INTERNATIONAL ECONOMIC AND ENERGY WEEKLY

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• Collection: FOIA Collection
• Document Number (FOIA) /ESDN (CREST): 05743573
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• Document Creation Date: December 28, 2022
• Document Release Date: August 28, 2018
• Case Number: F-2017-01874
• Publication Date: October 30, 1987

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Directorate of
Intelligence
International
Economic & Energy
Weekly (u)
30 October 1987
Sccrct
eLre
DI IEEW 87-044
30 October 1987
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SCl.
International
Economic & Energy Weekly (u)
30 October 1987
iii Synopsis
1 Perspective�South Korea: Aftermath of Labor Unrest
3 Poland: Second Stage of Economic Reform
9 Israel: Dealing With Bank Share Redemptions
13 South Asia: Growing Economic Dependence on Japan
17 Eastern Europe�Japan: Economic Ties Still Weak
21 Briefs Energy
International Finance
Global and Regional Developments
National Developments
Comments and queries regarding this publication are welcome. They may be
directed to Directorate of Intelligence
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DI IEEW 87-044
30 October 1987
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International
Economic & Energy Weekly (u)
iii Synopsis
1 Perspective�South Korea: Aftermath of Labor Unrest
In our view, recent labor turmoil has had a substantial but manageable short-term
impact on the South Korean economy. For the longer term, we believe the
20-percent average wage gains won by striking workers by themselves probably
will have little impact on South Korean competitiveness.
3 Poland: Second Stage of Economic Reform
Polish leader Jaruzelski this month launched a broad program of economic and ad-
ministrative reforms to revitalize Poland's economy and dig it out from a crushing
$35 billion foreign debt. Similar reform measures of this and previous regimes
have failed, but the timing may be ripe for what appears to be a genuine reform
initiative. Jaruzelski has succeeded in emphasizing a commitment to reform, but
implementation may prove another matter entirely.
9 Israel: Dealing With Bank Share Redemptions
Increased spending from the scheduled redemption this week of $1.2 billion in
bank shares�equal to about 5 percent of Israel's GNP�will put pressure on the
government's successful economic stabilization program. Looming on the horizon
is the much larger October 1988 redemption totaling $3.7 billion, which will swell
the budget deficit and further complicate long-term reform efforts.
13 South Asia: Growing Economic Dependence on Japan
South Asian countries are increasingly looking to Japan for financial and technical
resources to assist in their economic development. Tokyo's economic assistance to
the region�although not explicitly tied to purchases from Japan�probably will
give Japanese companies a major advantage when competing for markets in South
Asia.
17 Eastern Europe�Japan: Economic Ties Still Weak
Meetings earlier this year between East European leaders and Japanese Prime
Minister Nakasone have not resulted in a significant increase in trade or joint
venture activity because of Eastern Europe's financial problems, the mismatch in
tradable goods, and Eastern Europe's relatively close ties with Western Europe.
iii
--Seeret�
DI IEEW 87-044
30 October 1987
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Scent
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Perspective
International
Economic & Energy Weekly (v)
30 October 1987
South Korea: Aftermath of Labor Unrest
In our view, recent labor turmoil has had a substantial but manageable short-term
impact on the South Korean economy, the work
stoppages by some 650,000 striking workers�about 5 percent of the labor force�
who demanded higher wages, ouster of promanagement labor unions, and
improved working conditions:
� Sliced industrial production by $1.5 billion. Hardest hit was the automobile
industry, which lost about $800 million in output.
� Slowed South Korea's export growth. Exports expanded 18 percent in August�
the peak month of the strike�down from a 45 percent growth rate in July.
� Reduced projected real GNP growth for the second half of the year from 10.7
percent to about 9 percent, steepening the cyclical decline that already had
begun. Nonetheless, we expect real GNP growth for 1987 will still reach 12
percent.
For the longer term we believe the 20-percent average wage gains won by striking
workers by themselves probably will have little impact on South Korean competi-
tiveness. Our analysis�which utilized a version of South Korea's input-output
model and a forecasting model of manufacturing productivity�shows that:
� Wages account for less than 11 percent of the final cost of goods produced in
South Korea. Modest cost cutting could offset much of the impact of higher
wages. Moreover, profits�which account for a 7-percent share of the cost of
goods�were excellent this year, giving firms a cushion to fall on.
� Productivity gains will almost match the growth of workers' pay increases this
year, hence unit labor costs will remain steady in 1987. During 1988-89,
however, we believe wage hikes will outstrip increases in workers' output and
force about an 8-percent rise in unit labor costs.
Seoul can avoid a wage-induced slowing of export growth by adjusting its
exchange rate. For instance, a private forecasting firm estimates that a 4.2-percent
appreciation, rather than the actual 6.8-percent rise, would have maintained South
Korea's 1987 export growth rate despite the wage cost push. If Seoul maintained
its current exchange rate�voiding its planned 3.8-percent rise�South Korean
exports would grow by 15 percent next year, the same as the firm's prestrike
forecast.
Several developments could reverse our upbeat outlook for continued export-led
growth. Domestic factors will play a key role in shaping the growth path of South
Korea's economy. If productivity does not rise, or if labor becomes embroiled in
political turmoil during the presidential succession this winter, exports could
stumble badly and the economy deteriorate. A lack of experience in negotiating
with management and the possibility that the eager young leadership of the new
unions will press their demands too far could foster new strikes. Moreover, workers
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could launch new job actions if management does not keep its promises to workers.
Some labor pacts already have unraveled because firms have failed to make good
on wage payments./
External factors, however, remain the most important variables in South Korea's
economic growth equation. Protectionism in major markets, a slowdown in
developed countries' economic growth, or an oil price runup, could prevent South
Korea from achieving the 7-percent annual real GNP growth we now expect over
the next two years. In addition, a reversal of the substantial appreciation of the yen
and the new Taiwan dollar against the South Korean won�which has boosted
Seoul's competitiveness relative to these rivals�could seriously hurt South Korea's
economic prospects.
The adjustment to higher wages will bolster some key items on Seoul's economic
agenda but will also pose some risks. Higher wages will boost consumer spending
in South Korea, which will further the government's long-term goal of reducing
dependence on exports for growth. Better labor-management relations would bring
these longstanding rivals closer together and perhaps boost productivity by
improving cooperation. According to the US Embassy, however, economic techno-
crats acknowledge that higher wages threaten price stability�key policy objective
of Seoul's economic policy makers. In addition, Seoul claims that labor problems
have limited its ability to meet Washington's trade demands, particularly appreci-
ation of its currency, which will further strain bilateral economic relations.
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Poland: Second Stage of
Economic Reform
Polish leader Jaruzelski this month launched a broad
program of economic and administrative reforms to
revitalize Poland's economy and dig out from under a
crushing $35 billion foreign debt. The ambitious
package follows months of intense public debate in the
party and government�Warsaw's decision on imple-
menting austerity measures awaits a binding public
referendum slated for 29 November. Similar reform
measures of this and previous regimes have failed in
the past, but the timing may be ripe for what appears
to be a genuine reform initiative:
� Moscow's own policies create a favorable
atmosphere.
� Western creditors encourage similar or identical
measures.
� The church is more conciliatory to government
economic policies.
� Jaruzelslci can now draw on six years' experience in
pushing his reform agenda.
Jaruzelslci's efforts will face stiff resistance from an
entrenched bureaucracy and a restive, cynical work-
force. Many of the 129 proposals outlined this month
are likely to fall by the wayside or be circumvented;
the timetable for achieving various objectives is overly
optimistic. Nonetheless, Jaruzelski's plan of attack for
the reforms gives him some chance of laying ground-
work for long-run improvements in Poland's living
standards and hard currency debt situation. In the
meantime, Warsaw is making it clear it believes
reform success depends on attracting new credits from
the West to finance Polish industrial modernization.
New Reform Initiatives
Since the imposition of martial law and a sharp
economic decline in the early 1980s, the economy has
come back to about the level of production reached in
the late 1970s, although per capita income still is
about 10 percent lower than it was in 1979. Agricul-
ture�including a large private sector�has shown
3
Calendar for Second Stage-Reform Goals
1987 � Restructure the government
(October 24).
� Consolidate 26 ministries into 19.
� Abolish 3,000 government posi-
tions (25 percent of central
bureaucracy).
� Eliminate half of roughly 200
deputy ministers.
� Referendum on the pace of reform
(November 29).
1988 � Create market initiatives to stimulate
production, exports.
1989 � Stabilize the zloty exchange rate.
� Make wage structure systematic.
1990 � Bring inflation below 9 percent
annually.
1991 � Achieve current account balance.
� Lay groundwork for debt reduction.
Beyond: � Debt normalization.
� Zloty convertibility.
Unclassified
creditable performance in recent years, but industry
remains inefficient and wasteful of investment funds,
and overly focused on obsolescent heavy equipment
production. Major disequilibrium pervades domestic
markets, the result of excessive consumer subsidies to
placate workers and chronic market shortages.
The latest measures are a renewed effort to carry out
reforms legislated in 1981 that were not implemented
or were reversed in subsequent years. In pursuing
these changes, Jaruzelski hopes to revitalize Poland's
economy, improve living conditions, promote exports,
and improve Poland's international trade and debt
situation. Influenced by both Gorbachev's bold eco-
nomic initiatives and China's gains from reform,
�Seeret�
DI IEEW 87-044
30 October 1987
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--FErf�e
Jaruzelski has pressed hard this year for implement-
ing a second stage of reforms. We believe he sees a
unique chance to use the climate for change spawned
by current Soviet policies as the basis for change in
Poland. Increased confidence in his own abilities
stemming from six years as president probably are
also a factor.
The draft program for implementing the second stage
of reform is extremely ambitious, striving for funda-
mental change in the structure and operation of
Poland's economy. In all, the program includes 129
wide-ranging measures to be put in place from late
1987 through December 1991. Patterned after reform
efforts in other socialist states�Hungary in particu-
lar�the new program attempts to decentralize eco-
nomic decision making, create incentives for factory
and worker productivity, encourage entrepreneurial
activity, and allow market forces to help adjust prices
to reflect true costs of production and labor.
In drawing up his reform agenda, Jaruzelski has first
targeted the main sources of opposition to reform. His
program begins with a major restructuring and reduc-
tion of the bureaucracy, announced this past week,
followed by an unprecedented public referendum on
reform, now scheduled for 29 November. Jaruzelski
hopes that progress in these efforts will convince
critics abroad that the reforms are genuine, and will
prepare Poles for more unpalatable measures�wage
controls and price increases�that will probably begin
next spring.
Restructuring the Government...
To set the stage for later reform initiatives, Jaruzel-
ski's first objective is to reduce the interference of the
bureaucracy in the operation of Poland's economy.
The restructuring of the government's Council of
Ministers is meant to create a central body that will
focus on macroeconomic concerns while delegating
day-to-day operating authority to the factory level,
introducing profit and efficiency incentives, and elimi-
nating the present heavy industrial ministries' ability
to grab the lion's share of the state investment budget.
�Seefet--_
The restructuring of Poland's Council of Ministers,
approved this past week by the Sejm, Poland's parlia-
ment, eliminates or downgrades seven of 26
ministerial-level organizations. It replaces three in-
dustrial ministries that have been forceful opponents
of reform during this and previous regimes with a
single Ministry of Industry. The communications,
transport, and maritime economy ministries are com-
bined, and other ministries will absorb several former-
ly autonomous committees. The Polish press claims
that these moves will cut the size of the central
economic bureaucracy by one-fourth, abolishing some
3,000 jobs.
... and Bringing in Reformers
In restructuring the Council of Ministers, Jaruzelski
hopes to turn 16 ministers and committee heads out of
office by the end of the year; only two of the seven
reorganized ministries will be headed by current
ministers. Replacements at key positions announced
last week include some old-line politicians, but also
several non-Communists and technocrats that already
are stumping for the reform program.
To head the Planning Commission, a chronic oppo-
nent of decentralization and enterprise autonomy,
Jaruzelski has appointed his reform architect, Deputy
Premier Sadowski, to replace Chairman Gorywoda, a
party member and strong advocate for the industrial
ministries. Sadowski, not a party member, has borne
the brunt of moving the reform program through
government and party review, apparently keeping it
relatively intact.
In a particularly shrewd move, Jaruzelski's choice for
Minister of Industry is Jersy Bilip, manager of a
factory using US-licensed technology. Bilip's appoint-
ment not only plays up Jaruzelski's effort to overhaul
the bureaucracy, but also signals his intention to
promote further economic and technical cooperation
with the West. Jaruzelski undoubtedly also hopes to
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Secret
Ministerial Restructuring and Personnel Replacements
Existing Ministries/Committees Future Ministries/
Committees
Mining and Energy
Chemical and Light Industry
Metallurgy and Machine Industry
Industry a
Construction, Land Use Manage-
ment and Municipal Services
Land Use Management and
Construction a
Communications
Transport
Maritime Economy
Transport, Shipping, and
Communications
Labor, Wages, and Social Affairs Labor and Social Policy a
Foreign Trade
Committee for Economic Coopera-
tion with Foreign Countries
Foreign Economic
Cooperation a
Internal Trade and Services
Materials and Fuel Economy
Home Market
Education and Upbringing
Science and Higher Education
National Education a
Physical Culture and Sports Com-
mittee
Youth affairs
Youth and Physical Culture
Committee (downgraded
from ministry level)
Ministries not subject to restructuring:
Agriculture
Culture and Art
Environment b
Finance
Foreign Affairs
Health b
Internal Affairs
Justice
National Defense
Planning Commission b
Religious Affairs
Science and Technology
'New minister/committee head is not a former
minister/committee head.
b New minister announced this past week.
This table is Unclassified.
5
favorably influence the West regarding Poland's ef-
forts to regain access to hard currency loans through
the IMF and official credits, in its bid to modernize
through imports of Western technology.
Restructuring and restaffing the Council of Ministers
is a significant first step, but some opponents of
reform remain. For example, Deputy Premier Sza-
lajda, an ardent supporter of heavy industry, has
retained his post. While Jaruzelski's appointment of
new faces to the Council of Ministers is unlikely to
guarantee the success of upcoming reform policies, it
does increase the potential for achieving at least part
of his reform objectives.
Selling Reforms at Home
Jaruzelski's next step is an unprecedented public
referendum, now scheduled for 29 November, that
asks the people to vote on reforms. The two referen-
dum questions�one economic, one political�were
published this week. Couched in general terms, they
are worded to make a favorable impression; and, by
asking for support for "full implementation" of the
second stage of reform, Jaruzelski can use a positive
response�which could be rigged if necessary�as the
rationale not only to effect price and wage reform but
also to blunt resistance to reforms from within the
bureaucracy.
In promoting the importance of the upcoming referen-
dum, Warsaw hopes to condition the Poles to accept
with minimal unrest the inevitability of coming hard-
ships, including price and wage measures. Warsaw
will try to soften resistance by portraying these mea-
sures as temporary hardships agreed to by a majority
of the people. Jaruzelski can also cite the willingness
of the government to cut the bureaucracy before
asking the people to make sacrifices. Warsaw will
point out that these measures had been encouraged by
international institutions�the IMF, World Bank, and
official creditors�who can later be blamed for the
severity of these policies.
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The response to the referendum is hard to predict.
Poles realize reforms are necessary to restore the
economy, but also fear wage controls or the risks
associated with linking wages and employment to
productivity or introducing bankruptcy for poorly
performing enterprises. Most are cynical about the
current reform offensive being any different than
earlier efforts, and the novelty of having a chance to
express an opinion in a referendum may not prove
inspiring. It is also hard to predict how strongly
inclined is the man on the street to make a futile but
symbolic gesture of defiance: Solidarity�on the de-
fense and increasingly portrayed by the government
as uncompromising and unwilling to participate in
reform efforts�has asked the people to boycott the
referendum or write "Solidarity" on the ballot.
The US Embassy notes that the populace is not
uniform in its attitudes toward reform; Polish press
articles provide evidence that the campaign to soften
opposition from various sectors has already begun:
� We expect the church's position on the referendum
will weigh heavily on its outcome. The church has
not yet taken a stand on reforms, but may support
encouraging private enterprise and worker incen-
tives, especially if accompanied by political reforms.
While supporting the spirit and objectives of Soli-
darity, the church in recent months has hinted that
Solidarity as an organization is losing relevance.
� Pensioners, the disabled, those earning minimum
wage are most fearful of price increases. Warsaw
has announced this month, however, that the mini-
mum wage would be indexed for inflation, and that
sharp price hikes in consumer goods would be offset
by subsidies.
� Blue-collar workers have been able to keep wage
growth above inflation in the 1980s and are resis-
tant to change.
� Independent farmers are discriminated against, rel-
ative to collectives, and face government attempts to
consolidate less-efficient farms. They are suspicious
of reforms but attracted by possible banking policies
that would provide new sources of credit.
On the other hand:
� Urban white-collar workers believe their incomes
have been eroded, relative to heavy industry work-
ers, and may welcome a more flexible, market-
oriented economy. Intellectuals are suspicious of
reforms, but like white-collar workers may support
changes that reverse the relative decline in their
incomes.
� Frustration and hopelessness among young cou-
ples�who now face a 20-year waiting list for
apartments�could galvanize reform support in des-
peration from a presently apathetic sector of society.
Reforms and the West�Seeking Support
Jaruzelski admits that for his reform package to have
any chance of success he must attract greater
cooperation�economic, technical, and financial�
from the West. Warsaw wants new hard currency
loans that would enable Poland to modernize and
expand industrial capacity through increased imports
of technology, equipment, and materials. To get new
loans, however�Poland has received only token
amounts of new credits since 1981�Warsaw must
reschedule existing private and official debts and
implement a standby program negotiated with the
IMF.
Poland has made some progress in debt rescheduling
this year. A new commercial agreement that includes
some requirement to pay principal as well as interest
has been initialled, with signing expected by the end
of the year. Poland has also discussed rescheduling
with official creditors and negotiations continue de-
spite Poland's claim it can only pay half of what
creditors are seeking in 1987.
Poland hopes concurrent progress in its reform efforts
and in IMF negotiations will reinforce each other.
Jaruzelski expects success in restructuring and con-
ducting a referendum will increase Poland's chances
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Secret
at IMF loans; at the same time, Warsaw probably
hopes to legitimize reform efforts in sensitive areas
such as price hikes and wage controls by labelling
them as recommended or required by the IMF.
Outlook
Jaruzelski has succeeded in emphasizing a commit-
ment to reform, but implementation may prove anoth-
er matter entirely. According to the US Embassy
Warsaw, the government restructuring�although it
passed the Council of Ministers themselves as well as
the Sejm�has been bitterly opposed by the line
ministries most affected, especially the Ministry of
Mining and Energy. The staffing of new larger
ministries and the planning commission with reform
advocates will create a protracted struggle to redefine
the roles of these organizations in a more market-
oriented economy.
7
Jaruzelski's success in implementing other reforms
will depend, in large part, on maintaining stability
during a difficult adjustment period. A crucial factor
will be the balance Warsaw strikes between expand-
ing incentives and encouraging private enterprise on
one hand, and controlling wages while raising prices
on the other. Poland's debt situation will remain
serious into the next century, but with movement on
reforms Poland may be able to speed growth and
modernization via renewed access to substantial hard
currency loans.
Secret
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Israel: Dealing With
Bank Share Redemptions
The scheduled redemption this week of $1.2 billion in
bank shares�equal to about 5 percent of Israel's
GNP�will put pressure on the government's success-
ful economic stabilization program. Ministry of Fi-
nance officials fear that a decision by bank share
holders to spend their redemptions instead of reinvest
them will destabilize the economy and rekindle infla-
tion. Our econometric model of the Israeli economy
suggests that increased public spending would lead to
a surge in the current account deficit and spur growth
in real private consumption and real imports. The
increased spending would likely lead to higher infla-
tion and would apply pressure on the government to
adjust exchange rates. Looming on the horizon is the
much larger October 1988 redemption totaling $3.7
billion. While this redemption will put pressure on
next year's government budget, it will not be a threat
on the consumption side since the shares are held by
banks, other institutional holders, and households
with large holdings who will undoubtedly reinvest the
money.
Government Redemption Fears
Ministry of Finance officials, not surprisingly, are /
more worried about the imminent $1.2 billion re-
demption than the $3.7 billion that falls due next
October, according to the Embassy and press reports.
Next year's big payout is mostly held by financial
institutions�banks, mutual funds, and others. To-
gether, these institutions hold about $2.2 billion, but
they will be looking to reinvest their shares.
Of the remaining $1.5 billion, companies hold about
$500 million and private households hold $1 billion.
According to Embassy reporting, the government
believes the companies will simply roll over their
holdings into other investment channels. From the
households faced with redemption in 1988, one-third
of the owners hold an average of about $150,000 in
bank shares, and the remaining two-thirds have an
average of about $20,000 in holdings. According to
9
Bank Shares and the Stock Market Collapse
The first signs of stock market trouble appeared in
January 1983. Confidence in the continuation of the
stock boom had eroded and Israelis began to sell off
their holdings of nonbank shares. As nonbank share
prices dropped, panic set in and the prices of these
stocks collapsed. Bank shares, however, continued to
climb even after January, partly fueled by nervous
investors trying to get into the last supposedly safe
alternative in the stock market. These investors did
not know bank share prices were being propped up by
the major banks with the government's blessing,
according to Embassy reporting.
The timing of the stock market's collapse in October
resulted directly from Finance Minister Aridor's
defunct program of suppressing inflation through
slow depreciation of the shekel. The shekel's value
steadily became more unrealistic, and the foreign
payments situation deteriorated. As part of the move-
ment back into foreign currencies, the public sold off
bank shares to buy dollars as a hedge against
inflation. To forestall the drop in bank share prices,
the banks borrowed massively abroad to prop up
their own share prices. The end to the bank share
mania came in October 1983 when the government
announced it was closing the stock market and would
bail out bank share holders, who had suffered an
estimated $5 billion capital loss by their investments
in bank shares.
the US Embassy, the Ministry of Finance believes
these households are sufficiently well-to-do that they
have no need to spend the cash. These households will
likely roll over their holdings into other saving
schemes.
�Seeret--
DI IEEW 87-044
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While next year's big payout is not likely to end in
higher consumption expenditures, it will have a large
impact on the government budget. Without further
spending cuts, the government's budget deficit next
year is likely to swell to between 15 and 20 percent of
GNP from the current level of about 4 percent. A
deficit surge of this magnitude almost certainly would
undermine the government's stabilization program.
This month's scheduled $1.2 billion redemption, on
the other hand, is held entirely by individual investors,
who hold between $5,000 and $15,000 in bank shares
per household. The fear that a large proportion of this
money will be spent immediately thereby destabiliz-
ing the economy and rekindling inflation�currently
around 20 percent annually compared with the 185
percent inflation rate for 1985�has long been the
nightmare of Ministry of Finance officials.
Government estimates point to the public spending at
least 25 percent of this month's redemption for imme-
diate consumption. Our econometric model of the
Israeli economy suggests that higher public consump-
tion would increase this year's current account deficit
from $144 million to $317 million. The higher con-
sumption also would increase real import growth by
11.2 percent this year�compared with our baseline
forecast of 9.9 percent.
Households�Options to Immediate Redemption
Faced with the difficult decision of what to do with
their bank shares besides redeeming them now, many
households may simply do nothing. By doing nothing
they would automatically retain their shares and
could hold them until redemption in October 1989,
thereby accepting the government's payback scheme.
Beginning on 1 November, bank share holders also
will have the option of selling the shares due for 1989
redemption on the Tel Aviv Stock Exchange. The last
option available to share holders would be to explore
various saving offers from Israel's commercial banks.
Israel's commercial banks have undertaken major
campaigns to attract additional holders of bank
shares. Bank Hapoalim, Israel's largest commercial
Secret
Generous Redemption Terms
Under terms of the government's bailout stemming
from the October 1983 stock market collapse, bank
share holders were given a choice when they could
redeem their holdings. Bank share holders who
placed their shares in a frozen saving scheme are
eligible to redeem them now. Under this option, for
each $100 originally frozen in the scheme in October
1983 dollar terms, the holder would receive $112.
Bank share holders can, however, choose not to
redeem the shares, postponing redemption until Octo-
ber 1989. If the holder chose this option, he would
receive $134 in October 1989 for each $100 originally
frozen. By offering a lower yield in the period 1983-
87 as compared with the 1983-89 period, the govern-
ment clearly hopes to postpone individual redemp-
tions until 1989. According to the US Embassy in Tel
Aviv, however, most Israeli economists believe that,
no matter which period is chosen for redemption,
bank share bailouts will prove costly for the govern-
ment.
bank, has embarked on the most ambitious effort,
moving in mid-August to disseminate information on
numerous saving options for its 110,000 customers
holding bank shares. In a similar effort to attract
bank share holders, Mizrahi Bank has offered bridg-
ing loans to allow customers to deposit their money
early in saving schemes. Bank Leumi, Israel's second-
largest commercial bank, has yet to formulate a bank
share campaign, but according to press reports proba-
bly will have undertaken a major publicity campaign
before the 31 October redemption to attract bank
share redemption funds.
Outlook
Barring significant spending cuts�which seem un-
likely�the Israeli Government will face a budget
deficit next year totaling an estimated $3.7-5.0 bil-
lion�equal to 15 to 20 percent of GNP�to absorb
the 1988 redemption. The government made only
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limited progress in trimming this year's budget deficit
to about $900 million, which fully incorporated the
October 1987 redemption. A drastically higher bud-
get deficit in 1988 would force the government to step
up domestic borrowing or to print additional money,
both highly inflationary.
Increased government borrowing to finance a much
higher budget deficit also would undercut government
attempts to give the private sector�already nearly
crowded out by the government's need for financial
resources�a greater role in the capital market. The
public's redemption of bank shares to the government
also might result in the government's holding a major-
ity of the stock of Israel's commercial banks. Such a
de facto nationalization, however, would further com-
plicate capital market reform efforts.
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South Asia:
Growing Economic
Dependence on Japan
South Asian countries are increasingly looking to
Japan for financial and technical resources to assist in
their economic development.' South Asians are seek-
ing more concessionary economic assistance from
Tokyo, tariff relief for South Asian exports, access to
high technology, more direct investments, and greater
exposure to entrepreneurial expertise. South Asian
countries are anxious to increase economic coopera-
tion with Japan in part because the Japanese general-
ly do not require political and economic reforms.
Japanese Foreign Minister Kuranari in August af-
firmed Japan's intent to promote political dialogue
and increase economic cooperation with the region,
but South Asians will remain wary of new promises
without more action on Tokyo's part. Many South
Asians believe that Japan is still primarily interested
in quick sales of manufactured goods and will contin-
ue to require lengthy negotiations before buying more
goods from the region, transferring technology, or
concluding major aid agreements. Tokyo's economic
assistance to the region�although not explicitly tied
to purchases from Japan�probably will give Japa-
nese companies a major advantage when competing
for markets in South Asia.
The Economic Relationship
South Asian economic relations with Japan over the
past decade have focused primarily on trade. South
Asia sells mostly raw materials and food�iron ore,
cotton, and marine products�and buys manufactured
goods. The total value of trade between the two areas
grew by 18 percent in 1986 to nearly $5.8 billion.
Japan currently is the largest commercial exporter to
the region and the second largest in overall trade,
slightly behind the United States.
Direct Japanese investment and industrial collabora-
tion are beginning to show signs of growth. Japanese
joint ventures in the region have increased from an
' The South Asian countries covered in this article include Bangla-
desh, India, Nepal, Pakistan, and Sri Lanka
South Asia: Trade With the United States
and Japan, 1980-86
Billion US $
n United States
I-1 Japan
Exports Imports
4 4
3
2
3
2
0 1980 81 82 83 84 85 86 0 1980 81 82 83 84 85 86
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investment of about $5 million in 1980 to nearly $15
million in 1985. While total Japanese investment in
the region still remains small, Japan probably has
become the third-largest foreign investor after the
United States�US investment in the region totalled
$40 million in 1985�and the United Kingdom. Japa-
nese direct investment has been oriented toward the
domestic markets, especially the automobile industry
in India and Pakistan and the tourist industry in Sri
Lanka. These countries want more new Japanese
investment in export-oriented industries and joint
ventures that would help them compete in the export
market.
Growing Financial Assistance
Japan already is the largest Free World bilateral aid
donor in each of the South Asian countries, except
Pakistan, and is likely to increase its disbursements
this year. In 1986, Japanese loans, grants, and techni-
cal assistance exceeded $800 million. During his visit
to the region in August, Kuranari pledged additional
assistance for economic development. In India, for
example, he pledged a loan of $470 million for the
fiscal year that ends in March 1988�more than
double the amount disbursed last year�to finance
nine industrial projects, including the construction of
a fertilizer factory, a telecommunications facility, and
an electric power plant.
Tokyo also has been in the forefront of providing
relief for the natural disasters that have plagued the
region this year:
� It was the first major contributor to the relief effort
following the devastating floods in Bangladesh dur-
ing August, donating 100,000 metric tons of rice
and wheat.
� Earlier this month Tokyo offered India a $200
million long-term, low-interest loan for drought
relief.
While Tokyo has expressed a willingness to increase
economic assistance to South Asia, it appears unsure
of how to respond to all the requests from the area
and is interested in finding a mechanism to facilitate
aid disbursements.2 During his trip to the region
Kuranari announced that Tokyo would convene a
symposium between Japan and the South Asian Asso-
ciation for Regional Cooperation (SAARC) some time
before next April. According to the US Embassy in
Tokyo, Japan would like to coordinate its aid activi-
ties through the SAARC if the organization becomes
active in regional cooperation.
We believe Tokyo's increased bilateral assistance will
pave the way for greater trade and investment. While
only a small portion of the Japanese aid is explicitly
tied to imports from Japan. Tokyo uses concessionary
loans to promote purchases of Japanese goods. Goods
brought from LDCs, however, are not tied to Japa-
nese aid although most of the equipment needed for
large-scale protects is not produced by LDCs.
Pitfalls in the Relationship
A major expansion of economic relations between
Japan and South Asian countries faces obstacles.
South Asians remain wary of becoming a dumping
ground for Japanese manufactured goods. Relations
between South Asia and Japan before the late 1970s
focused on bilateral trade that was nearly balanced.
By the early 1980s, however, the South Asian trade
balance with Japan moved into deficit, reaching $2
billion in 1986. South Asia's imports from Japan,
including major purchases of capital goods, parts for
use in assembling automobiles, and consumer elec-
tronics equipment, have nearly doubled in the 1980s.
Regional exports to Japan, which are still primarily
raw materials, have grown by less than 40 percent
during the same period.
Tokyo has shown little interest in opening its markets
to a wider variety of South Asian goods despite
frequent complaints and meetings designed to address
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South Asia: Asia: Japanese Official Development Assistance,
1980 and 1986 a
Percent
1980 b
Bangladesh 11
Pakistan 6
India 2
Sri Lanka 2
Nepal 2
Total = US $2.0 billion
1986 b
East Asia
29
Africa
11
Other
26
South Asia
21
China
13
Total = US $ 3.8 billion
a Includes only bilateral disbursements.
bData for fiscal period beginning April of stated year.
Bangladesh 6
India 6
Pakistan 4
Sri Lanka 3
Nepal 2
314694 10-87 (b)(3)
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South Asia: Trade With Japan, by Country,
1980 and 1986 a
Billion US $
Bangladesh
11. Sri Lanka
Pakistan
r7 India
Exports
2.5
a Data excludes Nepal.
Imports
2.5
314695 10.87
the problems. Japanese businessmen are still unwill-
ing to relinquish their control in favor of an equitable
relationship and continue to drag their feet on increas-
ing the South Asian domestic content of joint ven-
tures, thus aggravating the regional payments deficit.
Many of their business ventures continue to serve
primarily as markets for Japanese exports.
Japan has found it difficult to deal with South Asian
bureaucracies on issues such as aid projects, in part
because of its own understaffed aid bureaucracy. Aid
appropriations have sometimes gone unused because
of delays and inefficiencies in the programs designed
to receive the assistance and because of problems
coming up with the large-scale projects Tokyo re-
quires for most loans. We believe these problems leave
some doubt that all the aid promised this year will
actually be disbursed. We also believe it will be
several years, if ever, before SAARC could play the
regional role the Association of Southeast Asian
Nations currently plays in coordinating economic
relations with Japan.
Outlook and Implications
We believe Japan will continue to make major eco-
nomic inroads in South Asia and could become the
region's largest commercial trading partner in a few
years. The prospect of a large new market opening as
a result of liberalization efforts undertaken by coun-
tries in the region has prompted a major influx of
Japanese seeking new business ventures and markets
for exports. Growing aid disbursements, even though
not explicity tied to sales of Japanese products, will
facilitate Tokyo's activities, possibly at the expense of
the United States.
South Asian countries are wary of Japanese business
and trade practices but nevertheless will seek a closer
economic relationship with Japan. They will continue
to reluctantly accept a large trade deficit with Japan
because much of it can be balanced by inflows of
capital from Tokyo. Loans and grants from Japan also
are often politically more palatable than those from
other bilateral or multilateral donors because they
normally are not tied to political and economic re-
forms. Japan also is generally less stringent than the
United States in controlling the level of technology in
equipment exported. Moreover, some South Asians
have expressed concern that the region is too depen-
dent on the United States for high-technology equip-
ment.
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Eastern Europe�Japan:
Economic Ties Still Weak
Meetings earlier this year between East European
leaders and Japanese Prime Minister Nakasone have
not resulted in a significant increase in trade or joint
venture activity because of Eastern Europe's financial
problems, the mismatch in tradable goods, and East-
ern Europe's ties with Western Europe. The most
recent effort to expand cooperation took place in
January, when Prime Minister Nakasone visited East-
ern Europe and Polish leader Jaruzelski subsequently
visited Japan. We believe the Nakasone visit, howev-
er, was intended to demonstrate to Moscow Japan's
growing global, political, and economic presence rath-
er than to generate new business. Eastern Europe
wants additional Japanese financing and technology
for modernization efforts and increased exports to
Japan to earn hard currency. Japan, for its part, is
looking for creditworthy outlets for surplus capital
and customers for industrial plant exports.
Limits to Expanding Trade Ties to Japan
Eastern Europe's expanding technology needs have
resulted in a number of purchases from Japan�
particularly in microelectronics, machine tools, and
robotics technology�but similar products available
from West European suppliers limit prospects for
stronger trade ties to Tokyo. Bulgaria's joint venture
with a Japanese firm has proved successful in engi-
neering and producing numerically controlled ma-
chine tool systems. Recently, East European countries
also have shown some interest in Japanese assembly
plants to produce consumer durables. In 1985 Berlin
negotiated the first of two contracts with the Mitsui
trading firm and the Toshiba Corporation for color
television and picture tube assembly plants that are
scheduled for completion this year.
Western Europe, however, continues to satisfy most
East European needs for products and technology,
and East European enterprises remain oriented to-
ward West European export markets. Romania has
sought West European integrated circuits, and Bul-
garia is interested in fiber optic products from French
17
and West German as well as Japanese suppliers.
Moreover, East European�West European trade ties
were recently strengthened when Poland signed a
cooperation agreement to produce small cars with
Italy�not Japan�although Warsaw is continuing
negotiations with the Japanese on a contract to manu-
facture medium-size cars.
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Japan and Italy Vie for Polish Car Deals
After months of deliberations, Japan lost out to Italy
when Poland signed a contract with Fiat early this
month for the production of small cars in Poland.
Japan and Italy are now competing for a plant to
construct medium-size cars. Warsaw appears to be
considering more seriously the contendi
offer
tf the contract is signed, the plant in Poland
would be the first Japanese automobile assembly
plant to be opened in an East European country.(
Despite the low volume of trade between Japan and
the region, cash-rich Japanese banks are a key source
of credit for some East European countries as West
European and US banks limit their exposure to the
region. Hungary has moved aggressively to acquire
Japanese loans, and Poland has sought new credits to
support the possible production plant for medium-size
cars. Japanese banks took sizable shares of almost all
new commercial loans to Hungary, Bulgaria, and
Czechoslovakia in 1986, although most banks remain
cool to problem debtors Yugoslavia, Poland, and
Romania.
Obstacles to Growing Economic Ties
COCOM Regulations. Some Japanese firms, fearing
US criticism, are pulling out of deals with Eastern
Europe.
Seel t
Eastern Europe: Trade With Japan,
1981 and 1986
Million US $
0 Manufactured goods
Other a
800
600
400
200
0 Exports Imports
1981
a Includes raw materials and foodstuffs.
Exports Imports
1986
314641 10.87
Restrictions on Joint Ventures. Japanese businessmen
maintain that shop-floor control over production pro-
cesses is key to successful joint ventures, but Poland,
East Germany, and Czechoslovakia appear unwilling
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to grant enough latitude to foreign firms to attract
Japanese managers. Even when East European coun-
tries try to be accommodating, the market opportuni-
ties for Japanese firms are too small to attract major
interest. The Japanese see little incentive for export-
oriented joint ventures in Eastern Europe because
their output would compete against exports from
Japan or with goods produced by Japanese direct
investments elsewhere.
Tougher Financial Terms. Bulgaria and Czechoslova-
kia still have access to Japanese banks, but Hungary's
recent loan requests have encountered some resis-
tance. Given Hungary's imminent request for an IMF
standby program, we expect Japanese banks to tempo-
rarily curtail new lending to Budapest and demand
higher interest rates on new loans until its financial
situation is clarified. Still the Japanese, probably
holding over half of Hungary's projected yearend debt
of $16 billion, have expressed confidence in Buda-
pest's central bankers, and probably will resume
lending, albeit on somewhat tougher terms.
The Japanese Government is one of the leading
official creditors of Bulgaria, East Germany, and
Hungary, but, like other Western governments, Tokyo
has not extended large new credits in recent years.
The amount of official debt as compared to Japanese
commercial bank exposure is small partly because
commercial banks are in some cases offering better
terms than the Japanese Export-Import Bank.
Playing Politics With Eastern Europe
Nakasone's sudden decision to visit the region last
January was billed as a step to promote increased
commercial ties to Eastern Europe, but, in our view, it
was a stopgap decision made after efforts to persuade
Soviet General Secretary Gorbachev to visit Tokyo
collapsed. We believe Nakasone's objective was to
19
Trade Remains Modest
East European trade with Japan is small compared
with the region's trade with West Germany, Italy,
Austria, and the United States. Eastern Europe
imports Japanese chemicals, machinery, and equip-
ment and exports chemicals, textiles, and foods. The
region has increased sales of chemicals and steel
manufactures since 1981 and appears to want to
increase food exports, but boosting exports to Japan
has been difficult because of the poor quality of its
goods and competition from the newly industrializing
countries. Eastern Europe's hard currency shortages
and Tokyo's reluctance to extend large, officially (b)(3)
backed credit lines also have prevented rapid expan- (b)(1)
sion of sales to Eastern Europe.
remind Moscow of Japan's growing political impor-
tance worldwide. Visits by key Japanese officials to
Poland, Bulgaria, Yugoslavia, and Romania last year
apparently had similar motives although yielded no
trade or joint venture agreements.
Outlook
The East European regimes will remain interested in
Japanese technology as they try to modernize their
economies, but they have little to offer in return.
Trade in high-technology fields such as semiconductor
production could be stunted by Japan's current efforts
to tighten enforcement of COCOM-related export
controls.
Japanese industry, facing trade restrictions elsewhere,
may seek to expand export markets in the region, but
Eastern Europe's debt problems and limited Japanese
demand for its goods will hamper expansion of con-
ventional trade. We see little prospect for joint ven-
tures and exports of industrial plants becoming key
elements of East European ties to Japan. For ties to
grow, Japanese businessmen and East European man-
agers will have to find mutually beneficial ways to
promote licensing agreements, joint ventures, and
innovative countertrade arrangements.
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Seerot
Briefs
Energy
Saudi Arabia Opposes
Oil Price Change
Greece To Import
Soviet and Algerian
Natural Gas
Revisions on Energy
Content of Soviet Coal
King Fand earlier this week indicated his opposition to any increase in OPEC's of-
ficial oil prices�which average $18 a barrel�through the end of 1988 and said
that demand for OPEC oil would have to rise before higher prices could be
considered even after next year. Fand's comments were probably prompted by
concern about weak oil demand and by OPEC's inability to hold down output.
OPEC crude oil production this month is probably close to 20 million barrels per
day, well above its self-imposed quota of 16.6 million b/d. Statements by Fand
have been a reliable indicator of future Saudi policy and will dampen any
prospects for an increase in official prices at OPEC's December meeting, despite
lobbying from a few cartel members�notably Iran. It is more likely that Saudi
Arabia and other members will be forced to trim output to prevent an oil price de-
cline if oil demand is sluggish in coming months.
Athens is moving forward with long-deliberated plans to import natural gas, with
an eye to reducing its dependence on oil imports and improving the environment.
Under an agreement reached earlier this month, the Soviet Union will supply 1-2
billion cubic meters (BCM) of natural gas annually for 25 years beginning in 1992.
The required 700-kilometer pipeline from Bulgaria and the gas distribution
network will cost roughly $2.2 billion to construct. Athens is also close to signing
an agreement with Algeria to provide about 0.5 BCM of liquefied natural gas
annually for 21 years. These preliminary accords follow years of difficult
negotiations, particularly with Moscow, and still leave several critical issues
unresolved�including the price of the gas, the payment terms, and financing for
the construction projects. The gas will be used mainly in industry and for
generating electricity, and is expected to cover 12 percent of total Greek energy re-
quirements by 2002. Athens probably decided to go with two suppliers to avoid un-
due dependence on the Soviet Union and to improve its negotiating position when
haggling over price and payment terms.
The recently released Soviet economic handbook for 1986 shows a major
adjustment downward�by roughly 10 percent�in the energy content of raw coal
produced. Until this year, Moscow did not take proper account of the growth in
production of lower quality coal from the Ekibastuz and Kansk-Achinsk coal
basins and did not adjust the factor used to convert raw coal tonnage into standard
fuel. Coal from these basins is low in energy value, comprising lignites or
subbituminous coals with a high ash content. In the 1985 handbook, raw coal
production for 1985 was equated to 487 million tons of standard fuel; in the new
handbook, this has been reduced to 440 million tons standard fuel. Moreover, the
1986 record output of 751 million tons of raw coal (35 million tons higher than in
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1980) is converted to 455 million tons of standard fuel-22 million tons below the
output listed for 1980. Plans to increase coal production substantially during the
next decade�primarily through increases in production from the Ekibastuz and
Kansk-Achinsk basins�can now be more clearly viewed as running in place rather
than achieving real growth in energy output.
International Finance
Credit Ratings of Increasing multilateral development bank (MDB) exposure to troubled debtors
Multilateral could gradually undermine the MDBs' high credit standings, making it more
Development difficult for these institutions to finance their lending operations. With the sharp
Banks at Risk cutbacks in commercial bank lending, the MDBs�including the World Bank, the
African Development Bank, and the Inter-American Development Bank�have
become an increasingly important source of funds for LDCs. World Bank
disbursements, for example, rose to a record $11.4 billion in the last fiscal year,
which ended 30 June. At the same time, however, debtor arrearages to MDBs have
also increased. Total arrears to the World Bank, for example, currently total $656
million. Growing arrearages and sustained MDB loan expansion to troubled
debtors could reduce the quality of the MDBs' loan portfolio and impact adversely
on these institutions' commercial borrowings. The World Bank, for example,
finances its lending operations mostly by selling bonds and securities in capital
markets; it currently is the largest nonsovereign borrower of money in the world,
owing investors over $82 billion. While the recent turmoil in international stock
markets may cause investors to look with renewed interest at the MDBs' "triple-
A" rated bond offerings, the investors may demand higher interest rates to
compensate for the MDBs' riskier financial positions.
Venezuela's New
Economic Team
Costa Rica Making
Progress in
IMF Negotiations
President Lusinchi's appointment of well-respected economic advisers Hector
Hurtado and Mauricio Garcia to head the Finance Ministry and the Central Bank
may lead to much-needed policy reforms and pave the way for new foreign loans.
Former Finance Minister Azpurua resigned last week after he failed to secure
foreign financing that Lusinchi and ruling party officials had said had to
accompany the $21 billion public debt rescheduling agreement that Venezuela
signed last month. Hurtado, who has broad political support, may be able to
persuade the government to approve a highly controversial increase in domestic
interest rates to improve Caracas's financing prospects with major lenders.
The IMF is close to approving a $65 million standby agreement for Costa Rica,
but an accord probably will not deflect mounting domestic criticism of President
Arias's handling of the economy. the agreement has tough
economic guidelines, and approval is contingent on Costa Rica making $15 million
in delinquent interest payments to commercial banks. Failure to pass a controver-
sial tax package will jeopardize Costa Rica's ability to meet the standby program's
December economic targets and would delay release of funds, according to the US
Embassy. The press is criticizing Arias for pursuing tax increases to satisfy the
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IMF while neglecting promised social programs. Opposition politicians oppose
austerity measures that do not reduce the public budget, and they are likely to
block or delay tax legislation. In addition, vocal labor factions and business groups
remain critical of Arias's failure to improve education and health services and
build more housing. If the IMF accord is approved, however, private creditors and
the Paris Club probably will renegotiate, and the debt rescheduling and new loans
eventually would give Arias greater flexibility to stimulate growth and meet his so-
cial program obligations.
Hong Kong Futures Local and foreign investors are watching closely as the Hong Kong futures
Exchange exchange faces crippling defaults. The main futures insurance firm has filed suit
Still Threatened against 39 brokers unable to meet $230 million in commitments, with more
defaults expected. The Hong Kong Government initially created a guarantee fund
of $256 million�later doubled�to prevent a large-scale default of the futures
exchange. Beijing's Bank of China, along with several prominent Hong Kong
banks, contributed heavily to the fund. Nevertheless, the licenses of 40 of the 182
futures brokers were revoked after they were unable to meet their margin-call
requirements, and brokers estimate that a guarantee fund of nearly $800 million
will be needed to cover potential defaults. Western investors, already wary
following last week's suspension of the market, could begin to withdraw investment
capital from Hong Kong if the futures market fails to stabilize.
Delay in SWIFT
Capacity Expansion
Cuba Losing Finnish
Trade Credits
SWIFT�the primary electronic global financial communications network�has
announced another delay, until early 1989, in introducing its new system. The
delay of this new system, which would double message capacity, increases concern
among bankers that SWIFT service could be interrupted, constricting global
financial activities. SWIFT officials hope that the addition of another processing
computer to the existing system�adding nearly 200,000 messages to its capaci-
ty�in early 1988 will reduce this risk. SWIFT now transmits almost 1 million fi-
nancial information messages and payment instructions daily to about 2,400 banks
in 60 countries. Operating near its 1.15 million message-per-day capacity, SWIFT
service has been interrupted more than usual in recent months, and we believe this
will probably continue as growing demands tax the system's capabilities.
Havana's failure to repay previous Finnish loans on schedule and its poor
creditworthiness have led Helsinki to cut off any further credit to Cuba for the im-
port of Finnish technology and equipment
Helsinki's move will undercut Cuban economic development plans generally and,
in particular, delay port modernization efforts and the construction of a textile
school. Finland provided Havana with about $6 million worth of intermediate and
capital goods in 1986. Helsinki's decision, which follows similar moves by many of
Havana's larger Western trading partners, is yet another signal that Cuba's
stagnant economic performance will continue.
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Global and Regional Developments
Brazilian-US Brasilia's recent hardline decisions to prohibit US computer firms from introduc-
Informatics Dispute ing their products into the Brazilian market have greatly increased bilateral
Sours Trade Relations tensions over Brazil's informatics policies and are symptomatic of a souring of
overall trade relations. A high-level Brazilian official, recognizing that the Special
Secretariat for Informatics' recent denial of a US firm's petition for market access
may trigger trade retaliation by Washington, advised US Embassy officials that
Brazil will respond in kind if sanctions are imposed. He continued that, in addition
to Brasilia's immediate reaction, nationalistic groups in the Constituent Assembly
probably will seize on US trade policies to justify highly protectionist, xenophobic
measures being prepared for the new constitution, which it is currently drafting.
We expect that other US software firms will face more difficulties. Moreover,
Brasilia may be less flexible on other bilateral commercial talks on issues such as
pharmaceutical patents and may increasingly charge the United States with
protectionism in international forums such as the GATT.
Taiwan Trade Surplus
With US Grows
Despite an 18-percent appreciation of the Taiwan dollar since the beginning of the
year, Taiwan's trade surplus with the United States for the first nine months of
1987 reached $12.5 billion�a 26-percent increase over last year's level. After
record exports in August and September, moreover, overall foreign exchange
reserves have surpassed $69 billion. Taipei believes that, if trends continue, foreign
exchange reserves will top $150 billion by 1992. To counter this, Taiwan has
reportedly mapped out a five-year plan to diversify exports and expand imports.
Although details are lacking, efforts would be likely to center on policies such as
continued gradual reduction of import restrictions, encouraging domestic firms to
buy American products, and increased direct investment in overseas markets. Past
efforts to diversify export markets, however, have had limited success; the US
share of Taiwan's exports has only declined by 3 percentage points this year, and
US markets still absorb close to half of Taipei's overseas sales.
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Soviets Purchasing
Grain From the
United States
The USSR has entered the US grain market for its first major purchase of US
corn-1.5 million metric tons�in the fifth and final year of the US-USSR Long-
Term Grain Agreement (LTA), which runs from 1 October 1987 to 30 September
1988, according to the US Department of Agriculture. This purchase follows an
earlier, small Soviet purchase of 65,000 tons of subsidized US wheat, which
reportedly will be fumigated in transit as a means of trying to solve wheat
infestation problems. Even if the Soviets make additional US grain purchases,
Moscow probably feels no compulsion to meet the terms of the LTA this final year
because it has not done so the last three. Moreover, because Moscow came into the
US wheat market in the 1986/87 LTA year only after the US agreed to subsidize
its wheat at some $40 per ton, Moscow is likely to push for wheat subsidies again
this year. These subsidies, while beginning to recapture lost grain markets, are
generating resentment of the United States for contravening the spirit of the Punta
del Este Agreement, which called for a halt to increased use of subsidies.
Australia�angered by increased use of the US Export Enhancement Program in
selling 4 million tons of subsidized wheat to Moscow during the 1986/87 LTA
year and by increased subsidized sales to other markets�has recently filed a
protest at GATT of the expanded US use of agricultural export subsidies.
Indochina May Vietnam, Laos, and Cambodia have been hit by severe drought and expect
Face Major Food substantial shortfalls in the current rice crop. Laos (b)(3)
Shortages and Cambodia will be hardest hit, as rice production is likely to fall at least 20 per-
cent from last year. Hanoi is anticipating a 5-percent drop in grain production, the
first decline since 1982. The Indochinese countries have no reserves to fall back on.
Moreover, limited foreign exchange and poor credit ratings make importing large
quantities of grain impossible. As a result, the countries would have to rely on for-
eign aid and austerity measures to bridge the gap. Moscow will probably continue
supporting Vietnam by providing rice purchased on the international market.
(b)(3)
(b)(1)
(b)(3)
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Kuwait-USSR Economic
Cooperation Talks
The recent visit of Kuwait's Oil Minister to Moscow has built on the closer
economic and political ties developed between the two countries over the past year.
The US Embassy reports that Kuwait and the Soviet Union agreed to create a per-
manent Soviet-Kuwaiti commission that will consider projects in oil and gas
industries, health care, banking, and construction in Kuwait, the Soviet Union, and
Third World countries. Kuwait will probably move ahead on several energy-
related projects with the Soviets, but the extent of the relationship will be
constrained by the poor rate of return on such arrangements and the relative
inferiority of Soviet goods.
Indo-Soviet New Delhi will probably continue to support the Tehri Dam project, although the
Power Project Soviet-financed project has come under fire from Indian ecologists for safety
Under Fire reasons. The power project is the cornerstone of the bilateral economic cooperation
agreement negotiated during Gorbachev's visit to India last November. After
completion, the dam�which will be located in India's most populated state of
Uttar Pradesh�is expected to increase the state's total power generating capacity
by 50 percent, irrigate 270,000 hectares of land, and store water during peak
discharge season to control flooding. Indian ecologists, supported by international
surveys, claim that the project is a high-risk venture because it is situated in a seis-
mic-sensitive area. The project was dropped in the 1960s for safety considerations.
The generous financial assistance offered by the Soviet Union combined with
India's rapidly increasing power needs are prompting New Delhi's decision to
support the project. Although Moscow shares some of the reservations expressed
by Indian environmentalists about the project's difficulty, the Soviet Union will
continue with the construction plans, viewing the project as an opportunity to
compete with the West and display Soviet technical know-how.
Secret
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Secret
National Developments
Developed Countries
Mixed Signals on Recent decisions by Japan's financial authorities provide mixed signals about the
Japanese Monetary, direction of monetary policy. The Bank of Japan early last week moved to increase
Policy liquidity�and thus lower interest rates�to cope with the plunge on the Tokyo
Stock Exchange, but by week's end the Finance Ministry approved a 0.4-
percentage point rise in the interest rate paid on postal savings and national
pension premiums. The postal savings rate hike, which took effect on 27 October,
also increases the base loan rate charged by government financial institutions such
as the Japan Development Bank and the Housing Loan Corporation, which could
dampen investor enthusiasm for some of the infrastructure and housing projects
included in last spring's stimulus package. Moreover, commercial banks are likely
to push for similar increases in the rates they can pay depositors in order to prevent
a loss of deposits to the $780 billion postal savings system. We suspect the Finance
Ministry probably agreed to the higher rates because it feared that without it the
funds received from the postal savings system would be insufficient to finance the
increased public works spending and recycling of funds to LDCs that Japan has
promised in recent months. However, the decision will be difficult to reverse and
may limit Tokyo's maneuvering room if the volatility in financial markets
continues.
French Government
To Write Off
Renault Debt
French Privatizations
Delayed
The US Embassy reports the French Government plans to write off up to $2 billion
in Renault debt it holds as part of a restructuring of the troubled finances of the
state-owned car company. Legislation will also be introduced to change the
company from a state agency�which protected the company against bankruptcy
and virtually guaranteed it unlimited state aid�to an ordinary limited-liability
company, although it will remain state owned. The plan could run into opposition
from the EC and the private Peugeot-Citroen car group, who see any state bailout
as risking serious distortion of competition in the car market. Renault is expected
to show a profit on operations this year after six years and $5 billion of cumulative
losses. If accepted, the government's refinancing plan could eventually lead to
partial privatization of the company.
French Finance Minister Balladur announced last week that the sale of the
government's 51-percent share of the defense and electronics group Matra would
be delayed by the recent stock market turmoil. While the conservative govern-
ment's entire privatization program has come under severe criticism by the
opposition socialists, Balladur stressed that the delay would only be for a matter of
days or a few weeks, depending on market conditions. So far the privatization
program has been one of if not the most successful of the government's economic
programs. In less than a year, 23 of the 65 companies slated for privatization have
been sold, earning the government about $8.5 billion in net proceeds. The money
has been used to reduce government debt and to inject capital into some of the
weaker nationalized companies. Prime Minister Chirac is counting on the success
of the privatization program to help him in the presidential election next spring
and will be interested in having further successful sales before then.
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Less Developed Countries
Strains in Egypt's According to the US Embassy, a significant share of the estimated $3-4 billion
Foreign Exchange workers remit annually is now accumulating outside Egypt, possibly because of the
Regime government disruption last May of the private, or unofficial, foreign exchange
market. Meanwhile, the lack of an effective interbank exchange market to
distribute existing foreign exchange more equitably is preventing many importers,
primarily in the private sector, from obtaining letters of credit. Government plans
to go ahead with accommodating debt obligations and private individual require-
ments for foreign exchange within the existing bank pool may only exacerbate the
current credit crunch. A sizable devaluation of the existing bank-pool rate may be
needed to balance supply and demand for foreign exchange. Despite government
assertions that it will allow market forces to determine the bank-pool rate, we
believe the potential inflationary impact of such an action on Egyptian living
standards may dissuade Cairo from acting. Unless some steps are taken, however,
Egypt's normally vibrant private-sector economy may experience a recession and
the viability of the IMF standby accord may be eroded.
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Secret
Thailand Revises Led by strong growth in manufactured exports and Bangkok's aggressive export
Economic Forecast diversification program, Thailand's Central Bank expects real GDP to rise by 6
Upward percent in 1987, compared with its earlier projection of 5.5 percent. Although the
economy is on the road to recovery from last year, when growth slowed to a
mediocre�by Thai standards-4 percent, the Bank's upbeat forecast may be
timed to restore business confidence following the Bangkok stock market's crash
last week. The Bank is projecting a $400 million current account deficit for
1987�imports are likely to be one-third higher than in 1986�after a modest
$222 million surplus last year, but increasing capital inflows may boost interna-
tional reserves to an unprecedented $5 billion.
Tunisia's
Current Account
Deficit Improves
Botswana To Mine
Soda Ash
Tunisia's current account deficit for the year will be approximately $340 million,
equal to about 4 percent of GDP and approximately one-half the level in 1986, ac-
cording to projections by the US Embassy in Tunis. During the first eight months
of the year nonoil exports were up 39 percent, tourism receipts increased 37
percent, and worker remittances increased 51 percent compared with the corre-
sponding period last year. Import growth was limited to about 6 percent, mainly
because of a near-record grain harvest and lower prices for food imports. We
believe the increase in exports and tourist earnings�tourism is one of the sectors
stressed in the development program�largely reflects the progress Tunis has
made in implementing its structural adjustment program. As a result of the
improvements and greater access to long-term borrowing, foreign exchange
reserves have increased to about two months of import coverage.
Botswana's plans to mine and export natural soda ash from a large deposit at Sua
Pan are likely to succeed following Pretoria's recent assurances of preferential
tariff treatment for soda ash sales to South Africa. According to press and US
Embassy reports, about 15 percent of Sua Pan's projected annual output of
150,000 metric tons probably would be marketed in Zambia and Zimbabwe for
use in the glass, paper, and steel industries. The remainder would be exported to
South Africa, which imports all of its nearly 300,000-ton annual consumption,
one-half of it from US producers. Gaborone believes that it has deflected
Pretoria's attempt to obtain political and security concessions in exchange for
South African protection of soda ash imports under a customs union agreement
between the countries. Gaborone remains concerned, however, over efforts by a
US export cartel�that now provides one-half of South Africa's soda ash
imports�to block the Sua Pan project. Pretoria has publicly accused the US
producers of waging "economic war" on Botswana and challenged the United
States to prevent the cartel from interfering with Botswana's development.
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USSR: Grain Imports, 1978-87 a
Million metric tons
� United States
ri Canada
El Argentina
El European Community
Australia
1-7 Other
60
0 1978-82 b 83 84 85
a Data based on marketing periods ending in June of the stated
year. Includes wheat and coarse grains.
b Annual average.
C Estimated.
86
87C
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Communist
Good Soviet
Grain Crop
East European Harvest
Results Mixed
The USSR had its second consecutive good grain harvest this year. Improved
growing conditions throughout most of the country from late spring through
summer made it possible for farmers to overcome earlier weather problems. The
grain crop will be about 205 million metric tons, 5 million tons below 1986 but
about 15 million tons above the average of the last 10 years. A crop of this size
would reduce Moscow's import needs for the 1987-88 marketing year to about 20
million tons, compared with roughly 30 million tons purchased in each of the last
two marketing years. If the Soviets opt to take advantage of low world grain prices,
however, imports could reach 25 million tons. Moscow can satisfy most of its
import requirements from non-US sources, and is not likely to buy any US wheat
without a substantial price subsidy. The United States is in a good competitive po-
sition, however, to supply the major share of Soviet corn needs.
Smaller harvests this year will add to economic strains in the southern countries of
Eastern Europe, while most of the northern countries will benefit from increased
grain production. Harvests in Yugoslavia, Bulgaria, and Hungary are likely to be
slightly below average because of drought and reduction of sown areas. In
Romania, grain output probably will be about average, but cold weather and dry
conditions reduced other crops, such as potatoes. Grain production in Poland, East
Germany, and Czechoslovakia was above average, but the harsh winter damaged
fruits and vegetables, particularly in Poland, leading to some consumer shortages
much of the year. Already poor food supplies in Romania will worsen and may
lead to local demonstrations if Bucharest continues to export food at current high
levels. Yugoslavia and Bulgaria probably will need to import more grain than last
year and reduce agricultural exports; this course will damage Belgrade's already
weak hard currency position. In Hungary, grain exports will also be down,
although supplies are sufficient for domestic needs. Better harvests in recent years
for Poland reflect increased incentives for private farmers, a trend that may be
strengthened by President Jaruzelski's reform program.
(b)(3)
(b)(3)
Rapid Growth for Chinese officials credit structural reforms and investment in new technology for
Chinese Electronics the boom in the country's electronics industry. The Chinese press reports the
Industry industry's output reached $8.4 billion for the first nine months of 1987, and
officials expect annual production to register a 33-percent increase over last year,
with exports quadrupling, placing enterprises under (b)(3)
local rather than central government control and introducing financial account-
ability proved to be powerful incentives on the heels of large investments in new
production technology during 1984 and 1985. Earlier plans, however, to refocus
the product mix on capital goods in order to curb the overheated growth of
consumer goods�currently about 70 percent of the total�apparently have yet to
take effect. (b)(3)
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Cambodian Currency
Devaluation
Phnom Penh, for the second time in less than two years, has implemented a major
devaluation of its currency. According to press reports, the riel was recently
devalued by almost 70 percent against the US dollar, apparently in an effort to
counter black-market trading and encourage international donor organizations
into providing more financial assistance. The new official rate of 100 riels per
dollar is much closer to the black-market rate of 130 riels to the dollar. Although
the devaluation may stimulate some exports, Phnom Penh�unlike its patron
Hanoi�shows no sign of introducing the kind of reforms needed to reverse the
country's downward economic spiral. In addition, Cambodia is almost certainly
worse off than Vietnam to the extent that it lacks the managerial skills to carry out
reforms.
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