DISCUSSION PAPER: YUGOSLAVIA

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP83M00914R000500110012-6
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 13
• Document Creation Date: December 21, 2016
• Document Release Date: June 11, 2008
• Sequence Number: 12
• Publication Date: November 15, 1982
• Content Type: MEMO

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CONFIDENTIAL
With SECRET Attachment)
Interagency Group No. 29
With SECRET Attachment)
DECL:OADR
OVP
NSC
Mr. Donald P. Gregg
- Mr. Michael O. Wheeler
Agriculture
- Mr. Raymond Lett
25X1
CIAO
Commerce
Defense
Mrs. Helen Robbins
COL John Stanford
EXIM Bank
Mr.
William H. Draper, III
OMB
Mr.
Alton Keel
Treasury
Mr.
David Pickford
USTR
Mr.
Dennis Whitfield
Federal Reserve
Mr.
Charles Seigman
SUBJECT: Discussion Paper: Yugoslavia
Attached is a discussion paper for use at the IG meeting
November 15. This is an interagency draft and is subject to
further amendment at the meeting.
United States Department of State
Washington, D.C. 20520
November 15, 1982
. Paul Bremer,
Executive'Secretary
Discussion Paper
State Dept. review completed.
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CONFIDENTIAL
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United States Department of State
Washington, D.C.
20520
November 5,
1982
SECRET
(With SECRET/SENSITIVE Attachment)
Interagency Group No. 29
TO OVP
NSC
Agriculture
CIA
Commerce
Defense
EXIM Bank
OMB
Treasury
USTR
Mr.
Mr.
Donald P. Gregg
Michael 0. Wheeler
Mr.
Raymond Lett
Mrs.
Helen Robbins
COL
- Mr.
John Stanford
William H. Draper,
III
- Mr.
Alton Keel
- Mr.
David Pickford
Mr.
Dennis Whitfield
SUBJECT: Interagency Group on Yugoslavia
A meeting of the Interagency Group on Yugoslavia is
scheduled for Tuesday, November 9 at 2:30 p.m. at the Depart-
ment of State, Room 6226. A representative from each addressee
agency is invited to attend. Attached is a paper for your con-
sideration before the meeting.
L. Paul Bremer, III
Executive Secretary
DECL:OADR DC!
EXcC
SECRET
(With SECRET/SENSITIVE Attachment)
!2 A
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United States Department of State
1Vashin ton, D.C. 20520
SECRET/SENSITIVE
DISCUSSION PAPER:
YUGOSLAVIA-- CONSIDERATION OF ASSISTANCE MEASURES
Yugoslavia is in deep economic trouble. Two and one-half
years after the death of Tito, the country is at a political
and economic crossroads. How we respond now to Yugoslavia's
pressing economic problems and related political concerns will
be critical factors in whether U.S. interests in this key
strategic-country can be sustained in the near and medium term.
This paper is designed to provide the basis for a
comprehensive strategy for dealing with U.S.-Yugoslav relations
over the next few years.- It.reviews the, economic/political
problem; our strategic interests; and measures we could -hake in
the economic, military and political fields. Ultimately it
will become an NSSD for Presidential consideration and decision.
ECONOMIC SITUATION
The Yugoslav economy is in a severe liquidity crisis and
may be approaching.default on its international obligations.
Industrial output is sharply falling, energy consumption is
being rationed and a sharp decline in short-term and
medium-term lending by major international banks has dried up
liquidity essential to the normal functioning of the economy..
U.S. bankers and other close observers seem agreed that,
barring a massive rescue effort, Yugoslavia may have to face
general rescheduling of its Western debt - perhaps in early
1983.
External borrowing to finance burgeoning burrent account
deficits in the late 1970's pushed Yugoslavia's convertible
(hard) currency debt to nearly $20 billion. The GOY has acted
decisively to correct internal and external imbalances, signing
on to a $1.8 billion, 3-year IMF standby in 1980. Moreover,
the Yugoslav debt service ratio, at 25%, is not excessive.
However, the ripple effects of the Polish crisis and sloppy GOY
foreign exchange management (failure to deal effectively with
commercial bank arrears) has sparked an abrupt decline in
private lending, including the withdrawal of short-term
deposits/lines of credit, and resulted in a swift depletion of
official foreign exchange reserves.
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Western European and Kuwaiti banks continue to provide to
Yugoslavia modest amounts of medium term funds--about $500
million in.CY 1982. The UK and Canadian banks are standing.
back. The GOY--may soon regain access to US, and Japanese
markets. A..$200 million Citibank-led syndicated loan should be
concluded soon, subject to the elimination of small remaining
arrears of a major Croatian commercial bank, Privredna Banka
Zagreb (PBS)-. However, the difficulty experienced in scraping
the package loan together, and the fact that the participation
of the New York agency of a Yugoslav bank was necessary to put
the loan over the top, will dilute the hoped--for image of
improved market receptivity and the positive catalytic effect
on other private lenders.
The financial strain will not abate in 1983. Even if the
full year current account is in balance, as expected, Yugoslav
financing needs will exceed $4.0 billion. Due to the seasonal
pattern of the Yugoslav balance-of payments, the entire
financing requirement for the year appears in the first half.
The IMF estimates first half needs of $4.25 billion--a current
account deficit of $1.25 billion; and principal payments of
$3.0 billion, of which $1.8 billion is on short-term debt. The
IMF figures are consistent with BIS and CIA projections.
The only readily identifiable source of financing for 1983
is the expected IMF/IBRD disbursement of about'$1.0 billion.
Continued private lending at 1982 levels (about $700 million)
and a rollover of all short-term debt would be necessary to
reduce the Yugoslav financing gap to $750 million. The risk is
that Yugoslavia could rapidly accumulate arrearages in the
first half of 1983, scuttling the IMF program, and shattering
what is left of private market confidence. The immediate next
step would be a general debt rescheduling. i
POLITICAL ASPECTS OF RESCHEDULING
Yugoslav top political leaders remain adamantly opposed to
any major rescheduling. This point was made forcefully by
Yugoslav Foreign Secretary Mojsov in his October 4 meeting in
New York with Secretary Shultz. The reasons are more political
than economic. While we may not agree with all the Yugoslav
reasoning, the political implications for the West of a
worsening Yugoslav economic crisis are serious.
Yugoslavia's decentralized economic, and banking system
would make a general rescheduling a complex and intrusive
undertaking. It has complicated efforts to implement economic
reform. The existing system of autonomous regional banks
reflects Yugoslavia's delicate internal political balancing
act. GOY leaders are now convinced that regional financial
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transactions must be better coordinated and backstopped. There
is also serious attention being given to the. need to
restructure the Yugoslav economy to be more efficient and
competitive -- more::market-oriented. The Yugoslavs' ability to
carry out structural reforms of this magnitude depends on
getting over the near term debt hump, since in current
circurrst'ances the GOY cannot afford the luxury of adopting a
long-term f'ccus. It is hoped to achieve all this without
turning the clock back on decentralization in general, which
has become a Yugoslav political hallmark. The current
leadership is caught in the middle. It wants to exercise
increased central control over fiscal matters in a way which
does not spill over into other areas. There. is concern that a
general rescheduling would be accompanied by outside pressures
for central controls going beyond what is politically
tolerable. (Obviously, even without general rescheduling,
outside assistance to Yugoslavia will be conditioned, as it
already--ha-St- on meeting inter-national lending
criteria.) -
As a coalition of historically-warring national groups-and
economically-disparate regions, Yugoslavia is not easy to
govern - especially by committee - even in good economic
times. Growing economic strains could interact with the latent
nationality problem, leading to- increased domestic unrest. The
choices before the top Yugoslavs over the next few months pose
a serious test of the post-Tito leadership and perhaps the
greatest challenge since the 1948 break with Stalin. If the
present market-oriented leaders are.di.scredited,._the old-style,
directed-economy types would be in a position to pose a serious
challenge, threatening- to undo progress over the years in that
country's gradual dernocratiz evolution.
The Yugoslav leaders are also concerned about the broader
implications of reaching an economic nadir in which
rescheduling becomes necessary and of what is seen in
Yugoslavia as a Western refusal to help. Webare already
hearing comments from influential Yugoslavs that the West has
decided to "abandon" Yugoslavia.. Some of this is a form of
pressure, but most of these persons are well-disposed to the
West and all of them want Yugoslavia to remain truly nonaligned
and politically and economically independent of the USSR. GOY
leaders have watched with concern the expansion of the Yugoslav
trading relationship with the Soviet Union, as Yugoslavia's
ability to buy and sell in Western markets has stagnated or
diminished.
For all of these reasons, the Yugoslav leaders view the
prospect of general rescheduling not as a new beginning or
fresh start but.as a formal admission of failure. Directives
from outsiders regarding conditions to be met for rescheduling
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would be.a serious blow to Yugoslav pride. One cannot predict
how serious the "abandonment" syndrome will become, or how this
will change attitudes within Yugoslavia toward the West and the
U.S. in particular.?. The top leaders are deeply worried,
however, that rescheduling will be widely interpreted outside
Yugoslavia -as symbolizing the failure of the vaunted Yugoslav
alternative to?traditional, centralized communist control. It
would also, in 'their view, project economic and leadership
weakness so serious as-to leave the country vulnerable to
outside pre:ssures.- Foremost, of course, is concern. over
potential Soviet pressures for concessions in political and
military areas.
YUGOSLAV ADJUSTMENT EFFORTS
GOY top political leaders still hope that something can be
done to give their economy a-boost and avoid reaching the point
where general eschQduling is unavoidable. Unpopular domestic
measures have been taken. The GOY has acted firmly _to compress
the domestic economy and to reduce the current account
deficit. In the past two years, it has adhered to the
conditions of its three-year IMF stand-by agreement and is in
the process of negotiating the terms `of the third and final
leg. Setting the stage for the third year of the IMF program,
the GOY has devalued the dinar-by a further 20%, raised
interest rates and taken further steps to control the growth of
credit and nominal incomes. Gasoline has been rationed and
politically-explosive disincentives have been placed on travel
abroad and withdrawals from individual hard currency accounts.
However, private markets remain unconvinced of the GOY's
capacity to manage this situation, and with good reason.
Frequent payments delinquencies and uncoordinated requests for
mini-reschedulings by some regional commercial banks
(especially PBZ), together with the GOY's failure to provide
timely and accurate economic information, have turned off
private lenders. The primary constraint. on iinproved Yugoslav
performance in this area is, as noted above, the Yugoslav
domestic political situation and structure.
Moreover, GOY requests for official financial assistance,
at least in their initial form, lack realism. The Yugoslavs
recently approached the BIS informally concerning their
interest in obtaining $500 million in four-year money. Central
bankers, stressing the short-term nature of BIS arrangements
(Mexico and Hungary obtained maturities of only three and six
months, respectively), reacted negatively and suggested that,
when a formal request is made, it be more realistic. The GOY
has not yet come back, awaiting first the completion of the
current IMF review assessment.
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The_Yugosla.vs recognize that their independence hinges on
internal stability and the country's economic viability. They
also believe that American perceptions and interest coincide
with their own in this respect. This seems to explain why the
leadership, despite-. its suspicions and desire to avoid
dependence on either "super power", has turned first to us.
Examples include then-President Kraigher's meeting with the
President at Cancun, Foreign Secretary Mojsov's
Westward-looking inaugural foreign policy address this summer,
and President Stambolic's.July letter to the President asking
that he support Yugoslavia's loan effort.
U.S. INTERESTS:
Yugoslavia's unity and stubborn independence of "blocs'
serves our strategic interest in the Balkans and Mediterranean
as well as our political interest in encouraging the
attenuation and eventual dissolution of the Soviet empire:
a. Geopolitical
The Adriatic is an open sea, the Warsaw Pact is denied
bases there,, and the Soviet threat to NATO allies Greece and
Italy and to the Middle East is, as a consequence,
-substantially'less. Yugoslavia controls the only air corridor
from the Warsaw Pact to the Mediterranean and the Middle East
through non-NATO airspace. The Soviets are denied Adriatic
airfields. Thus they have no tactical air support for the
Soviet Mediterranean Fleet. The Yugoslav ground defense is
primarily geared to repelling an attack from the Warsaw Pact.
It is presumably determined to block any move through northern
Yugoslavia by Pact forces seeking to enter northern Italy via
the Gorizia Gap.
b. Economic
U.S. economic interests in Yugoslavia arj substantial. The
Yugoslavs have purchased billions of dollars worth of U.S.-made.
industrial equipment, agricultural products, and manufactured
goods ($6.3 billion since 1965). The presence of well-known
U.S. and other Western products throughout the country
constantly underscores the efficacy of the industrial
democracies in producing a rising standard of living and the
material well-being associated with Western life. Seeing this,
the Yugoslavs have continued to work toward a. market-oriented
economy, seeking to stimulate-their firms to greater
efficiencey through competition with foreign firms both in
export and domestic markets. Foreign private investors are
welcomed, and the U.S. is the largest foreign equity investor
in Yugoslavia. Yugoslavia is a full member of the GATT, the
IMF, and the World Bank. All this takes place under a system
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that is nominally socialist, greatly magnifying the Yugoslav
example's impact on its neighbors to the East.
c.Political
Yugoslavia, the prize that eluded Stalin in 1948, has not
been forgotten in the Kremlin. The U.S. gave Tito the help
that was essential to keep Yugoslavia independent while he
began the. slow process that has resulted in opening Yugoslavia
to the Wes} and permitted evolution in the direction of
pluralism, and fostered receptivity to Western attitudes and
culture. As a result, Yugoslavia-is now well along a course
that is the envy of the Eastern European countries of the
Warsaw Pact (with the partial exception of Hungary), and has
made significant progress toward liberalization. What happens
in Yugoslavia has obvious implications for future developments
with respect: to Romania and other Eastern European countries.
A protracted Yugoslav economic crisis accompanied-by a loss
of faith in the West could lead that country in several
possible directions, none of them in our interests. At a
minimum, the Yugoslav model would stand as a less powerful
example of the benefits of pluralism'-for the communist world. A
prolongation of Yugoslavia's problems could threaten that
country's independent course and seriously weaken Yugoslavia's
ability to withstand Soviet pressures for political and
military concessions.
OVERALL POLICY
.In sum, it is in the strategic interest of the United
States to preserve the independence and territorial integrity
of Yugoslavia, and to promote its gradual liberalization and
integration into the West. This has been our basic policy for
three decades. We now face a critical juncture in ensuring its
success.
There is only so much that the USG can do to help the
Yugoslavs economically and to bolster their confidence in our
general support. Much depends upon the U.S. and international
commercial banking community, over which we have no control.
Other Western countries have as great a stake as we do in
preserving Yugoslavia as..an independent bulwark and as an
alternate model for the communist world. There are,
nevertheless, certain areas in which the USG is already
involved and require urgent attention:
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a. Economic/Financial
-- U.S. support for a Bank for International Settlement
(3IS) facility. The Yugoslavs have informally raised the
cuestion of a $500 million BIS facility. Pursuit of this
request must await an IMF approval of the next IMF tranche,
anticipated following a visit within the next several weeks to
Yugoslavia of an IMF team.
Commodity Credit Corporation (CCC) credits could ease
the hard currency burden for needed imports this year of wheat,
cotton, soy beans, vegetable oils, and soybean meal.
Eximbank facilities. Eximbank programs available for
Yugoslavia at this delicate juncture
readplay by a thecrucial
Gavernment of
Curtailment of any of them would
Yugoslavia as a hostile signal. .- _
Reprogramming -of- Eximbank loans- Three =of- Yugosrav-ia s-
most financially troubled projects (the Krsko nuclear power
plant, the DOW/INA petrochemical complex., and the Feni nickel
complex) were constructed with Eximbank loans and the most.
modern U.S. technology. Debt service for these projects
respresent the bulk of approximately $460 million due as
interest and payments to Eximbank in 1982-84. We should
consider being prepared to respond sympathetically to requests
for a payment stretch-out for all U.S. official debt. The
Germans, French, British, and Japanese would readily agree to
do the same for their official debts in the "P.aris Club"
context.
b. Military Cooperation
--- Procurement of U.S. weapons systems. A significant
group within the GOY leadership is concerned by the degree to
hbich Yugoslavia is dependent upon the Soviets Union for
military hardware. U.S. policy has sought to assist the
Yugoslavs in. the procurement of specialized weapons systems
based on the premise that diversification of supply would
strengthen Yugoslavia's dependence from Moscow. Yugoslavia's
severe financial constraints have compromised our efforts to
develop a meaningful military sales program. There are,
however, a number of areas where we see scope for close
military cooperation with the Yugoslavs over the long run, and
where major purchases would not take place for a number of
years.
-F5 -G and release of the PW1120 aircraft engine..
Discussions for the purchase of the F-5G are` at a relatively
advanced point.' The next step is to'obtain NDP approval. If
1iashington approval for release of classified information and
an,eventual sale is forthcoming, a possible sticking point will
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be financing for the aircraft and the degree of offset
purchases that Northrop may be willing to accept. We may wish
to encourage Northrop to be flexible in this area, but as a
matter of policy th?e USG does not become involved in the
specifics of commercial offset arrangements. We may also wish
to explore .,the*possibility of FMS credits, although this
approach does hot look promising during the FY 85 budget cycle
in view of current budget stringency. (Heretofore the
Yugoslavs.have see.n FMS_ credits- as inconsistent with their
nonaligned status.) The planned visit of Secretary Weinberger
to Belgrade-.in early December will provide an occasion for
discussions on this topic.
--IMET Training. While not a substitute for expanded
cooperation in arms procurement, an expanded IMET program in FY
85 would provide an important signal to the Yug.oslavs and
enable us to monitor more effectively attitudes in the Yugoslav
armed forces. Our access to the upper echelons of the Yugoslav
military should be enhanced as officers with exposure to the
U.S. military move up the command chain. Our current program
for FY 83 and 84 will fund about six students. We should be
able to give Yugoslavia a high priority if IMET funds become
available late in FY 83 for reprogramming.
c. Bilateral High-Level Dialogue
Visits by senior U.S. officials can complement the measures
listed above and have an intrinsic value of their own because
they visibly give value to and stimulate the bilateral
relationship. The recent conversation in New York between
Secretary Shultz and Secretary Mojsov is a good example of the
worth of high-level talks. The GOY expects, however, that
material support will be linked with these exchanges. In other
words, there must be substance to bilateral exchanges, such as
the prospective visit of Secretary Weinberger, in order to-
achieve the desire impact. 4
d. Encouraging the NATO Allies
Our own bilateral measures need to be in a larger framework
of actions by others. The Allies should be encouraged to
initiate bilateral actions of their own, namely debt relief,
bilateral trade, as well?.as joint Franco/Anglo/German
initiatives to alleviate EC trade restrictions which have
hampered Yugoslav trade with western Europe. We will need to
consult closely with our key allies regarding multilateral
measures as well.
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U.S. OPTIONS
The measures above can contribute to the U.S. policy of
maintaining Yugoslav independence (and encourage Allied help).
However, although the BIS facility, maintenance of Eximbank
facilities,'and_ CCC credits are all significant steps, these
measures by:the,mselves are not adequate in all probability to
stave offtle need -for general rescheduling. A debt
rescheduling is inevitable absent official financial support, a
resurgence of confidence among private lenders and further
significant actions by the GOY. Thus, we have three options:
(1) take the lead in-marshalling official assistance at a level
sufficient to insure Yugoslavia against the need to reschedule
its debts,:-(2) arrange a more modest support package, hoping
that a concrete demonstration of Western governments'
commitment to Yugoslavia would induce a change in private
sector,-.. lending behavior.; or .(3) candidly inform the GOY that
their financial problems appear to have reached the point where
a "more permanent" solution is necessary, stating that the US
would accede quickly to a GOY request for an official
rescheduling. These options are discussed below..
(1) Provide financing, in coordination with other Western
governments, sufficient to insure against a rescheduling. IMF
sources estimate that Yugoslavia will require, at a minimum,
$750 million from the BIS and a $1.0 billion consortium loan
from governments to 'avoid default' in the first half of 1983.
Our assessment is that official financing at this level would
be overkill if the banks continue to lend at last year's level
and hold constant their short-term exposure; it would be
inadequate if private credit dries up. Increasing the amounts
to cover the worst-case scenario would constitute a 'bail-out"
of the banks.. Moreover, any package with a US share much above
$150 million would require a supplemental appropriation.
4
(2) Arrange a more modest package--$750 million - through
the BIS. The US portion would be $150-200 million, roughly
consistent with our share of Yugoslavia's external debt. The
sources of funds would be the Treasury's Exchange Stabilization
Fund ?(ESF) and the Federal Reserve swap line with the BIS.
This would decrease, but still not eliminate, the probability
of rescheduling. On the .assumption that such a concrete
demonstration-of Western governments' political and economic
support for Yugoslavia would induce a substantial change in
private lending behavior, rescheduling might not be necessary.
Some US banks have suggested to us that they would welcome such
a signal from Western governments. In addition, the BIS loan
to Hungary was apparently a factor in inducing banks to reverse
their withdrawal of funds.
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In return, we should require much more extensive financial.
information than we are now receiving, before proceeding with
an official assistance effort. We will be compiling a list of
specific types of information which we should require the
Yugoslavs to provide and look at other measures in such areas
as foreign exchange management--which could have a beneficial
effect.
We should expect significant action on economic reform from
the GOY, all-bough imposition of performance conditions should
ideally come from the IIF, BIS or other international "chub",
We may also insist on collateral--the BIS has indicated that
most of the GOY's $800 million in gold is unpledged (which will
need to be verified). GOY actions would also be essential to
spark a positive, catalytic effect in the private sector, and
thus would be critical to the success of the exercise-.-
The costs of US participation in a loan package for
Yugoslavia are reduced flexibility to respond to similar crises
in other countries and the risk of non-repayment. (Collateral
would insure us against non-repayment.) Rescheduling would
reduce the non-repayment risk as it would release substantial
amounts of foreign exchange. The BIS funds would not be
rescheduled. - -
(3) Candidly inform the GOY that. their. financial
difficulties have reached the point where a "more permanent"
solution is necessary, noting that the U.S. would accede
cuickly to a GOY r=quest for an official rescheduling. Because
of the serious political implications,,--this alternative would
seem a first choice only "by default,' i.e. only after having
reached the conclusion that rescheduling is an unavoidable
foregone conclusion. Our present projections indicate that,
given some outside assistance, rescheduling is not inevitable
because Yugoslavia's debt service ratio is oily 25%, the
maturity structure of the debt is.favorable, with the short
term component only 10% of total outstanding obligations and
economic policy is moving in the right direction. We are
currently updating the balance of payments forecasts, and
seeking a detailed maturity schedule. We are also seeking
from the GOY detailed information on the size and location of
gold and foreign exchange reserves.
Obviously?Option 2 may fail, either because of a shortfall
in private lending or on the current account. Rescheduling may
still be necessary. If so, we should encourage the GOY to face
reality, stressing that a buildup of arrears would lead to a
broken IMF program and thus to an extended period of financial
uncertainty.
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