(SANITIZED)

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP83M00914R000500070006-8
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 5
• Document Creation Date: December 19, 2016
• Document Release Date: September 21, 2006
• Sequence Number: 6
• Publication Date: April 18, 1982
• Content Type: MEMO

Approved For Release 2006/09/21: CIA-RDP83M00914R000500070006-8
Approved For Release 2006/09/21: CIA-RDP83M00914R000500070006-8
 The Soviet Bloc Hard Currency
Problem
Introduction
A fundamental reassessment of the risk of lending to
Soviet Bloc countries has curtailed those countries'
access to Western private credit and made some of the
remaining credit flows vulnerable to new negative
developments. The Soviet hard currency position has
worsened greatly in recent months. The USSR is in
the midst of a short-term liquidity problem, due partly
to bad crops and the Western recession. With large
assets (gold reserves of 1,825 tons worth some $20
billion at a price of $350 an ounce) and small fixed
obligations (long- and medium-term debt service re-
quirements of $2-2.25 billion a year, or less than 10
percent of merchandise and arms exports), Moscow
has the flexibility to cope with this problem. But a
fundamental long-term problem will remain-the
USSR's hard currency exports are likely to stagnate
or fall, with the result that hard currency imports will
also stagnate-or decline unless the West is prepared to
provide substantially more credit than in the past.
Eastern Europe's hard currency position is far worse
than the USSR's. Most East European countries
either cannot meet their hard currency obligations or
must make severe economic adjustments to do so.
The severe deterioration of the Soviet and European
hard currency positions has been due to the following
factors:
? Increasingly evident systemic deficiencies, resulting
in declining growth of productivity.
? The logical implications of the rapid accumulation
of hard currency debt in past years-a process
which obviously could not continue unless hard
currency earnings were also growing rapidly, which
they are not.
? In the Soviet case, and to a much lesser extent the
East European countries, events outside their con-
trol (Western recession, bad crops, lower oil and
gold prices).
? The Polish political crisis and economic collapse and
its fallout.
? The general worsening of East-West relations, espe-
cially in the past year.
Western government policies played a role in encour-
aging the accumulation of Soviet and East European
debt by providing credit on easy terms during the
1970s. Without Western government encouragement;
private bank exposure would not have increased to the
extent that it did. In the past few months, the
possibility that Western governments might restrict or
discourage credit to Eastern Europe has created add-
ed uncertainty in financial markets and has further
discouraged bank lending.
The Crisis of 1981-82
Following two years of soaring foreign exchange
earnings as a result of the 1979-80-oil price rise and
continued increases in arms sales, Moscow suddenly
encountered a severe hard currency bind in the latter
part of 1981. The Soviets probably expected some
worsening in their hard currency position during the
year, but the speed of the turnaround appears to have
caught them by surprise. The following appears to be
a plausible reconstruction of events:
? In the first quarter, Moscow gave Poland nearly $1
billion in emergency hard currency aid.
? Oil prices unexpectedly began to fall so that Mos-
cow had to revise downward its expected earnings
from oil exports.
? A third successive bad grain crop forced Moscow to
buy even more grain, meat, and soybeans than had
been planned.
? The weakening of the Western economies after the
first part of the year reduced the demand for Soviet
exports.
1 Secret
 These unexpected expenditures and shortfalls were
probably responsible for the precipitous decline in
Moscow's hard currency assets in foreign banks from
$8.6 billion at the beginning of 1981 to only about
$3.5 billion six months later. The mid-1981 level
appears to be the lowest for at least 10 years relative
to Soviet hard currency imports, being equivalent to
only about one month's imports. Moscow must have
concluded that a severe liquidity problem had devel-
oped and had to take some drastic action immedi-
ately.
The Soviet Policy Reaction
During the final quarter of last year, Moscow took the
following steps to quickly improve its hard currency
position:
? Selling large amounts of gold, despite a weakening
market. After largely staying out of the market for
the first three quarters of 1981, Moscow sold an
estimated 200 tons between August and the end of
1981 (twice the amount sold in all of 1980) and at
least 50 tons through mid-February 1982.
? Increasing its use of short-term credit.
? Severely rationing expenditures for hard currency
imports other than food, by requiring additional
authorization and controls throughout the Soviet
economic decision structure.
Moscow has not entered the Eurodollar market for
mid- or long-term nonguaranteed bank credits as it
did in 1975 when faced with a similar foreign ex-
change crunch. One can only speculate as to the
reasons. Many Western bankers have been reluctant
to make new large Eurodollar syndications to the
USSR. Even so, Moscow probably could obtain Euro-
dollar credits, but on less favorable terms. That it did
not do so may be due to a desire to avoid the
widespread publicity that such a step would have
stimulated in view of the situation in Poland and the
tense state of East-West relations generally. There
would have been speculation in the Western press that
the Soviets were borrowing money to pay off Polish
debts; others would have pointed to the borrowing as a
sign of Soviet economic weakness and vulnerability to
Western government pressures. In recent months, the
Soviets have been investigating borrowing possibilities
in Arab banks, apparently with little success as yet.
Short-Term Prospects
The emergency measures adopted late last year al-
most certainly enabled the Soviets to return their
liquid hard currency assets to more normal levels, but
did not eliminate the need for various other forms of
extraordinary financing to meet expenditures in 1982.
Forces beyond Moscow's control are even less favor-
able to Moscow's hard currency situation this year
than they were last year.
? Oil prices are continuing to fall.
? Demand and prices for Soviet exports are probably
also falling.
? Moscow's food import bill will probably be a billion
dollars or so higher than last year.
Since other major balance-of-payments items-arms
sales, service receipts and payments, and so forth-
are unlikely to change much, this means that unless
nonfood imports are cut very sharply indeed, Moscow
will have to sell substantially more gold or borrow
more short-term capital than last year.
It is impossible to know what combination of import
cuts, short-term borrowing, and gold sales Moscow
will select. For example, if the Soviets cut their
nonfood imports by 10 percent in volume (which,
given higher prices, would mean little change in
value), with exports down and food imports up, their
trade and current account deficits would be some $2
billion larger than last year. By selling their net
annual gold production of 275 tons, worth a little
more than $3 billion at $350 an ounce, they would
still have to borrow about $3 billion in short-term
credits to cover the deficit. This is by no means
infeasible, although the interest cost would be high.
__ .. I I- 17K-K5FMMUM_T4EUULJt~ ~= '8
 Approved. For. Release 2006/09/21.: CIA-R DP83M00914R000500070006-8
Short-term borrowing is a reasonable means of filling
a financial gap fora year or so, but obviously not over
much longer periods. Import cuts, too, would be
viewed differently as a means of coping with a brief
foreign exchange shortfall than as part of a longer
term problem. The USSR, like most bureaucracies,
tends to spread short-term cuts fairly evenly among
users, except for a few priority areas like food. Over a
longer period, priorities among different types of
imports and their uses would have to be much more
carefully worked out.
Moscow probably believes that the foreign exchange
bind is partly a temporary phenomenon. There is a
reasonable basis for Moscow to hope that Soviet grain
crops will return to normal or better, which would
make some reduction .in food imports possible. In
addition, the likely cyclical upswing of the Western
economies during 1983-84 should increase both the
price of and the demand for Soviet exports. These
factors alone could add several billion dollars to meet
Moscow's other hard currency needs.
The Long-Term Bind
Even with some likely improvement in the hard
currency position during the next year or two, the
USSR faces a scarcity of hard currency through the
1980s. The chances are that the volume of Soviet hard
currency exports will stagnate or decline during the
coming decade. Specifically:
? The volume of Soviet crude oil exports has been
declining for three years and, with domestic oil
production likely to be at best constant, and at worst
in steady decline, it will be extremely difficult to
prevent a further drop, and eventually perhaps a
complete cessation, of oil exports for hard currency.
? Gas exports will continue to increase-but not on a
large scale until the Yamal Pipeline can be complet-
ed-which will probably not be before the latter
part of the decade. Even then the increase in gas
exports will probably less than offset the decline in
oil exports.
? Arms exports for hard currency appear to have
leveled off for lack of large new clients. Even
current large customers, such as Libya, may have to
pare purchases if oil export revenues continue to
decline.
? Other Soviet exports (wood, metals, manufactures)
are likely to stagnate because of supply limitations
and Soviet inability to adapt to Western market
needs.
Without the Yamal pipeline a sizable decline in
exports would be inevitable, even if Moscow redirect-
ed some of the gas to its own and Eastern Europe's
use in order to free some oil for export to the West.
With the pipeline and some good luck in oil develop-
ment, the volume of hard currency exports may be
held about constant.
Moscow's main hope for sizable increases in hard
currency earnings would be another large jump in the
prices of oil, gas, and gold-in the case of oil, an event
that appears unlikely in the next two or three years,
but increasingly likely during the second half of the
1980s.
If Soviet hard currency earnings are stable or declin-
ing in the long term, Moscow will need to increase its
new borrowing from the West to avoid a decline in its
hard currency import capacity. Soviet debt service
payments will slowly increase, reflecting the past
growth of new credits; consequently, if drawings on
Western long- and medium-term credits remained
constant, the net inflow of long-term Western capital
would slowly decline, and import capacity would fall.
A constant or declining hard currency import capacity
would pose serious problems for Moscow. In the 1980s
slower economic growth will present the Soviet leader-
ship with increasingly tough and politically painful
choices in resource allocation and economic manage-
ment. Annual increments to national output will be
too small to simultaneously meet mounting invest-
ment requirements, maintain growth in defense
spending at the rates of the past, and raise the
standard of living. Simply stated, something will have
to give. The Soviet need for Western goods and
 Approved For Release 2006/09/21: CIA-RDP83M00914R000500070006-8
c'nology will th
te
erefore increase greatly. Imports
can relieve some economic problems by raising the
technological level of key Soviet industries and by
reducing shortages of grain and such important indus-
trial materials as steel. Western equipment and know-
how will be particularly important to raising produc-
tivity in the critical machine-building and energy
industries. The Soviets must continue importing large
amounts of agricultural products and will probably
expand their purchases of steel and some other indus-
trial materials.
The East European Hard Currency Problem
East European countries' hard currency problem is
far more severe than the USSR's. Their gold and
foreign exchange assets are minimal and their debt
service obligations are enormous. Leaving aside Po-
land, which is in a class by itself, East Germany has a
debt service ratio above 60 percent, and the rest,
except Czechoslovakia, are all aboveafpercent.
These ratios put the East European countries in the
same class as Brazil, Mexico, and Chile, countries
with far more flexible economies and generally rapid-
ly increasing export earnings.
Poland aside, the fact is that Romania cannot meet its
obligations, and that East Germany could not achieve
any substantial reduction in its indebtedness without
wrenching economic adjustments. Hungary, too,
would have great difficulty reducing its debt. Even if
existing debt were just rolled over, the East European
economies would at best limp along with little or no
economic growth for the next several years. It is
important to keep in mind that Western credits played
an important role in financing a large increase in
investment in nearly all East European countries
during the 1970s, and that this investment was an
important factor in sustaining tolerable, if generally
slow, growth rates. This important prop for inefficient
economies has disappeared.
The Soviet-East European Connection
Soviet-East European economic relations rarely in-
volve transfers of hard currency. Last year's Soviet
hard currency aid to Poland was clearly viewed as an
exceptional step, outside the normal framework of
economic cooperation and aid. Some trade is paid in
hard currency, but the net flows are probably small.
More basically, Soviet trade with Eastern Europe
helps to knit the Soviet empire together, but at
substantial cost to Moscow. By denying East Europe-
an countries the possibility of developing economies
and economic systems that could be reoriented mainly
toward the West, Moscow has little choice but to
provide some direct and indirect forms of aid. The
direct aid is in the form of credits on bilateral
account. The indirect aid takes the form of delivery of
undervalued Soviet raw materials and foods in return
for overvalued East European manufactured goods.
Many of the Soviet exports are sold on the world
market and some of them, notably oil, are sold to
Eastern Europe far below world market price. Most of
the East European exports can be sold on world
markets only at severe discounts, if at all, but the
Soviets pay world market prices for them.
A worsening of the East European hard currency and
economic situation is bound to impose additional
burdens on the USSR. Moscow simply cannot afford
to let the East European countries go begging to the
West by themselves, or alternatively to let their
economies deteriorate to the point that serious politi-
cal consequences could follow. Additional Soviet as-
sistance to Eastern Europe may or may not take the
form of hard currency, but even if it did not, there
would be indirectly an unfavorable impact on the
Soviet hard currency position.