percent in 1984 and 1985�but remained strong by
East European standards. We estimate this translates into GNP growth of 2.1
percent compared with a 1984-85 annual average of 2.8 percent. We calculate that
industrial production increased 2.2 percent. High-tech sectors, including comput-
ers, electronics, and robotics, grew rapidly, but several important industrial
ministries, including chemicals, did not meet their targets. Agriculture turned in
another good year with grain production a record 11.6 million metric tons. Foreign
trade, however, was a disappointment. East Berlin's reported hard currency trade
Secret 30
6 February 1987
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eLret
China Appoints
New Science
Academy Leaders
surplus declined to about $500 million from an estimated $746 million in 1985, we
believe largely as a result of lower prices for exports of refined petroleum products.
Trade performance with the USSR may also have worsened. Although Soviet
statistics show a sharply higher East German bilateral deficit through Septem-
ber�caused largely by a 9.3-percent decline in East German deliveries�the East
German claim that bilateral trade rose 1.5 percent for the year suggests that East
German exports may have rebounded considerably in the fourth quarter. Continu-
ing trade problems, January's severe cold, and the explosion at the country's
largest power plant last month indicate a poor start for 1987. The lower 1986 hard
currency trade surplus will further inhibit purchases of much-needed Western
capital goods and retard investment. As a result, East Berlin may have trouble
meeting its 1987 growth target of 4.5 percent.
The appointment of new leaders for the Academy of Sciences (CAS), the
organization responsible for China's elite science research institutes, suggests
Beijing is interested in continuing S&T reforms and scientific ties to the United
States. Zhou Guangzhao, a 58-year-old physicist who replaced Lu Jiaxi as
president, has been involved in international activities since becoming a CAS vice
president in 1984. Teng Teng, an advocate of reform while a vice chairman of the
State S&T Commission, takes over Yan Dongshan's position as vice president;
Teng also was just named president of the University of S&T, a site of recent stu-
dent demonstrations. A joint interview with Lu, Yan, and Zhou last week appears
designed to stress the normal retirement of elderly scientists. At the same time,
however, Teng's background in the party's propaganda department and the timing
of the announcement�shortly after the ouster of the S&T university's previous
leaders for poor handling of the demonstrations�is probably a signal that Beijing
intends to strengthen control over ideological issues within the scientific communi-
ty. Teng has reinforced Beijing's recent conservative rhetoric by stating that his
most important task at the university is to criticize ideological errors.
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