INTERNATIONAL ECONOMIC & ENERGY WEEKLY

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP84-00898R000400060005-2
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 49
• Document Creation Date: December 22, 2016
• Document Release Date: January 26, 2012
• Sequence Number: 5
• Publication Date: December 9, 1983
• Content Type: REPORT

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Directorate of
Intelligence
Weekly
International
Economic & Energy
DI IEEW 83-048
9 December 1983
Copy 8 0 6
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Weekly
International
Economic & Energy
iii Synopsis
1 Perspective-New Economic Stresses and Opportunities in the Caribbean) I 25X1
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Energy
International Finance
Global and Regional Developments
National Developments
17 International Financial Situation: Big Seven Economic Recovery on Track) I 25X1
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19 International Financial Situation: Nonoil LDC Terms of Trade Bottoming
Out 25X1
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23 International Financial Situation: Fading LDC Hopes for Commodity Trade
Revival
27 Grenada: Picking Up the Pieces
33 Cuba: Patterns and Prospects of Soviet Economic Aid
Hungary: New Horizons for Private Entrepreneurs
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directed to Directorate of Intelligence,
Comments and queries regarding this publication are welcome. They may be
Secret
9 December 1983
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International
Economic & Energy
Weekly
Synopsis
1 Perspective-New Economic Stresses and Opportunities in the Caribbean
Despite the tentative world recovery, the fragile Caribbean economies are
unlikely to recover much over the near term. Expected interruptions in
international lending will prompt Caribbean nations to seek increased econom-
ic support from Washington.
17 International Financial Situation: Big Seven Economic Recovery on Track
This article is part of our series on the economic and political aspects of the in-
ternational financial situation. Outside of North America, the economic
recovery among the Big Seven industrial countries is developing much as
private and official forecasters expected. The debt situation of the financially
troubled LDCs will not change significantly given the present course of the re-
19 International Financial Situation: Nonoil LDC Terms of Trade Bottoming Out
This article in the series on the economic and political aspects of the
international financial situation examines the gains in the nonoil LDC terms of
trade in the first half of this year, ending a five-year slide.
23 International Financial Situation: Fading LDC Hopes for Commodity Trade
This article in our series on the international financial situation examines
commodity price trends. While commodity prices have recovered somewhat,
we see little prospect in the near term for a strong pickup in LDC earnings
27 Grenada: Picking Up the Pieces
Grenada's recently appointed interim governing council has inherited an
economy beset with widespread unemployment, breakdowns in public services,
and depleted public coffers. Over the next few years, continuing external
assistance will be required to restructure the economy and lay the groundwork
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DI IEEW 83-048
9 December 1983
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33 Cuba: Patterns and Prospects of Soviet Economic Aid
Fidel Castro's goal of making the Cuban economy independent of foreign
powers has become increasingly distant after 25 years of his rule. Soviet
economic aid in 1982-valued at about $4.6 billion-corresponded to some-
what more than 30 percent of Cuba's output.
41 Hungary: New Horizons for Private Entrepreneurs
Since 1981 the Kadar regime has further legitimized and thereby spurred an
increasingly wide range of activities in Hungary's huge "second economy" in a
bid to ease some of the country's economic ills. Even though the Western .press
overplays the "capitalist" aspects of the new ventures, such measures-if
sponsored vigorously over the long term-could transform Hungary's economy
into an even bolder model for change in the rigid, inefficient systems of other
Soviet Bloc countries.
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Secret
International
Economic & Energy
Weekly
Perspective New Economic Stresses and Opportunities
in the Caribbean)
US policies in the Caribbean can be expected to face new challenges-
particularly in light of recent events in Grenada-as economic difficulties
continue to batter the region. Despite the tentative world recovery, the fragile
Caribbean economies are unlikely to recover much over the near term.
Although gradual improvement in world agricultural and mineral prices, a
pickup in tourism and offshore assembly industries, and benefits from the US-
sponsored Caribbean Basin Initiative (CBI) could provide some relief by late
1984, interruptions in IMF and other lending could easily offset any gains.
Prolonged economic retrenchment by a number of Caribbean governments has
narrowed their maneuvering room for accommodating the IMF on existing or
new austerity programs. Meanwhile, concerns about the creditworthiness of
the larger debt-saddled Latin American countries are prompting international
bankers to manage their Caribbean loan portfolios more cautiously, thereby
further jeopardizing the viability of IMF programs. We expect Caribbean
nations to seek increased economic support from Washington
The economic deterioration in the Caribbean has not been as severe as that in
Central America, but it has been longer lived and generally more deepseated.
The Caribbean economies reacted sooner to soaring prices for oil and other im-
ports, a world recession-induced decrease in tourism, and stagnant export
earnings. Tighter local restrictions and growing political uncertainty clipped
foreign investment inflows. Lacking sound credit ratings needed to raise long-
term foreign capital, most Caribbean countries resorted to a patchwork of
short-term commercial credits, small-scale economic assistance, and foreign
reserve drawdowns. Subsequent belt tightening, particularly direct import
controls, caused real growth in the region to dwindle to 2 percent annually dur-
ing 1978-82; many Caribbean ministates performed substantially worse.
Although a number of Caribbean governments are evincing a more rational 25X1
approach to economic decision making than previously, the patterns of
deterioration and international responsiveness are changing with worrisome
implications. Regional output will drop about 1 percent in 1983, the first such
decline in nearly two decades, partly because governments of most of the
region's largest economies have slashed spending to qualify for IMF help.
Where IMF agreements are in place, we see potential long-term positive
effects; implementation has improved tax collection, trimmed and redirected
the bloated public sector away from make-work projects toward productive
investments, raised interest rates to encourage domestic saving, and stimulated
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DI IEEW 83-048
9 December 1983
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The
Bahamas
Cu
Cayman
Islands
Turks and
Caicos Islands
(U.K.)
Jamaica
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9 December 1983
Dominican
RQpubi,[c
Puerto
Rico
(U.S.)
St. Christopher
and Nevis
`Antigua and Barbuda
_Guadeloap-
(F..)
Dominica
y Martinique (Fr )
St. Lucia
St. Vincent and ' Barbados
the Grenadines
Grenada c
Boundary representation is
not necessarily authoritative.
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the search for foreign investment. Nevertheless, in the short term economic
hardships have worsened because other financial backers have failed to
respond adequately to the IMF imprimatur. The resulting import cuts are
likely to shrink the region's combined current account deficit in 1983 to under
$1.5 billion-the first such decline in six years. Even so, the burden of the re-
gion's external account adjustment is becoming more onerous as popular
dissatisfaction with austerity deepens.
The situation in Jamaica, the Dominican Republic, and Haiti-where three
out of four non-Cuban Caribbean nationals live-typifies the region's
problems:
? Jamaica's long-awaited recovery is sputtering. Any economic upturn must
await a rekindling of demand for bauxite and alumina, which we believe is at
least a year off. Jamaica recently devalued its currency 43 percent and
abandoned its IMF Extended Fund Facility in favor of a 15-month standby
program to begin in January. Opposition-led civil disturbances in the coming
months could threaten recovery.
? In the Dominican Republic, sinking sugar prices and government overspend-
ing had brought the economy to its knees by 1982. Borrowing shortfalls and
a delayed Paris Club debt rescheduling appear to have pushed the country
out of compliance with its 1983 IMF targets, thereby undermining an
already limp recovery.
? Under the IMF's aegis, Haiti's byzantine public finances are becoming less
opaque, but a drought-inflicted drop in coffee production will limit economic
recovery through 1984.
The smallest English-speaking islands continue to face intractable develop-
ment problems. Banana production, which contributes more than 40 percent of
their export earnings, has yet to regain 1979 levels because of a series of
hurricanes.
Until recently, there were at least a few bright spots. Trinidad and Tobago, the
Netherlands Antilles, and The Bahamas experienced oil-based economic
booms that had begun to spread to other sectors. Despite their perennially high
unemployment, these countries had become a magnet for many other Caribbe-
an nationals seeking jobs surreptitiously. Declining oil prices-and in the case
of Trinidad falling oil production-have seriously dimmed economic prospects
over the near term. For its part, The Bahamas has taken steps to expel the
40,000 or so illegal immigrants, mainly Haitians, residing there.
Despite this gloomy picture, we do not expect any resurgence in Communist
influence over the short term at least. In Jamaica, for example, Prime Minister
Edward Seaga has called for elections next week in order to capitalize on the
popularity he gained by supporting US action in Grenada. An opposition
boycott to protest the use of outdated voter lists has assured Seaga's election.
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Meanwhile, Brasilia's bid to preempt Cuba in Suriname-reinforced by recent
events in Grenada-appears to be succeeding. Well-established democratic
traditions and strong labor movements will continue to vent popular grievances
over individual austerity programs elsewhere.
The region's economic deterioration and worsening divisiveness in the Caribbe-
an Community (CARICOM) will almost certainly mean increased petitioning
of Washington for help. Grenada could need $20-40 million through 1984 to
replace lost sources of foreign funding. Caribbean leaders probably are overly
optimistic in hoping that revived investor interest in Grenada will have a
substantial spillover effect in the region. The CBI's duty-free benefits and the
expected hardening of Generalized System of Preference terms for other
LDCs after 1984 have sparked US, Asian, and other investor interest in the
Caribbean. Probable lapses in IMF and other foreign funding, however, will
crimp the ability of Caribbean countries to broaden their export bases in order
to take full advantage of the CBI and world recovery. Moreover, CARICOM's
cohesiveness is frayed over local trade restrictions and the region's involvement
in the Grenada crisis, thereby further complicating regional solutions to the
area's problems. In these circumstances, Caribbean countries are likely to ask
Washington not only to take a larger hand in revitalizing their economies but
also to prod the IMF and other benefactors to keep their money spigots open.
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Energy
Japanese Ease Suspen- Agreement by Japan's Seaman's Union to permit Japanese tankers to load
sion of Iranian Liftings crude at Iran's main oil export terminal at Khark Island on a case-by-case
basis eases recent restrictions that had interrupted Japanese liftings. Concern
about a possible escalation of military activity in the Persian Gulf prompted by
the sinking of a Greek merchant ship by Iraq off Bandar-e Khomeini late last
month had led the union to ban all liftings at Khark. Japan currently has con-
tracts to lift nearly 400,000 barrels per day of Iranian crude. Should the ban
be reimposed, we believe Japan probably would charter foreign vessels to
transport Iranian crude outside the Persian Gulf. Last summer Tokyo
chartered Norwegian flagships during the height of Iraqi strikes at Khark. For
its part, Tehran could opt to lighter or shuttle oil to ports at Sirri and Lavan Is-
lands for export if ships refuse to go to Khark. The Iranians probably would
offer substantial crude discounts or enter barter agreements as well in order to
maintain oil exports.
Iranian Oil Well Iran experienced a well blowout at its off- 25X1
Blowout shore Firouzan field on 14 November. The blowout reportedly occurred during
routine maintenance being performed by a US drilling company at a five-well
platform, resulting in a spill of nearly 3,000 barrels of oil per day into the
Persian Gulf. This marks the second serious Iranian oilspill this year. Two
platforms in Iran's offshore Norwuz field-located approximately 120 kilome-
ters north of Firouzan-were set ablaze in March by Iraqi airstrikes and
continue to leak at a rate of 1,000 to 2,000 barrels per day. The spills threaten
water supplies and operation at desalination plants along the Gulf. We believe
the Iranians do not have the expertise needed to perform the difficult capping
operations at Norwuz or to stop leakage at Firouzan and will need foreign as-
sistance. According to the US Embassy in Bahrain, the Iranians probably plan
to task a team of US experts to plug Firouzan. 25X1
Saudis Lose LPG Sales The US liaison office in Riyadh reports that 1984 LPG sales may fall 25
percent below Riyadh's goal if the Saudis fail to meet Japanese and other
customers' demands to lower LPG prices from about $235 per ton to $200 per
ton. Earlier this year most LPG buyers signed long-term supply contracts with
the Saudis that appeared to offer reasonable hope of stabilizing prices. Low oil
production levels in the second quarter of this year, however, forced cancella-
tion of a large number of deliveries and allowed Riyadh to hike prices to $280
per ton. The runup in prices caused many companies to invoke phase-out
clauses in their contracts, and Japanese companies, which take close to half the
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kingdom's LPG exports, probably will refrain from signing long-term con-
tracts. Riyadh apparently does not now intend to accede to customer pricing
demands because of expectations of a tighter LPG market, but unless demand
picks up the Saudis face a potential revenue loss of over $250 million next
year.
Saudi Arabia Planning Petromin, Saudi Arabia's state-run oil company, is proposing as much as a
Increases in Domestic threefold increase in domestic petroleum product prices for the next fiscal
Petroleum Prices year-beginning in April 1984-according to the US Embassy in Riyadh. The
increases are aimed at reducing the estimated $1 billion annual subsidy on
petroleum products. The move would bring Saudi petroleum prices more in
line with those of other Gulf states for products such as gasoline, diesel,
kerosene, and LPG. Petromin and Ministry of Petroleum economists hope that
higher prices will moderate the increases in petroleum product consumption,
which have averaged more than 20 percent annually over the past three years.
Gasoline products, however, will still be viewed as a bargain; premium gasoline
currently costs only $0.25 per gallon. Although King Fahd did not agree to
price increases recommended earlier this year by a special ministerial commit-
tee, he probably will approve at least modest increases for the next fiscal year
because of pressure from other members of the Gulf Cooperation Council to
standardize prices for petroleum products.
Soviet Offshore The Soviets intend to begin construction of a facility on Sakhalin Island early
Oil Platforms next year that will produce offshore platforms for oil and gas exploration and
production, They are discussing contracts for
the project with Japanese, French, and Canadian firms but favor the
Canadians because of their expertise in harsh environments. Being able to
build offshore oil platforms would make the Soviets less vulnerable to possible
Western economic sanctions. The length of time needed to construct a
production plant, however, and the Soviets' difficulty in handling the associat-
ed advanced technologies, would keep the USSR from becoming self-sufficient
in this field for many years. The exploratory drilling phase off Sakhalin
reportedly is complete-the fields are expected to begin producing oil late in
the decade-and the Soviets presumably will continue to rely on Western-built
platforms and other oil-related equipment for some time.
Saudi Named President Ali Naimi, the current Senior Vice President for Oil Operations, has become
of Aramco the first Saudi national to be elected president of Aramco. The change was
widely expected and is effective 1 January 1984 when the current president, an
American, retires. Naimi has bachelors and masters degrees in geology from
the United States and has been an Aramco vice president since 1975.
'the oil industry consider Naimi to be a highly capable
individual with the necessary experience to fill the post. His appointment is not
expected to result in any major changes in the company's operations. Naimi
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Sakhalin Island's Petroleum and Natural-Gas-Bearing Areas
Japan
Sea
of
Okhotsk
Highly promising !/ . 1\10
Japan
KAM' CHATKA
North
Pacific
Ocean
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must also be considered a front-runner to fill the Chairman's position if
Riyadh eventually chooses someone from within the company for Aramco's top
slot-a post held by an American since the company's formation in 1933.
Trucks Stop Carrying Jordanian transport authorities ordered a halt to truck shipments of Iraqi fuel
Iraqi Oil to Jordan oil on 9 November because of damage to the Baghdad-Aqaba highway,
according to information obtained by the US Embassy in Amman. Two
Jordanian trucking firms had been using a fleet of about 600 trucks to deliver
a contracted volume of 15,000 b/d of fuel oil produced at Iraq's new refinery
at Baiji. The trucks weigh 30 tons each and are capable of carrying 60 tons of
-oil fully loaded. Trucking officials say the new regulations would permit only
half loads, which they consider unprofitable. While the shutdown of the
Jordanian export outlet affects only a small volume of oil, it still is a setback to
Baghdad's efforts both to maximize oil export earnings and to dispose of
surplus fuel oil. Baghdad's main export outlet remains the crude oil pipeline
through Turkey, which is expected to reach a throughput of 900,000 b/d early
this month.
Indonesia Discounting In an effort to boost crude export volumes and revenues, Pertamina is
Oil Prices marketing crude oil under arrangements that effectively discount the oil by $1
to $2 per barrel below the official OPEC selling price
Although each $1-per-barrel price cut costs Indonesia about $300
million in foreign exchange earnings on an annual basis, each additional
100,000 b/d of exports earns about $1 billion annually. Indonesian crude
output in recent months has exceeded its OPEC production ceiling of 1.3
million b/d, and the source estimated that November production might be
200,000 to 300,000 b/d above the ceiling.
IMF Resources The IMF confirmed on 30 November that member nations representing more
Increase than 70 percent of total member subscriptions-the minimum share necessary
for the quota increase to be implemented-had ratified the eighth general
quota increase. As a result the Fund lifted restrictions on the approval of new
standby and extended programs, which it had imposed out of concern for its li-
quidity position. The $31 billion quota increase will provide the fund with
roughly $16 billion in hard currencies with the remainder being in domestic
currencies of weaker economies. Those smaller nations that have not yet
indicated their consent will be allowed two additional months to respond.
We now expect that central bank governors of the G- 10 countries (less the
United States) and Switzerland will move forward with the $3 billion interim
financing facility that will cover IMF financial commitments until the quota
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increases are paid in. We expect the BIS will announce a final decision on the
$3 billion loan following its meeting on 12 December. A favorable BIS
response should then release a $3 billion short-term loan from Saudi Arabia
that has been linked to the BIS action. These actions put the Fund in a much
better position to make large balance-of-payments loans to countries such as
Argentina, Nigeria, Egypt, Yugoslavia, and Hungary, which are presently
negotiating or considering large financing programs. The new financing also
should demonstrate to commercial creditors and debtors alike that the major
industrialized nations remain committed to the current debt management
Peru's Growing Finan- Lima's deteriorating fiscal position and continued large military outlays are
cial Problems generating problems with the IMF and commercial banks that could upset
Peru's financial rescue package. According to Embassy reporting, the govern-
ment is now renegotiating targets under the IMF program because it failed to
reduce the public deficit as stipulated in the agreement. Instead, Peru's federal
deficit doubled to 9 percent of GDP this year because of (a) the fall in tax reve-
nues caused by the 10-percent decline in economic activity, (b) the higher
public spending necessitated by both the increase in inflation to 130 percent
and programs to blunt the impact of natural disasters, and (c) the inability to
trim military and security outlays.
Dismayed by Lima's failure to comply with the IMF program, international
lenders are now delaying some project loan disbursements.
these funds are likely to remain frozen, in part, to express 25X1
displeasure with large military expenditures such as a planned $800 million 25X1
purchase of Mirage aircraft. As a result of these loan delays, Lima probably
has been forced to cover this year's $1.1 billion current account deficit in part
through reductions in its foreign reserves by more than the IMF agreement
permits. Failure to get the IMF program restarted soon-a task now made
more difficult by rising domestic opposition to austerity and the planned
departure of the finance minister next month-will jeopardize more than $800
million in rescheduling and new loans arranged earlier this year and Lima's
ability to obtain $400 million in new loans it claims to need in 1984. 25X1
Dominican Republic Negotiations between the Dominican Republic and the IMF to set 1984
Breaks Off Talks performance targets under the country's $450 million Extended Fund Facility
With IMF apparently have broken down and are unlikely to resume before January.
Santo Domingo has rejected as politically unacceptable Fund stipulations that
the Dominican Republic slash the public sector's projected $600 million
budget deficit, eliminate foreign payment arrears, and move toward unifying
the dual exchange rate-either by an official devaluation or the transfer of at
least $140 million in trade transactions to the more costly parallel exchange
rate. The government's intransigence arises from labor pressures over chroni-
cally high unemployment and shrinking real wages, business opposition to new
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tax increases, and denunciation by both factions of the ruling party of any de-
valuation of the peso. Failure to reach agreement soon on 1984 performance
criteria would further delay Paris Club renegotiation of some $400 million in
official debt and would be likely to freeze international lending necessary to re-
stock depleted petroleum and food reserves.
Global and Regional Developments
Soviet Purchase In late November the USSR purchased 250,000 metric tons of Indonesian
Squeezes Palm Oil palm oil-a palm oil trade-for shipment through July
Market of next year, Soviet veg-
etable oil imports have increased dramatically from 200,000 tons in 1978 to
870,000 tons in 1982 because of declining production and growing consumer
and industrial use. Although Soviet vegetable oil production picked up in 1983,
we believe imports will remain high-650,000 to 700,000 tons in 1983 and at
least 600,000 tons next year.
Palm oil prices have risen about 80 percent since the first of the year; the large
size of the Soviet purchase could push prices even higher in the weeks ahead.
Pressure on palm oil prices, however, is expected to ease some time next year
because production worldwide is projected to reach a record 6.5 million tons,
according to USDA estimates. Supplies of most other vegetable oils are
expected to remain tight and prices high during the 1983/84 crop year.
Vegetable Oil Prices
Price Percent Change
(US $ per metric ton, Since 1 Jan 83
Rotterdam)
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EC Moves on Wheat New EC efforts to reduce burgeoning wheat stockpiles-currently at over 12
Surplus million tons-may undercut US exports of nongrain feed substitutes, such as
corn gluten; in 1982 the United States exported $700 million of these products
to the Community. The EC Commission has instituted a three-month program
to use up to 2 million metric tons of surplus wheat in animal feed. The wheat
will be sold to EC feed producers at approximately $170 a ton, about 3 percent
below the current EC support price. EC officials have debated this measure
since November, but it was delayed because of opposition from Belgium and
West Germany who feared it would seriously distort the Community's
domestic grain market.
The measure is another in a series of patchwork EC efforts that are intended to
dispose of surplus agricultural output rather than address the fundamental
causes of excess production-high support prices. In October the Community
provided extra export subsidies for wheat flour sales to Egypt, and since July
the EC has sold 1.7 million tons of subsidized grain to the Soviet Union. The
EC Commission is also considering a proposal to tax imports of nongrain feed
substitutes in order to encourage domestic wheat consumption. Some Commu-
nity members, particularly France, insist that imports of corn gluten must be
limited as part of an overall plan to contain runaway EC farm spending.
Eastern Europe Resell- At least three East European countries-Bulgaria, Hungary, and Poland-are
ing Libyan Oil reselling Libyan crude oil to bolster their hard currency trade performance.
During January-June 1983, the three countries imported nearly 60,000 b/d
from Libya compared with almost nothing during the same period a year
earlier. Polish and Hungarian oil exports for hard currency, in turn, have
tripled over this period while Bulgarian sales increased at a slower pace. The
resold oil brought in an estimated $225 million for Hungary, $120 million for
Poland, and $140 million for Bulgaria. The importance of the resales is shown
by the fact that Hungary's total hard currency exports grew by only $155
million during January-June 1983 compared with the first half of 1982,
Poland's exports were up by $330 million, and Bulgaria's fell by $135 million.
The three countries apparently have obtained the Libyan oil under different
terms. The Poles have announced that their imports came from a $230 million
Libyan credit for oil. Because of its desperate need for cash, Warsaw had to re-
sell the oil at a loss of well over $2 a barrel. Bulgaria and possibly Hungary ap-
pear to have received their oil as repayment for past credits extended to
Tripoli. Both Sofia and Budapest were pressing Libya last year to cover late
payments. Some market observers, however, believe that the Hungarians
obtained some of their Libyan oil on 360-day credit and then resold it for cash.
Such transactions would enable the Hungarians to show a desperately needed
gain in exports this year and prop up faltering cash reserves. The practice
would bode ill for 1984, however, when Budapest must cover a sharply rising
level of debt repayments to Western banks.
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Libyan-Italian Com- Libya has made little progress in resolving its $625 million payment arrearages
mercial Payments to Italy Tripoli's reliance on trade
Problems with Italy and Rome's long-term interest in developing Libya's offshore
petroleum resources, however, weigh in favor of a near-term settlement. In the
meantime, the payment difficulties have caused Rome to stop issuing export
insurance coverage on new credits to the Libyans. Qadhafi probably will
remain intransigent on the payments problem, however, until Rome agrees to
larger purchases of crude oil and natural gas at higher prices. Complicating
the issue further is Qadhafi's demand in October that Italy pay large
indemnities for the colonial occupation of Libya; the Italians have been unable
to elicit any clarification of the demand.
National Developments
Developed Countries
West Germany Unveils Labor Minister Norbert Bluem has unveiled a government plan to encourage
Early Retirement Plan early retirement in an effort to slow the growth of unemployment. If the plan is
adopted early next year, as expected, workers could retire at age 59 and
receive a pension of 65 percent of their gross wage. The government would pay
40 percent of the pension if the employer hires a replacement from the ranks of
the unemployed. Full pensions would continue to commence at age 63 for men
and 60 for women. Government labor statistics show that about 800,000
German workers-4 percent of the labor force-could take advantage of the
program
Italian Labor Talks Crucial talks among government, labor, and management on the Italian
Begin Today economy began today and probably will focus on Italy's wage indexation
system. The Craxi government wants to modify the indexation system and
reach an agreement on a broad incomes policy in an effort to bring inflation
down from 15 percent this year to 10 percent in 1984. Confindustria, the
employers association, will join the government in pushing for a reduction in
indexation; the group has called for its elimination. The United Federation,
Italy's umbrella union, is divided on the indexation issue although it can agree
on the need to contain inflation. The unions are likely to make concessions on
wage indexation if new government employment programs and favorable
changes in labor laws currently under consideration are enacted.
Exports Boost Spanish Strong export growth during the first 10 months has prompted Madrid to
Economic Growth boost its 1983 economic growth projections from 1.7 percent to 2.1 percent. In
real terms, exports were up 8 percent from the same period a year earlier-
well above Madrid's target of 5 percent. Imports remained stagnant. In our
view, the export surge reflects improved competitiveness since the end of 1982,
the US economic recovery, and the slight economic upturn elsewhere in
Western Europe. Although the 2.1-percent economic growth rate will be
Secret
9 December 1983
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Spain's best since 1977, it remains short of the 3.5-percent growth Madrid
estimates is needed to hold unemployment steady. Unemployment has contin-
ued to creep upward, reaching 17.8 percent at the end of the third quarter.
While the strong export performance is expected to continue next year,
Madrid and the OECD predict that economic growth will improve only
slightly, to 2.5 percent, as private consumption spending remains sluggish.
Declining South Gold production, the largest single source of government tax revenues and
African Gold foreign exchange earnings, has fallen roughly one-third since its peak of 1,000
Production metric tons in 1970, and average yields have dropped from 11.2 grams per ton
in 1970 to 6.6 grams last year. On the basis of a mine-by-mine review, we be-
lieve that output will decline further to about 600 tons by 1990. This
expectation is based on the belief that no major new discoveries will occur and
that ore grades will continue to decline. The depletion of gold reserves is
inducing the South African mining industry to shift its attention to coal
mining, according to the South African Chamber of Mines. Unless gold prices
regain high levels for a sustained period-$800 an ounce or more-we
estimate that investment in the South African gold industry will soon begin to
Less Developed Countries
New Bolivian Economic The Siles administration decreed new economic policies last month to deal
Policies with Bolivia's worsening financial crisis. These first steps represent a gradual
approach that is about the best that could be expected given Siles's tenuous po-
litical position. To smooth the way for austerity, however, La Paz announced a
72-percent increase in minimum wages on 5 November. This was quickly
followed by austerity measures to improve the payments accounts and qualify
for IMF assistance. The Siles government:
? Devalued the peso by 60 percent.
? Removed food and gasoline subsidies.
? Hiked transport fares and electric power tariffs 50 percent.
As a further palliative to workers and businessmen, La Paz announced income
tax reductions for the last quarter of 1983 and new credits for farmers,
industrialists, and exporters.
The IMF representative in La Paz has expressed disappointment with the
measures, according to the US Embassy, because they did not go far enough.
To qualify for an IMF loan, Siles may be required by the IMF to slash the
budget deficit, tighten monetary policy, and close the remaining gap between
the official and the free market exchange rate. We believe it will be hard for
Siles-who faces a serious threat of a coup-to implement more painful
economic adjustments. Indeed, the recent measures caused brief work stop-
pages and public demonstrations. Serious social unrest sparked by tougher
austerity could give military coup plotters the pretext needed to replace Siles.
Secret
9 December 1983
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West Bank Economy The buoyant West Bank economy-real income has grown at an average
Slowing annual rate of 12.7 percent since 1968-is beginning to feel the impact of
Israel's economic problems. The purchasing power of West Bankers employed
in Israel or by the Israeli Civilian Administration has been temporarily
squeezed by large price hikes for such goods as bread, milk, and fuel. These
workers, however, will receive the same cost-of-living adjustment scheduled to
be paid on 1 February as Israelis. A Ramallah merchant claims local sales
have dropped by 30 percent since summer, according to reporting from the US
Consulate in Jerusalem. In addition, the West Bank press reports that West
Bankers, as well as Israelis, are being laid off at Israeli factories.
Remittances from relatives in the Gulf states and the United States and
sizable accounts abroad, however, are enabling many middle- and upper-class
West Bankers to maintain living standards. The Consulate reports that such
residents in Ramallah are still buying expensive clothes and large appliances.
Local travel agents report that business has not declined.
Finding jobs for young West Bankers who will increase the labor force by 5
percent annually over the next few years is the area's most pressing economic
problem. While still very low, the 2.4 percent unemployment rate in the first
quarter of 1983 was the highest recorded in more than a decade. Since the soft
oil market is forcing Gulf states to scale back development plans, these
countries cannot be counted on to provide job opportunities for the growing
West Bank labor force. The Consulate reports that West Bank university
graduates are having difficulty finding employment in the Arab countries. The
number of West Bankers working in Israel has stabilized in recent years and is
unlikely to increase any time soon.
Impact of Sluggish The UAE government has responded to the protracted soft oil market with
Economy in the United limited austerity policies-instituting controls on bank lending, insisting on
Arab Emirates loan repayments, cutting back on new contracts, and reducing foreign
employment. The downturn in the economy and stricter government policies
have threatened some major UAE businessmen with bankruptcy. Many local
businessmen became rich quickly during the mid-1970s because of the oil price
boom, but subsequently went deeply into debt because of lavish spending and
bad investments. According to the US Embassy in Abu Dhabi, several families
who have built large enterprises face major losses. We believe the government
will continue its austerity measures, despite the rising bankruptcies.
Soviets Cut Retail The USSR on 1 December reduced prices by 13 to 30 percent on selected con-
Prices sumer durable goods. This is the second round of retail price cuts in four
months. The price reductions-like those in the past-probably are designed
to reduce inventories, particularly of poor-quality items. So far, however, the
cuts apparently have not spurred sales.
sale signs in stores have attracted little
Secret
9 December 1983
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By lowering prices the Soviet leadership may hope to offset earlier price
increases and limit 1983 inflation. Official state retail price indexes show an
unprecedented inflation rate in 1982 of 3.8 percent. Soviet data for the first six
months of 1983 show an annual inflation rate of 1.7 percent-still high by
Soviet standards-reflecting unannounced retail price increases in February.
The September and December price cuts could well be an effort to hold 1983
inflation to the lower past levels.
Secret
9 December 1983
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International Financial Situation:
Big Seven Economic Recovery on Track
This article is part of our series focusing on the
economic and political aspects of the international
financial situation.
Outside of North America, the economic recovery
among the Big Seven industrial countries is devel-
oping much as private and official forecasters
expected at the beginning of 1983.' In the United
States the recovery picked up steam far more
rapidly than most forecasters had earlier predicted,
and the US advance in turn has boosted Canadian
growth. While most economic observers believe
that the US and Canadian economies will stay
buoyant for the next year, the recovery is expected
to remain weak in Western Europe and Japan. In
general, the debt situation of the financially trou-
bled LDCs will not change significantly from earli-
er predictions given the present course of the
recovery in the Big Seven countries. More rapid US
economic growth, however, should provide some
extra export earnings for Latin American and East
Asian countries. If the Big Seven recovery starts to
falter in late 1985 or early 1986, as many forecast-
ers now expect, this could worsen LDC debt prob-
Few Surprises in the Recovery
The strength of the US economy has been the
major unexpected development in the current re-
covery. Real GNP boomed in the first three quar-
ters of 1983 and now is projected to advance 3.3
percent for the year as a whole. The rise in US
GNP in turn is pulling the Canadian economy
along because Canada sells 70 percent of its exports
to US customers. Accordingly, Canada is expected
to post 2.7-percent growth in 1983, compared with
expectations of 1.3 percent at the beginning of the
year.
The growth of the Big Four West European econo-
mies in 1983 is somewhat less than had been
expected. In Western Europe, the effects of tighter
French and, to a lesser extent, Italian monetary
and fiscal policies have outweighed the improve-
ment in the West German and British economies.
GNP in France and Italy for 1983 is now expected
to contract. The West German economy is expected
to grow nearly 1 percent this year, double earlier
expectations, because workers are spending more
than previously expected. British growth for 1983 is
now projected at 2.3 percent, up from earlier
estimates because of tax cuts implemented in April.
As expected, the recovery in Japan is relatively
sluggish. Despite a healthy pickup in exports to the
large North American market, GNP growth is
lagging largely because of weak corporate invest- 25X1
ment. Forecasters now expect Japanese real growth
to advance only 3.3 percent in 1983. Even the
recently announced stimulus package failed to af-
fect the economic outlook because many of the
important measures will not take effect until next
year.
Most forecasters believe GNP growth will pick up
across the board in 1984. Consolidating the gains
made this year, US and Canadian economic growth
rates are projected to reach, or even exceed, 5
percent. Trade barriers and attempts to control the
Secret
DI IEEW 83-048
9 December 1983
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Secret
government budget deficit are expected to hold
Japanese growth to about 4 percent, lethargic by
past Japanese standards. Forecasters think that all
four major West European countries will post GNP
advances next year, with growth averaging 2 per-
cent. Slow growth among trading partners, the
effects of anti-inflationary policies, and the loss of
international competitiveness in basic industries are
the principal factors that will hold down the pace of
recovery in Western Europe next year.
Impact on LDCs
Although marginal improvement in Big Seven eco-
nomic growth prospects will help LDC trade
performance, the overall financial outlook for the
debt-troubled LDCs is barely affected. Using
CIA's Linked Policy Impact Model, we estimate
the pickup in Big Seven growth adds only a few
billion dollars to nonoil LDC exports. With their
economies closely tied to North America, Latin
American and East Asian LDCs benefit the most
from the extra boost in the US economy. African
and South Asian countries, on the other hand, may
be slightly worse off since they trade more with
Western Europe. In the first half of 1983, Big
Seven imports from the four largest LDC problem
debtors-Mexico, Brazil, Argentina, and Chile-
were about $1 billion higher than in the same
period a year earlier; the United States accounted
for almost all of the advance
Secret
9 December 1983
Forecasters increasingly believe that the Big Seven
countries may suffer a short, mild recession start-
ing in late 1985 or early 1986. This could com-
pound LDC debt problems as grace periods from
recent debt rescheduling run out. Most forecasters
expect inflation to pick up in all the Big Seven
countries in 1985, causing them to adopt more
restrictive policies. Many forecasters point to large
budget deficits and low saving rates in several of
the Big Seven as the major factor behind the
projected upswing in inflation, although several
also believe that this year's upsurge in money
supply growth will contribute to faster price in-
creases. Most forecasters presently expect that the
next recession will be mild; they believe that gov-
ernments will not let inflation get out of control
before adopting anti-inflationary programs and
thus will not have to rein in as hard as they did in
1980 to 1982
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International Financial Situation:
Nonoil LDC Terms of Trade Bottoming Out
This article is part of our series focusing on the
economic and political aspects of the international
financial situation.
The five-year decline in the nonoil LDC's terms of
trade appears to have ended. We estimate that the
terms of trade in the second quarter of this year
rose about 7 percent from the low point reached in
fourth-quarter 1982 because of rising prices for
LDC primary export commodities and the continu-
ing slide in prices of imported manufactures. More
favorable terms of trade would make it easier for
LDCs to service foreign debts, rebuild reserves, and
reverse sharp import cuts, but the outlook for
further improvement is uncertain.
Five-Year Decline Bottoming Out
Nonoil LDC terms of trade-the ratio of their
export prices to their import prices-fell 28 percent
between 1977 and 1982. During 1977-80 the de-
cline was due to rising import prices-particularly
for oil-which soared 60 percent, more than offset-
ting a 39-percent gain in export prices. In 1981 and
1982 the situation was reversed; although import
prices began to decline in early 1981, this gain was
outweighed by a 14-percent drop in export prices
between 1980 and 1982 as recession in the devel-
oped world reduced demand for LDC raw materi-
als.
Although current export and import price data are
not available for most LDCs, our estimates indicate
that the sharp terms of trade decline has finally
bottomed out. The estimated 5-percent rise in the
first half of this year from second-half 1982 is the
first sustained improvement in nonoil LDC terms
of trade since 1977.
Index: 1980=100
110
1981 1982 1983
Terms.of trade 25X1
The improvement in first-half 1982 was due both to
a turnaround in commodity prices and a continuing
decline in dollar import prices for oil and OECD
manufactured goods. The strength of commodity
prices is confirmed by the Economist and the
Journal of Commerce indexes; in June both were
almost 20 percent higher than a year earlier. At the
same time, prices for manufactured imports from
developed countries continued to fall, dropping an
estimated 6 percent between first-half 1982 and
first-half 1983.
Secret
DI IEEW 83-048
9 December 1983
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Secret
Estimating the Terms of Trade
Most nonoil LDCs lack current and accurate ex-
port and import price data. To estimate export
prices for these countries, we took dollar price
indexes for 13 commodities (or commodity aggre-
gates), plus a proxy for manufactures export
prices, and calculated a trade weighted average.
Import prices were estimated by taking dollar
export price indexes for 13 developed countries
plus a world oil price index, and again calculating
a trade weighted average. This methodology pro-
vided terms of trade estimates which are consider-
ably more current than those provided by the
IMF's International Financial Statistics and are
probably more comparable on a cross-country ba-
sis since individual LDCs often have differing
methodologies and limited data. Using the IMF s
definition of nonoil LDCs, our estimates match the
IMF's historical data quite closely, although some
divergence occurs in the second half of 1982 when
the IMF series relies on only a few LDC reporters.
Our final nonoil LDC series excludes Mexico,
Ecuador, and other net oil exporters included in
the IMF's nonoil LDC grouping.
Regional and Country Developments
The nonoil LDCs in Latin America have shown
substantial improvement in their terms of trade.
Argentina's terms of trade in the second quarter of
this year was nearly 10 percent above the fourth-
quarter 1982 level. Brazil showed even more im-
provement with its terms of trade up about 17
percent over the same time period. This increase
followed a decline of more than 50 percent between
1977 and 1982. Mostly because of higher copper
prices, Chile recorded a 16-percent jump in its
terms of trade in first-half 1983; copper prices
subsequently weakened.
Secret
9 December 1983
In Asia, terms of trade developments were mixed.
Our estimates indicate a moderate gain by the
Philippines between fourth-quarter 1982 and sec-
ond-quarter 1983. Asian LDCs more dependent on
manfactured exports-Taiwan, South Korea, Hong
Kong, and Singapore-showed less improvement,
but they had also shown far less deterioration in
recent years. Prices for manufactured and semi-
manufactured goods tend to be less volatile and
tend to lag the price swings of primary commod-
ities. These countries are likely to benefit from a
gradual rise in export prices as well as a higher
volume of sales to developed countries.
For African nonoil LDCs the situation remains
grim. Although Kenya's terms of trade rose an
estimated 18 percent in the second quarter of this
year from the low point reached in the fourth
quarter of 1981, it is still 60 percent below the 1977
peak. Kenya's heavy dependence on coffee and tea
exports makes it particularly vulnerable to price
swings in those commodities. Zaire showed a slight
terms of trade gain, mostly on the strength of
copper prices in the first half of this year.
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Selected Nonoil LDCs: Export Prices, Import
Prices, and the Terms of Trade
Export prices
98
99
102
102
99
93
88
89
89
87
84
83
85
85
Import prices
95
99
103
104
107
104
103
105
104
102
100
100
98
95
Terms of trade
103
100
100
98
92
89
86
85
86
85
84
83
86
89
Argentina
Export prices
92
95
105
110
104
97
91
86
85
84
79
77
80
84
Import prices
98
99
102
102
102
99
97
99
99
98
96
95
96
95
Terms of trade
94
95
103
107
102
98
93
87
86
85
82
81
83
89
Brazil
Export prices
100
100
102
100
95
88
82
80
82
80
76
74
78
80
Import prices
94
98
103
105
108
107
106
108
107
105
104
104
101
96
Terms of trade
106
102
100
96
88
82
77
75
77
76
73
72 '
78
84
Chile
Export prices
110
95
99
96
90
86
84
82
79
75
72
72
77
82
Import prices
97
99
102
103
104
102
101
102
103
101
99
98
99
97
Terms of trade
113
96
97
93
86
84
83
80
77
74
73
73
78
85
India
Export prices
99
99
102
102
98
92
89
90
89
86
82
81
84
85
Import prices
96
99
103
104
105
102
99
102
101
99
97
96
95
92
Terms of trade
104
100
99
98
93
91
89
88
88
87
85
84
88
93
Export prices
108
108
99
92
88
82
73
73
79
79
74
72
78
77
Import prices
95
99
103
104
105
102
99
102
100
98
97
96
93
91
Terms of trade
114
109
96
88
84
81
74
72
79
80
76
75
83
85
Philippines
Export prices
96
98
104
104
101
91
86
85
84
80
76
74
77
80
Import prices
95
99
102
105
108
106
105
107
106
104
102
102
101
98
Terms of trade
100
99
102
99
93
86
83
79
80
76
74
73
76
82
Export prices
97
99
103
102
100
95
92
95
94
92
89
88
90
89
Import prices
95
99
102
105
109
107
106
108
107
106
104
103
102
99
Terms of trade
102
100
100
97
91
88
86
88
87
87
86
85
88
90
Taiwan
Export prices
97
99
103
103
100
95
92
95
94
92
88
87
89
89
Import prices
95
99
102
105
109
107
105
108
107
105
103
102
101
98
Terms of trade
102
100
100
97
92
89
87
88
88
87
86
85
88
91
Zaire
Export prices
104
97
100
99
95
91
88
87
87
85
83
82
84
84
Import prices
99
100
102
100
97
92
90
93
92
91
88
87
88
87
Terms of trade
105
97
98
99
98
98
97
94
94
93
95
95
95
97
21 Secret
9 December 1983
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International Financial Situation:
Fading LDC Ho es for Commodit
Trade Revival
This article is part of our series focusing on the prolonged since World War II-together with siz-
economic and political aspects of the international able falloffs in export volumes severely crimped
financial situation. revenues. While prices have recovered somewhat,
we see little prospect in the near term for a strong
Debt-troubled LDCs have been hoping that a reviv- turnaround in LDC earnings from either mineral or
al in commodity markets would help solve their agricultural commodities.
financial problems. During the recession, a steep
slide in commodity prices-the most severe and
Selected LDCs:
Commodity Export Dependence, 1982
Commodity
Commodity Export
Commodity
Commodity Export
Earnings as a Share of
Earnings as a Share of
Total Export Earnings
Total Export Earnings
(percent)
(percent)
Wheat
14
Hides and skins
10
Peru
Petroleum
22
Meat
9
Copper
14
Brazil
Soybeans
11
Lead
7
Coffee
9
Silver
6
Iron ore
9
Fishmeat
6
Sugar
2
Iron ore
3
45
Philippines
Coconut products
12
Costa Rica
Coffee
27
Copper
6
Bananas
27
Wood
6
Beef
6
Zaire
Copper
40
Sugar
2
Coffee
19
Ivory Coast
Cocoa
22
Diamonds
12
Coffee
20
Cobalt
7
Wood
9
Secret
DI IEEW 83-048
9 December 1983
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January to October 1979-80 Peak
1983 to October 1983
Palm oil 79.7 -3.6 Malaysia, Singapore, Indonesia, Ivory Coast
Soybean oil a 79.4 -1.8 United States, Brazil, European Community
Soybeans a 49.0 -3.0 United States, Argentina, Brazil
Corn a 47.0 -2.8 United States, Brazil, Argentina
Aluminum 45.6 -30.1 United States, Canada, Japan
Rubber (natural) a 31.2 -30.2
Zinc 26.6 1.2
Cocoa 17.6 -43.9
Cobalt a 12.0 -78.0
Tin 8.4 -25.4
Beef 7.6 -22.8
Australia, Brazil, Philippines,
European Community
Malaysia, Indonesia, Thailand, Sri Lanka, Liberia
Canada, Australia, Peru
Ivory Coast, Ghana, Brazil, Nigeria, Cameroon
Zaire, Zambia
Indonesia, Thailand, Bolivia, Brazil, Malaysia
Australia, Argentina
Early in 1983, evidence that the US recovery was
under way sparked a rally in commodity prices. By
August the Economist price index of industrial
materials was up about 20 percent from its Novem-
ber 1982 low, although it has since dropped slight-
ly. The rise in many commodity prices was touched
off by speculators anticipating a strong surge in
demand similar to that which followed other reces-
sions. With the exception of zinc, however, none of
the major commodities has regained its prereces-
sion price level; several remain 40 percent or more
below their peak prices. Indeed, prices of some
commodities are below those of a year ago. Particu-
larly disappointing from the LDC exporters' point
Secret
9 December 1983
of view has been the performance of copper; its
current price is 10 percent below the January 1983
level.
Prospects for an export turnaround on the commod-
ity front are considered poor by most trade sources,
particularly for metals. Demand for metals is high-
ly sensitive to the business cycle, and the current
OECD recovery is neither as widespread nor as
rapid as the 1976-80 recovery. Even if the recovery
gains some momentum, we believe that several
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Differing Commodity Market Responses
to Recent Recoveries
Circumstances this year differ dramatically from
those of the last two recoveries. When commodity
prices rose sharply during 1973-74, the United
States, Western Europe, and Japan were experi-
encing a synchronized and rapid recovery. Indus-
trial production, and therefore demand for many
primary commodities, grew rapidly. In addition,
fear of shortages, inflationary expectations, and
the imposition of price controls stimulated specu-
lative demand.
coffee, and corn crops. Frost reduced Brazil's
coffee output, and heavy rains flooded Malaysian
tin mines. Political chaos in Chile and Zambia's
decision not to use a Rhodesian railway led to
decreased copper production. These events, cou-
pled with the surge in oil prices, led to market
disruptions and soaring prices. After a sharp de-
cline in prices during a recession in 1975, the 25X1
developed world again shared a common business
cycle leading to increases in commodity prices.F_~ 25X1
During the same period, none of the normal buffer-
ing mechanisms existed to moderate the price
pressures. Inventories were low, and metal produc-
tive capacity was in short supply. This was due, in
part, to uncertainty over currency values under the
then new system of flexible exchange rates, costly
environmental regulations that deterred new in-
vestment, and a general belief that growth during
the 1960s had been excessive. In addition, unfavor-
able weather conditions and political events led to
production shortfalls. Droughts in the USSR,
Asia, and Africa ruined wheat, sugar, rice, cocoa,
factors will continue to constrain metals price
increases:
? Capital investment activity-which is metal in-
tensive-is still slow because of high interest
rates and low industrial capacity utilization-
79.6 percent in the United States and 77 percent
in the EC.
? Consumer goods industries, although enjoying a
revival in the United States, have reduced their
material demands because of down-sizing and
synthetic material substitution.
? Metal fabricators are likely to limit stockbuild-
ing, buying only to cover current consumption
because of oversupply and expectations of contin-
ued low prices.
The current recovery is different from the previous
two. There has been no synchronized surge in
demand, and inflation is expected to stay relatively
low. Large. producer and institutional stocks are
restraining prices. High interest rates and low
industry profits will continue to restrain invest-
ment in new plant and equipment. In addition, the
increased participation by industrializing LDCs as
commodity importers during the past decade has
slowed considerably because of low export earn-
ings and severe debt problems.
? LDC demand will remain weak as financial
problems and IMF-mandated austerity measures
limit imports and investment.
? LDCs-reluctant to cut exports-continue to in-
crease metals production using new capacity that
results from ambitious development plans con-
ceived years ago.
Agricultural markets are less closely related to the
business cycle, but huge stocks-especially of
grain, cocoa, sugar, and coffee-will keep farm
prices depressed. In addition, better farming tech-
nology, increased acreage under production, and
subsidies in OECD countries that encourage over-
production are all working to dampen agricultural
prices.
Secret
9 December 1983
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On the demand side, trade analysts report that
China and some Middle Eastern food importers
have recently canceled or postponed deliveries on
agricultural commodity contracts because of im-
proved domestic supplies or because of financial
strains. Changing consumer tastes, substitution,
and more efficient processing will also depress
demand in the industrial countries. Examples in-
clude the trend toward use of artificial sweetener,
lower demand for red meat, and higher recovery in
instant coffee processing.
While the near-term economic outlook for LDC
commodity producers remains dim, countries that
depend on the sale of one commodity face the most
risk and are likely to fare the worst. For example,
we expect that Chile and Zaire, which depend on
copper for nearly half their export earnings, will
continue to suffer because of weak copper demand
and low prices. On the other hand, countries such
as the Philippines, which depend on markets in the
United States and Japan, should enjoy improved
earnings sooner than those selling to other OECD
countries and to each other.
Secret
9 December 1983
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Grenada: Picking Up the Pieces
Grenada's recently appointed interim governing
council has inherited an economy beset with wide-
spread unemployment, breakdowns in public ser-
vices, and depleted public coffers. If the govern-
ment is unable to replace economic assistance from
previous donors, it eventually will be forced to
adopt unpopular austerity measures that could
jeopardize its political acceptability. New donors
already have promised $4.5 million in economic
assistance and are considering more, but these
funds may not fully offset lost foreign aid from
Cuba and Arab and Soviet Bloc countries and other
foreign exchange losses that could total $20-40
million through 1984. Over the next few years,
continuing external assistance will be required to
restructure the economy and lay the groundwork
for sustained economic growth.
Economic Legacy of the Bishop Regime
Former Prime Minister Maurice Bishop's leftist
New JEWEL Movement (NJM) overthrew the
government of Sir Eric Gairy in March 1979 and
soon began expanding the government's role in the
economy. It also began to strengthen ties with the
Soviet Bloc-particularly Cuba-and some Arab
states such as Algeria, Iraq, Libya, and Syria.
Initially the regime won kudos from international
financial institutions for its efforts to tighten fiscal
management by centralizing and controlling expen-
ditures, improving tax collection, and reducing
longstanding debts to regional institutions. Ten-
sions with the private sector developed, however,
when the government began appropriating private-
ly held agricultural land, took control of commod-
ity marketing boards, and declared itself the sole
importer of rice, su ar, cement, and milk powder.
GDP (1983, estimated)
Population (1983) a
Land
344 square kilometers: 44% cultivated;
4% pastures; 12% forests; 17% unused
but potentially productive; 23% built
on, wasteland, other
Main products: cocoa beans, bananas,
nutmeg, clothing, fresh fruits, mace
Major buyers: United Kingdom (32%
in 1982), Trinidad and Tobago (26%)
Netherlands (10%), West Germany
(10%)
Main products: food, machinery and
transport equipment, oil (mainly from
Trinidad and Tobago)
Major sellers: United States (20% in
1982), Trinidad and Tobago (19%),
United Kingdom (15%)
a We do not believe the population data released by the Bishop
regime. Most estimates seem to fall within this range.
Recognizing the need to upgrade the island's trans-
portation network and utilities, the government also
embarked upon a large-scale investment program.
The centerpiece of the regime's efforts was the
airport project at Point Salines, which accounted
for nearly half of all capital expenditures during
1979-83. Other projects included the extension of
feeder roads and expanded access to piped water.
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The regime increasingly turned to Cuba and Arab
countries to finance development projects that
many Western donors considered too large for the
government's limited financial resources and not
adequately supported by the island's tourist infra-
structure. Reflecting Bishop's longstanding ties
with Fidel Castro, Cuba became the largest donor.
According to Grenadian data, Cuba provided over
half of the $65 million in grants of technical
assistance, supplies, capital equipment, and cash
received during 1979-83.' An additional $15 mil-
lion or so in grants was provided mostly by Arab
states, and the USSR also provided a small amount
of assistance. Moreover, East Germany, Libya, and
Iraq authorized large loans, although most of the
promised Iraqi and Libyan funds apparently never
materialized. In addition, the USSR also promised
about $26 million in free military aid.
At the same time, trade relations with Communist
Real GNP Growth
Percent
External Debt Service Ratio
Percent
countries were strengthened. The regime turned to
Cuba for sugar and cement, and, in 1982, signed a
five-year trade agreement with the USSR calling
for the export of about 500 metric tons of nutmeg
annually-close to one-fifth of the crop-and an
unknown quantity of cocoa.
With the increased centralization of economic deci-
sion making, public spending became the major
force behind an average annual economic growth
Stayover Visitors
Thousand Persons
rate of 2.9 percent between 1978 and 1983. Public-
sector employment swelled as the government built
up its security forces and hired workers for develop-
ment projects. These projects particularly benefited To
the construction sector, which more than tripled its
share of GDP-to 7 percent-by 1982.
Other sectors of the economy were hit by the world
recession as well as growing domestic and Western
apprehension over Bishop's political and economic
intentions. Disease, poor weather, tight credit, la-
bor shortages, and falling prices disrupted farm
' Although official Grenadian figures are not entirely accurate, and
may well have overstated the value of aid flows, we judge that these
data correctly describe general economic trends over the past four
Secret
9 December 1983
Overall Public Sector Deficit
Percent of GDP
Origin of GDP, 1982"
Percent
services-4l
Utilities-2-
Hotels and
Transportation and
communication-6
Construction-7-
Wholesale and
retail trade-14
a Preliminary.
b official projections reported by the IMF before
the recent fighting.
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Grenada: Balance of Payments
Current account (excluding transfers)
-7
-13
-27
-37
-50
-48
-54
Trade balance
-16
-23
-35
-38
-46
-47
-48
Exports (f.o.b.)
17
22
17
19
19
21
23
Imports (f.o.b.)
33
45
52
57
65
68
71
Net services
9
10
8
1
-4
-1
-6
14
15
16
14
13
15
9
Transfers
8
15
26
27
31
36
35
Net private transfers
7
8
13
14
14
15
15
Net official transfers
1
7
13
13
17
21
20
Capital account
1
0
2
13
12
13
7
Net direct investment
1
0
0
0
2
1
1
Long-term capital
0
2
1
7
7
16
10
Short-term capital, including
errors and omissions
0
-2
1
6
3
-4
-4
Change in gross reserves
2
2
1
3
-7
1
-12
3 Estimated.
b Projected. Assumes the loss of $15 million in Communist and
Arab grants and loans; and the inflow of $17 million in project-
related grant aid from the United States.
output. These factors caused a 5-percent drop in
agricultural production during 1979-82 and contin-
ued to hamper farm activity in 1983. Tourism was
hit by a 30-percent drop in stayover visitors, reflect-
ing Western recession, adverse publicity in major
tourist markets, and the closure of a major hotel.
The number of arrivals rose earlier this year be-
cause of the world recovery but probably fell short
of the 1979 peak. Moreover, local businessmen,
fearing eventual government takeovers, and unable
to borrow domestically in 1982-83 because the
government was absorbing available credit, adopt-
Soaring budget deficits-projected at close to 30
percent of GDP this year compared with 7.5 per-
cent in 1978-emerged from the regime's policies.
The rapid increase in government spending since
1978 far outweighed revenue gains from sharply
increased excise and trade taxes, including a specif-
ic import duty to help fund the airport. Moreover,
external assistance for the airport failed to reach
planned levels, as some backers reneged on their
pledges. Although the regime began to lay off
government workers in 1981, delayed salary and
other payments, and eventually slowed investment
spending, the budget deficit continued to climb. To
cover it, the government borrowed at home and
abroad, appropriated additional money from the
domestic banking system, and siphoned funds from
the National Insurance Scheme.
The Bishop government's increasing role in the
economy led to a deteriorating foreign payments
situation, particularly in 1981-83 when the invest-
ment program was under full steam. Encouraged
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by Cuban grants and increasing remittances from
Grenadians living abroad, the government pushed
the current account (excluding transfers) deeply in
the red. The deficit rose from $7 million (12 percent
of GDP) in 1978 to $50 million (47 percent) in
1982, according to official figures released to the
IMF. Merchandise export earnings stagnated in
1979-83, as sharply falling export volumesor prices
for Grenada's traditional crops (nutmeg, mace,
cocoa, and bananas) offset gains in sales of nontra-
ditional agricultural and manufactured products.
At the same time, imports doubled because of
rising oil prices and government purchases. Uncer-
tainty over political and economic conditions led to
capital flight. Faced with rising payments pressures
and low foreign exchange reserves, the government
turned increasingly to external borrowing, includ-
ing a $6 million IMF loan in 1981 and a three-year,
$14 million Extended Fund Facility for 1983-86.
As the economic situation deteriorated, policy rifts
within the ruling NJM increased. Bishop, heading
the more moderate faction, favored the expansion
of Western-especially US-tourism and invest-
ment The more
ideological faction led by former Deputy Prime
Minister and Minister of Finance Bernard Coard,
preferred increased economic ties with the socialist
bloc. Indeed, personal tensions between Bishop and
Coard apparently sparked the upheaval in October.
Economic Challenges Ahead
Grenada faces severe economic difficulties over-the
coming year with the most intense problems likely
to occur in the next few weeks. The new govern-
ment must deal both with the economic troubles
inherited from the Bishop regime and with political
and economic reconstruction. Unemployment is a
major concern. As many as 7,000 Grenadians were
out of work before the recent conflict-up to 25
percent of the labor force-and now up to 1,600
People's Revolutionary Army and militia members,
400 airport workers, and 150 people formerly em-
Secret
9 December 1983
ployed by Cuban and Soviet personnel are without
jobs as well, according to US Embassy reporting.
Infrastructure and basic services damaged by fight-
ing and neglect need to be repaired and upgraded.
The expulsion of Cuban and other doctors, teach-
ers, and technical personnel has disrupted health
and education services.
During the coming year Grenada will need to
replace some $20-40 million in aid-in-kind, project
funding, and foreign exchange earnings:
? Severing ties with Communist and Arab coun-
tries has cut off almost $15 million in project
loans and Cuban grants expected in 1984 by the
previous government. These funds were tied to
airport construction, agricultural assistance, in-
dustrial expansion, communications, and health-
and education-related projects.
? Grenada's IMF program-under which the gov-
ernment was to receive $1.2 million in November
and $4.7 million in 1984-has been suspended,
apparently because the IMF is reluctant to dis-
burse funds until a stable government has taken
control. The program probably will have to be
renegotiated because of the changed economic
environment.
? Tourism earnings in 1984 are likely to fall sharp-
ly below the $18 million projected by the previous
government because of the political uncertainty
that is coinciding with the current peak tourist
season. Although expenditures by military and
press personnel are offsetting much of the loss in
tourism revenues at present, almost all of the
military and much of the press may be gone by
January.
? As much as $1 million in nutmeg exports to the
Soviet Bloc will be lost in 1984 and prospects for
sales to other markets are dim because Indonesia
is dumping nutmeg on the world market.
? Up to $5 million more would drain from the
economy if the US medical school were to leave
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the island-a move under consideration in Octo-
ber because of the school's proximity to the end of
the Point Salines airport runway. Even if the
school stays, we doubt that all the registered
students will return in January-the scheduled
reopening date-because they have been given
the choice of continuing their studies in Barba-
borrow to pay workers, and businessmen are find-
ing it difficult to repair shop damages and restock
depleted inventories.
dos.
New aid to fill some of the shortfall already has
been promised. The United States, the largest
donor so far, has disbursed $475,000 in disaster
assistance and is spending $2 million for infrastruc-
ture repairs. An additional $5 million in US bal-
ance-of-payments support and $10-15 million in
project aid is under consideration. The United
Kingdom has announced a $1.1 million grant, to be
spent by March 1984, that will be used for public
works projects and to provide equipment and train-
ing for a new Grenadian police force. Venezuela
may ship 10,000 barrels of asphalt-previously
promised but never delivered-to use on road re-
surfacing projects. In addition, Venezuela and
Trinidad have begun discussing the possibility of
supplying refined petroleum at concessional prices.
Quick disbursement of US project aid has allowed
the interim government to begin tackling the em-
ployment, repair, and services problems. Two tem-
porary road repair projects are employing close to
450 people. US personnel are providing medical
services, and the government has been. able to
replace many of the expelled teachers with educa-
tors from neighboring Caribbean countries.F_
Meanwhile, cash shortages continue to haunt the
inexperienced government. The government is hav-
ing difficulties meeting public-sector payrolls and
other current expenses,
The former government
had expected to use IMF disbursements for these
outlays, but other sources now must be found.
Moreover, domestic banks apparently cannot boost
credit to the private sector because the government
has had insufficient funds to repay local bank
overdrafts. As a result, agricultural activity is being
disrupted because landowners have been unable to
Beyond these immediate financial problems, gov-
ernment leaders face several difficult policy and
timing tradeoffs. By mid-1984, in addition to reve-
nue losses attributable to the recent fighting, Gre- 25X1
nada will face its normal seasonal low in tax
receipts and foreign exchange earnings. Several
factors will inhibit the imposition of new revenue
levies or the reduction of outlays to ease budget
problems; the existing tax burden is already high,
there is intense pressure to maintain government
payrolls and public works projects, and there are
high expectations of additional aid from the United
States. Moreover, promised project aid may be too
narrowly directed to enable the government to meet
politically necessary expenditures. Without in-
creased general purpose aid or success in obtaining
foreign loans, the governing council would face
politically unpopular austerity measures.
Economic Restructuring
Over the longer run, the government needs to
restructure the economy to revitalize the private
sector and promote sustained recovery. A promis-
ing strategy suggested by the World Bank would be
to increase foreign exchange earnings by stimulat-
ing agriculture, tourism, and manufacturing. Both
export and domestic agriculture would benefit from
expanded credit, improved extension services,
better management of commodity marketing asso- 25X1
ciations, and increased access to high-quality agri-
cultural inputs, such as herbicides and pesticides.
Investment in nontraditional fruit and vegetable
production, tourist facilities, and light assembly
and agroindustries also could lead to greater for-
eign exchange earnings.
25X1I
25X1
The government intends to complete the Point 25X1
Salines airport, at an estimated cost of up to $20
million, to boost tourism earnings. The overall
increase in visitors and earnings, however, would be
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sharply limited by the small number of hotel
rooms-fewer than 800, of which fewer than 300
are considered first class, according to the World
Bank and US Embassy reporting. To take full
advantage of the airport, a minimum of some 1,500
luxury and first-class rooms would be needed.
To spur other investment and production, the gov-
ernment probably will soon apply for the 12-year
investment incentives and tariff-free access allowed
for many Caribbean exports under the provisions of
the US Caribbean Basin Initiative. In addition, the
government probably would have to demonstrate
that it could maintain order and had established
political confidence, that it intended to reduce
tariffs and revise the burdensome tax system, and
that it planned to upgrade inadequate transport,
power, communications, and sanitation networks.
Grenada primarily will look to bilateral and multi-
lateral assistance over the next few years to finance
its infrastructure projects, and we think it will turn
increasingly to the United States as the major
source of this aid. Grenada's export and tourism
earnings will be insufficient to pay for necessary
investments. We believe international lenders-
concerned about the payments performance of ma-
jor LDC debtors and faced with increasing de-
mands from major industrial borrowers-could be
reluctant to substantially increase their exposure in
Grenada.
Secret
9 December 1983
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Cuba: Patterns and Prospects of
Soviet Economic Aid 1
Fidel Castro's goal of making the Cuban economy
independent of foreign powers has become increas-
ingly distant after 25 years of his rule. The extent
of Cuba's reliance on the USSR is most evident in
its need for direct aid: whereas US economic aid to
Cuba in 1958 was equivalent to less than 1 percent
of national output, Soviet soft currency economic
aid in 1982-valued at about $4.6 billion-corre-
sponded to somewhat more than 30 percent of
Cuba's output. Composed mainly of trade subsidies
and development assistance, this soft currency aid
has increased dramatically since 1974 and has
totaled nearly $29 billion since 1960. In addition to
the aid, Moscow helps Cuba through hard currency
purchases. Without the Soviet help, Havana would
be hard pressed to meet even basic consumption
and investment needs.
As long as Moscow continues to derive significant
political and military benefits from its preeminent
Third World client, we judge that it will not slash
its aid to Cuba. Moscow has made it clear to
Havana, however, that there are limits to its lar-
gess. Unless the pricing formulas used in Soviet-
Cuban trade are altered, we believe the annual aid
flow will decline slightly over the next two years. In
addition, we believe Moscow will demand more
accountability for the use of its aid.
Cuba depends on the Soviet Union for 60 to 70
percent of its total trade. Moscow supplies Havana
with nearly all of its crude oil, petroleum products,
grain, lumber, and much of its industrial, agricul-
tural, and transport equipment. In turn, Cuba
exports one-half its sugar crop as well as the bulk of
Cuba: Total Trade Balance Adjusted
for Soviet Price Subsidies
-3 Total trade balance adjusted
1 I I I I I I I I I I I-]
1961-70a71 72 73 74 75 76 77 78 79 80 81 82
cy through a bilateral clearing account.
its nickel and citrus production to the USSR.
Nearly all of this trade is conducted in soft curren-
Trade subsidies-totaling about $20.3 billion since
1960-are the principal component of Soviet aid to
Cuba; Moscow pays artificially high prices for
Cuban goods while pricing its own exports to Cuba
below world market levels. The general pricing
formula established in Cuba's current five-year
(1981-85) trade agreement with Moscow is de-
signed to maintain the purchasing power Havana
had in 1974-75-the period of high world sugar
prices and oil prices that averaged $11 per barrel.
In 1982, for example, the USSR paid over five
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Cuba: Imports From USSR as a Share
of Cuban Consumption, 1980
Tractors
Bulldozers
Oil
Automobiles
Lumber
Wheat
Cranes
Steel
Tin
Whole plants
Rubber
Trucks
Spare parts
Lard
Ball bearings
Corn
Machine tools
Fertilizers
Buses
Conserved meat
Tires
Motol S
Beans
Secret
9 December 1983
Cuba: Share of Total Trade,
by Major Area
1957
1965
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982 (est.)
0 Soviet Union
Other Communist
? Non-Communist
times the world market price for Cuban sugar and
charged Havana only about three-fifths of the
OPEC benchmark price for oil.
The other major category of Soviet aid-totaling
nearly $9 billion since 1960-consists of develop-
ment assistance and easy terms for trade deficit
financing. Both directly and through the Council
for Mutual Economic Assistance (CEMA), Moscow
provides materials, equipment, and advisers for
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Cuba: Subsidized Versus World
Market Prices
Sugar
Cents per pound
projects relating to export development and import
substitution. Over
200 projects valued at 1.2 billion rubles ($1.7
billion) were completed during Cuba's first five-
year plan (1976-80). We estimate that plants built
or modernized with Soviet participation since Cas-
tro took power in 1959 account for 100 percent of
the output of sheet metal, 95 percent of steel, 50
percent of fertilizers, and 40 percent of electric
power. As for the financing aspect, that part of
Cuba's annual ruble trade deficit with the USSR
not covered by development credits is financed on
favorable terms.
In addition to this large volume of soft currency
assistance, Moscow also helps Havana to a lesser
degree-$773 million in 1982-with its hard cur-
rency account. It does this by purchasing some
Cuban sugar and other goods for hard currency
and by making hard currency purchases of grain
T- I I I I I I I I I I I
0 1971 72 73 74 75 76 77 78 79 80 81 82
Petroleum
US S per barrel
Average OPEC priceb which it then resells to Cuba for soft currency.
% ' Without these direct and indirect cash infusions,
30
we believe Cuba would have had to reschedule its
/
hard currency debt months before the actual re-
t, t 1982
ques In ugus .
-Price charged by USSR
L EI I I I_ 1
0 1971 72 73 74 75 76 77 78 79 80 81 82
Nickel
US S per metric ton
4,000
2,000 1971 72 73 74 75 76 77 78 79 80 81 82
aIncludes only soft currency sugar purchases.
b Based on crude product ratio of 60 to 40.
Despite the huge volume of Soviet aid, Cuban
economic growth during 1976-80 did not match the
average of the non-OPEC LDCs. During this peri-
od these countries achieved an average annual real
growth rate of 4.7 percent compared with our
estimated 3.4 percent for Cuba.' Moreover, Cuba's
hard currency debt increased by about 140 percent
over the same period-nearly the same as the 145-
percent average of non-OPEC LDCs. We believe
that the centrally planned economy and lagging
productivity were the main contributing factors.
Because of the favorable trade agreements with 25X1
socialist countries, Havana was not hurt as much as
other LDCs by the drop in commodity prices after
1980. As a result, Cuban growth for 1981-83 is
expected to average 2.3 percent compared with
' In 1981 Cuba received about $165 per person in official develop-
ment assistance from the Soviet Union, Eastern Europe, and the
West, or about six and a half times the per capita amount received
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Soviet Soft Currency Assistance to Cuba a
Total
1974
1975
1976
1977
1961-82
2,946
3,178
3,463
4,438
4,561
3,944-
4,560
320
460
830
1,415
975
1,000-
1,100
2,626
2,718
2,633
3,023
3,586
2,944-
3,460
Sugar d
13,800
-408
577
989
1,638
2,427
2,324
1,165
1,366
2,580
2,644-
3,160
Petroleum e
6,292
411
310
374
378
164
381
1,480
1,657
1,006
300
Nickel d
245
40
27
21
24
35
13
-12
0
0
0
a Based on official Cuban and Soviet trade data.
b Projected.
Based on (a) estimated balance-of-payments aid necessary to cover
Cuban trade deficits with the USSR; (b) Cuban purchases of
capital goods from Moscow; and (c) public statements by Cuban
and Soviet officials concerning the amount of development aid
extended. This aid is repayable but terms are highly concessional.
Projection for 1983 is based on preliminary trade data.
about 1.2 percent for non-OPEC LDCs. Neverthe-
less, Havana was not totally sheltered from interna-
tional conditions during this period, and the deteri-
oration in its economic dealings with the West
made Soviet aid even more important.
For the most part, the levels of trade and aid
between Cuba and the Soviet Union through 1985
have already been established as part of the five-
year trade agreement. Moscow is likely to meet the
commitments set in this agreement, even if Cuba's
exports fall short of plan due to weather-related
crop problems, but we doubt that it will do more
than this. In fact, unless Cuba's economic position
experiences more damage from natural disasters or
sanctions imposed by the West, Moscow probably
Secret
9 December 1983
d Sugar and nickel subsidies are estimated as the difference be-
tween the price Moscow pays for these commodities and their world
market value. The difference is considered a grant and not subject
to repayment.
e The petroleum subsidy reflects the difference between the value of
petroleum purchased from the USSR and the value of these imports
at world market prices. It is considered a grant and not subject to
repayment.
will look for ways to make Cuba a less expensive
client.
Reportedly, Moscow already is irritated at Cuba's
inefficient use of resources.
Soviet complaints about Cuba's
low worker productivity, inefficient utilization of
land, and underutilization of Soviet advisers and
technicians. In addition, Moscow apparently has
been pressuring Havana to meet soft currency
sugar contracts this year even at the expense of
hard currency sales to the West.
We expect Moscow's soft currency economic assist-
ance in 1983 to total a little more than $4 billion-
almost as much as last year. This figure is likely to
decline to $3-4 billion by 1985, however, primarily
because of the formulas used by Moscow and
Havana to calculate the prices of traded goods. In
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Soviet Hard Currency Flows to Cuba a
Total
1961-82
1974
1975
1976
1977
4,864
123
601
343
546
Soviet sugar 1,525
purchases
0
424
159
223
Grain/flour exports 2,605
123
174
173
216
133
213
234
319
266
250
Others 734
0
3
11
107
31
9
141
216
216
200
a Based on Soviet and Cuban trade data.
b Projected.
c As reported in Cuban trade data, not further specified.
particular the price Cuba pays for its approximate-
ly 200,000 b/d of oil imports-about $25 per barrel
in 1983-will rise because it is based on a moving
average of the world price of oil over the previous
five years. The sugar price in turn is linked to the
oil price and thus will increase by a few cents per
pound. Furthermore, we estimate that Moscow's
contribution to Cuba's hard currency balance will
drop this year, to about $450 million, although it is
likely to return to the $700-800 million range in
1984 and 1985.
Moscow probably will continue its hard currency
purchases, but a poor harvest will keep the amount
of sugar purchases negligible this year. As Cuba's
sugar output recovers in 1984 and 1985, Moscow is
likely to purchase perhaps 500,000 metric tons
annually. Cuban trade projections indicate that
Soviet hard currency purchases in the category of
unspecified goods will continue at the 1982 level of
$200 million annually through 1985. Part of this
amount, however, could represent credit for petro-
leum Cuba did not consume.
the Cuban press, reported that a 1981
agreement offered Havana convertible currency
credits for oil saved from its protocol allotment.
This Soviet incentive, unique to its trade with
Cuba, probably represents an effort to lessen Ha-
vana's energy dependence without imposing the
hardships of abrupt declines in oil shipments. We
expect Soviet hard currency grain purchases on
Cuba's behalf to grow more slowly over the next
two years. The Soviets may encourage Cuba to
utilize its $70 million Argentine credit line for corn
purchases in order to decrease their own burden. F_
Preliminary Soviet trade data indicate that its total
development aid to Cuba in 1983 will remain
large-$1-1.1 billion. We think this figure will be
about the same in 1984 and 1985. According to
public statements by Soviet officials, project aid is 25X1
scheduled to rise by 80 percent during 1981-85 and
total roughly $3 billion for the entire period. Impor-
tant projects using this aid include a nuclear power
plant that will decrease Cuba's oil needs by about
10 percent in the late 1980s and a new nickel plant
that will double Cuba's output. In addition, Cuba's
soft currency trade with the USSR is likely to
remain in deficit-probably on the order of $500
million annually-through 1985, and Moscow will
continue to provide favorable financing.F 25X1
According to Cuban data, repayments of Soviet
development aid will begin to come due in 1985.
Though Havana may be able to expand its exports
enough to make the $125 million payment due that
year, the problem will worsen in 1986 when the
grace period on Cuba's recently rescheduled hard
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9 December 1983
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currency debt expires. We believe Havana is likely
to give these latter debts priority to preserve its
reputation for honoring commitments to the West,
and Moscow probably will again reschedule, or
by 5 percent. In addition, thermoelectric power
plants scheduled to open could raise needs by an
additional 3 to 5 percent.
perhaps even forgive, Cuba's debt.
Economic Impact of Reduced Aid
The expected decline in Soviet soft currency aid in
1984 and 1985 will force Havana to slow the
growth of its imports from the USSR. Soviet oil
deliveries are likely to stagnate at the reduced 1983
level, while imports of consumer goods-and capi-
tal goods not connected to certain Soviet-funded
projects-will increase less rapidly than Havana
would like. The oil shortfall is likely to slow Cuba's
economic activity during the next two years, while
fewer capital goods will contribute to slower growth
beyond 1985 as investment projects are delayed.F-
After rising 30 percent during 1976-81, Cuban oil
imports dropped 7 percent in 1982. Oil imports
thus far in 1983 are slightly lower than for the
same period last year, probably reflecting Cuba's
desire to earn convertible currency in accordance
with Moscow's incentive plan. We believe that
Havana's hard currency needs through 1985 will
force it to continue restricting oil imports. Thus, we
do not expect deliveries to rise to the 1981 level
again during this period even though ener de-
mands will increase as new factories ope
We have no evidence that the fall of petroleum
imports in 1982 and 1983 has resulted in shortages,
but this is probably due mainly to a drop in
demand. In particular the lack of foreign exchange
has curtailed imports for industry and transporta-
tion. Thus, petroleum demand in these sectors-
which account for about 70 percent of total oil
demand-probably was depressed.
We believe the decline in oil deliveries will be felt
in 1984 and 1985, however, when a moderate
pickup in economic growth is expected. A new
nickel plant is scheduled to come on line during this
period, and this alone will increase total oil demand
Secret
9 December 1983
Judging from the regime's past practices, we expect
consumers to bear the brunt of any oil shortages.
There will be very little or no impact on sugar
production because most of its energy requirements
are satisfied by bagasse-a byproduct of sugarcane
milling. Tobacco production likewise uses only min-
imal amounts of petroleum, while the export indus-
tries most dependent on oil are nickel and seafood.
There will very likely be brownouts to homes and to
industries that produce for domestic consumption,
as well as decreased availability of public transpor-
tation.
Cuban Response
The prospect of coping with import shortages is
likely to renew debate within the Cuban leadership
over economic policy, especially the issue of moti-
vating the labor force. In our judgment, moderates
and technocrats will press again for increased
material incentives, lowered restrictions on private
enterprise activities, and greater autonomy for en-
terprise managers. Such policies go against the
ideological grain of the hardline elements who
currently dominate the leadership. The ideological
purists' antipathy for liberalization was shown by
the restrictions placed on the farmers' free mar-
kets-even though the markets had stimulated
productivity.'
' The so-called hardliners are primarily ex-guerrillas from the
struggle against Batista. More than three-fourths of the Politburo
fall into this category. They are politically unsophisticated, tend to
view the world in black and white terms, and are intensely anti-
American. Moderates in the hierarchy include veterans of the pre-
Castro Communist Party and a younger group of "technocrats"
who are largely responsible for the daily operation of the economy.
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Although Fidel Castro is, in our view, more prag-
matic and sophisticated than the ideological purists
in the leadership, he generally sees any economic
liberalization as a necessary evil to resolve short-
term problems. Like his hardline colleagues, he
fears that such reforms will lead to a popular desire
for additional liberalization and a decentralization
of economic decision making. For these reasons, as
long as Fidel Castro remains in power, significant
economic liberalizations are unlikely. In Castro's
mind, worker motivation must be accomplished
through exhortation, ideological education, and re-
pression. In periods of economic difficulty, he has
sided with the hardliners who assert that tough
measures are necessary to achieve improved pro-
ductivity and to encourage proper "socialist behav-
ior."
Implications for Moscow and Washington
We believe that Moscow will continue to provide
large amounts of aid to Cuba as long as Cuba
reciprocates with the kind of political and military
benefits it has provided in the past. Havana, for
example, has been a valuable ally in assisting
Moscow in its Third World policies. Cuban mili-
tary personnel have played a key role in preserving
pro-Soviet regimes; Cuban support was an impor-
tant factor in the Sandinista victory in Nicaragua.
Castro has promoted the USSR's political position
on various international issues, and Cuba continues
to afford the Soviets valuable military facilities in
the Western Hemisphere. As long as Castro's
position is not endangered by sharper economic
difficulties than we now foresee, we believe he will
continue to provide these benefits.
Castro's deeply held antipathy toward the United
States and his dominance over Cuban policy sug-
gest that, as long as he remains in power, Washing-
ton will have little direct leverage on Cuban policies
and, short of war, can do little to reduce the
military value of Cuba to the USSR. On the other
hand, Cuba's economic problems will increase US
opportunities for indirect influence in some areas.
US demarches to Cuba's official creditors, for
example, may help to reduce the flow of Western
credit to Havana or tighten conditions for future
reschedulings. In addition, as consumer disgruntle-
ment and economic crime increase in Cuba, oppor-
tunities for the United States to exploit these
feelings will be enhanced. Moreover, if-as we
expect-the regime responds with even more re-
pressive measures, such as executions of common
criminals, its image in the Third World could be
undermined. Eventually, however, Castro is likely
to be tempted to export the dissidents as he did in
1980
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9 December 1983
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Hungary: New Horizons for
Private Entrepreneurs
Although a socialist country, Hungary has long
tolerated private enterprise in agriculture and, to a
lesser extent, in retail trade and consumer services.
Since 1981 the Kadar regime has further legiti-
mized and thereby spurred an increasingly wide
range of activities in Hungary's huge "second
economy" in a bid to ease some of the country's
economic ills. Even though the Western press over-
plays the "capitalist" aspects of the new ventures,
such measures-if sponsored vigorously over the
long term- could transform Hungary's economy
into an even bolder model for change in the rigid,
inefficient systems of other Soviet Bloc countries.
With the onset of severe economic difficulties in the
early 1980s, Budapest recognized the need for
institutional reforms that further encourage private
initiative, building on the "New Economic Mecha-
nism" introduced in the late 1960s. We believe the
Hungarian regime has come to appreciate that
private market activity provides essential goods and
services, supplements personal incomes during a
period of austerity, and promotes a risk-taking
entrepreneurial spirit lacking in the large, monopo-
listic, and grossly inefficient state and cooperative
enterprises. Budapest has concluded that some
enlargement of the legal private sector need not
compromise its socialist principles and that legal-
ization should strengthen its ability to record and
tax the vast volume of economic activity going on
outside the socialized sectors. Moreover, like most
other East European countries, Hungary has been
struggling to redress chronic balance-of-payments
deficits while trying to avoid attendant declines in
economic performance and living standards. F_
The Specter of Capitalism
The regulations expanding the scope of authorized
private enterprise unleashed a flurry of reports in
the Western media that Hungary was "going capi-
talist" and probably raised some doubts among
Budapest's more orthodox CEMA partners. Earlier
this year Party Chief Janos Kadar stressed that the
new measures had nothing to do with capitalist
methods and emphasized that 98 percent of the
means of production in Hungary remains socialized
property. Kadar also stated that, whereas private
activity accounted for 14 percent of agricultural
production in 1982, it contributed a mere 1.1
percent in industry and a scant 1 to 2 percent in
retail trade. Although Kadar's numbers roughly
portrayed the situation in 1982, they do not fully
reflect the importance of the second economy in
delivering some key goods and services nor the
momentum of the small enterprise program in
The Second Economy. Estimates by Hungarian
researchers of the size of the second economy of
legal, semilegal, and illegal private activities show:
? Three families in four in Hungary's population of
10.7 million enjoy a "secondary" income in addi-
tion to that received from state or cooperative
sources.
? Roughly half the population, including urbanites,
cultivate private plots full or part time, making
agriculture the largest single employer in the
private sector; for some food items-pork, eggs,
potatoes, vegetables, and fruit-private agricul- 25X1
ture is the primary supplier.
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DI IEEW 83-048
9 December 1983
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An Enterprising Hungarian Family in the 1980s Hungary: Estimated Number of Units
A prominent Hungarian journalist, Istvan Lazar,
writes that "a model of a very fortunate family in
contemporary Hungary" could be described as
follows:
? The parents live in a village.
Thefather enjoys the high income of a miner or
receives a pension, having benefited from early
retirement.
The mother is a member or pensioner of an
agricultural cooperative and works on her pri-
vate plot.
? One son gets a good income from wages and large
tips working as an automotive mechanic in the
workshop of the industrial cooperative of a near-
ties in the private sector.
marketable in the second economy, certain social
tensions inevitably arise. But he concludes that in
a period of near-stagnant economic growth such
tensions would be much worse without opportuni-
gary have lucrative pensions, private plots, or skills
by town; on weekends, he moonlights for an
untaxed supplementary income.
? Another son lives in Budapest, where he performs
professional work and often travels abroad.
? A daughter lives in the county seat, working in
the party or government power hierarchy.
? Most family members have a car and/or one or
more weekend houses (for example, on Lake
Balaton) which they rent out at a rather high fee
during some part of the year.
Lazar observes that since not all families in Hun-
and Employees in New Small Ventures
as of Mid-1983 a
Total
Socialist sector
Small state enterprises
100
NA
Subsidiary enterprises
70
NA
Small cooperatives
155
NA
Semiprivate sector
Business partnerships within
socialist enterprises
5,862
52,831
Specialized work units within
cooperatives:
In agriculture b
2,688
NA
In industry and services
660
NA
Private business partnerships
3,481
NA c
Civil law partnerships
409
NA
a Our grouping of the units into socialist, semiprivate, and private
sectors is provisional. Small ventures in the "semiprivate" sector are
hybrids that seem to be neither purely socialist nor purely private
enterprises.
b In agricultural producer cooperatives and state farms.
c Although documentation is lacking, press commentary makes it
clear that private business partnerships are the second-largest
employers among small ventures.
retail merchants are added, the number of persons
working full or part time in small enterprises comes
to 243,000, or roughly 5 percent of the labor force.
repair, and other consumer services.
? The second economy also supplies the bulk of
workers in housing construction, maintenance,
Small Enterprises. Partial statistics indicate that
by mid-1983 some 13,400 new small enterprises
had been established, primarily in the industrial,
construction, and service trades. Employment in
these ventures totaled only about 81,000 persons,
partly because the regulations limit the permissible
number of entrepreneurs and employees per enter-
prise. If legally licensed private craftsmen and
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9 December 1983
Some examples illustrate the kind of sanctioned
activity allowing private entrepreneurs to seek out
opportunities complementing-and, in some cases,
competing with-the much larger state and cooper-
ative enterprises:
? A small advertising agency operating as a subsid-
iary of a state-owned corporation and designed to
serve the needs of private entrepreneurs.
? Eight small cooperatives and 33 semiprivate busi-
ness partnerships in a large state automotive
enterprise that handle tool design, toolmaking,
machinery design, and some transport tasks.
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? A private business partnership of professional
mountain guides, called Sub-Alps, doing highrise
repair work on state hotels.
? A two-person automotive repair service, named
Non-Stop, which operates during the hours when
state facilities are closed.
? Private taxi services, which for a fee can use state
garage and service facilities and the VHF radio
system.
? A private partnership producing small computers
for hospitals.
We have not seen any figures suggesting the
volume of previously semilegal or illegal activity
that has been absorbed by the new small enterprise
program. We suspect, however, that the bulk of
unlicensed private entrepreneurs have adopted a
wary, wait-and-see attitude.
The Property Rights Issue
In liberalizing its attitude toward private ventures,
the Hungarian leadership has shown a willingness
to adopt innovative approaches to the problem of
mobilizing and managing capital in a socialist
economy. But Kadar's stress on the continuing
dominance of socialist ownership demonstrates that
control over the means of production remains a
highly sensitive ideological issue.
The most generally accepted form of small enter-
prise activity to date involves leasing arrangements
in which groups of individuals or enterprises pool
their money and engage in competitive bidding for
the right to rent the facilities, equipment, land, or
livestock of larger, unproductive enterprises. The
group promising the largest sales and rental pay-
ment wins the lease. In another accepted variant,
an enterprise needing investment capital sells
shares, stocks, or bonds to its employees who
receive a rate of return higher than the interest
rates paid by banks on savings deposits.
At the same time, Hungarian economists, sociolo-
gists, and lawyers are locked in a wide-ranging
debate over further institutional reforms that reach
far beyond the small enterprise program now envis-
aged by the regime. One proposal calls for a
separation of society itself into three distinct sec-
tors-economic, government, and party-with the
aim that the latter two not be allowed to interfere
with the former. Capital in this system would be
managed by holding companies that would make
investment decisions as if they owned the assets
under their control but in fact would be acting in
behalf of the state. Still another proposal would
foster competition for capital by creating a com-
mercial banking system offering enterprises alter-
native sources for both loans and deposits.
Advocates of the various proposals recognize that
they are raising politically touchy issues of capital
ownership rights-or, at least, the rights to use the
means of production in pursuit of private or quasi-
private ends. Accordingly, they adopt a certain 25X1
ideological caution reflected by resort to terms such
as a mixed socialist economy, three-sector social-
ism, or entrepreneurial socialism. Although policy-
makers remain less sanguine than many reform
advocates about the tolerable limits for private
activity, Budapest seems satisfied with the develop-
ment of the small enterprise program and is ready
to promote its growth.
Climate for Expansion
In recent months, the regime has been gradually
reducing obstacles to rapid expansion of the small
enterprise program. These impediments-exces-
sively high taxes, limited provision for loan capital,
and cumbersome legal restrictions-were probably
introduced deliberately at the outset to gain policy
consensus, especially among ideological hardliners
suspicious of any "private" inroads into the social-
ist system. As the program has unfolded, official
policies toward these constraints have eased.
Punitive Income Taxes. The new tax codes intro- 25X1
duced in 1981-82 generally extended to the small 25X1
semiprivate and private ventures the income tax
structure already in place for licensed private
craftsmen and retail merchants. The tax was highly
progressive, ranging from 6 percent on annual
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incomes of $400 or less up to 75 percent on incomes
of $4,000 or more. The steep rates at the middle
and upper ends of the scale had long been criticized
on the grounds that they deterred many private
entrepreneurs from joining the legal economy and
encouraged those who were already legally licensed
to understate their real earnings. More recently,
the high taxes have come under fire for discourag-
ing participation in the new small ventures. As a
result, starting next year the lowest tax rate has
been reduced to 2 percent on incomes of $400 or
less per year and the highest rate has been cut to 65
percent on incomes of $12,000 or more.
Lack of Venture Capital. At the start, little provi-
sion was made for loans to prospective entrepre-
neurs. Recent decrees have authorized new "com-
petitive" credit arrangements intended to
encourage faster expansion of small ventures and
channel their activities more along the lines pre-
ferred by the government. Small ventures already
operating or about to be formed may apply to
central authorities for loans amounting to the
equivalent of several hundred thousand dollars. The
amount is limited only by how much collateral. the
applicant can provide and how much risk he is
willing to assume.
Legal Restraints. Existing regulations for setting
up small businesses are extremely complicated, and
the process of obtaining a license to operate has
been protracted because of a maze of bureaucratic
procedures. These legal restrictions are presently
undergoing extensive review, with the aim of sim-
plification and striking a better balance between
the sometimes conflicting goals of greater unifor-
mity in institutional forms and wider diversity of
productive activities. Major modifications in these
and other rules of the game probably will not be
codified until the government gains more experi-
ence and has had more time to assess the various
pros and cons of institutional alternatives.
Official thinking seems ambiguous on how far
legalized semiprivate and private activities should
be pushed. Prospects for the program are difficult
Secret
9 December 1983
to discern. Little information exists on how many
second-economy entrepreneurs have converted to
legal status and the extent to which roadblocks are
being created by large state and cooperative enter-
prises who view the changes as threatening.
There are good reasons why second-economy entre-
preneurs appear to have made no headlong rush to
register as legal enterprises. Apart from the high
taxes they face when successful, these people are
being invited to exchange the risk of arrest on
charges of engaging in illegal activity for the risk of
policy shifts that might destroy their business. Only
a consistent attitude by the authorities will gradu-
ally dispel such fears and suspicions.
Since there are limits beyond which the govern-
ment does not want small semiprivate and private
ventures to grow, the large enterprises have little to
fear in terms of quantitative competition for labor
and market shares. Rather, qualms are more of a
qualitative nature. In the case of labor, complaints
have been voiced that young workers with above-
average talent will switch their careers from state
to higher paying jobs in the small ventures-
threatening a "brain drain" from state enterprises.
Perhaps even more unpleasant is the prospect that
the small ventures, in their search for gaps in the
market and under pressure to excel because of
competitive risks, will further demonstrate the inef-
ficiency of many large enterprises
The program is vulnerable to criticism for contrib-
uting to a more unequal distribution of income and
is arousing resentment among those unable or
unwilling to become private entrepreneurs. Work-
ers in a steel mill, for example, even if they could
acquire the necessary capital, generally have nei-
ther the education nor skills in demand for legal-
ized moonlighting. In the first half of this year, the
purchasing power of a worker earning only regular
wages declined more than 5 percent, whereas in-
comes for participants in the second economy con-
tinued to far outpace the country's 8.5-percent rate
of inflation
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Expansion of legalized private activity may also be
complicating the economic stabilization program
Budapest worked out with the International Mone-
tary Fund to help it through its financial difficul-
ties. In its midyear assessment of the 1983 pro-
gram, the Fund noted that the rapid expansion of
income in the private sector was a major factor
preventing the reduction in domestic demand need-
ed to improve Hungary's current account balance.
While the IMF probably sees merit in legalizing
second-economy activity as a means of helping to
prevent a serious decline in living standards, it
apparently has been pressing the regime to further
boost-rather than reduce-taxes on large incomes
in the 1984 program
At this stage, we believe the regime still sees more
benefits than drawbacks to broadening the scope of
legalized private enterprise. Thus, we expect a
steady but measured evolution of the small venture
program. If the government sticks with it over the
next decade and if the debates on concepts of
property rights lead to even more novel institutional
reforms, Hungary will stand in even sharper con-
trast to its less imaginative, hidebound CEMA
partners. A "socialist" economy with ownership
shared among state, cooperative, semiprivate, and
private enterprises would constitute a challenging
model for emulation-particularly if it succeeds in
promoting the efficiency that has eluded centrally
planned economies.
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9 December 1983
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