LDC INFLATION AND LDC FOREIGN INVESTMENT POLICIES

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP85T00287R001200830001-9
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 19
• Document Creation Date: December 22, 2016
• Document Release Date: November 4, 2010
• Sequence Number: 1
• Publication Date: December 18, 1984
• Content Type: MEMO

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Recent Inflation Rates in
Key Debtor Countries*
Bolivia
Argentina
Brazil
Peru
Mexico
Philippines
(through October 1984)
(through October 1984)
(through October 1984)
(through August 1.984)
(through November 1984)
(through October 1984)
*Annual percent change over preceding 12 months
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Government Deficit as Percent of GDP in
Key Debtor Countries
Annual Averages, 1977-80 and 1.981-83
1977-80 1.?81-8
3
Difference
Bolivia
-6.0 -17.1
*
-11.1
Brazil +
-7.1 -15.
6
-8.5
Mexico
-3.1 -10.
2
-7.1
Argentina
-3.1 -9.
3
-6.2
Philippines
-1.1 -3.
3
-2.2
Peru
-3.9 -3.
9
0.0
* Data available for years 1981 and 1982 only.
+ Public Sector Borrowing Requirement (PSBR), as (negative) percent of GDP,
used here because Brazilian goverment budget must be formally reported
to be in balance.
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formulating an economic program to deal with the deficit problem.
In many debt-troubled LDCs, neither foreign nor domestic lending could he
mobilized in amounts sufficient to cover the ballooning deficits:
o Foreign lending growth to many developing countries slowed
dramatically as lender banks began to question LDCs' ability to
service their accumulating debt. According to the IMF, new cannercial
lending to non-oil LIEs fell from $41 billion in 1982 to $27 billion
in 1983.
o Domestic lending could not meet the widening gap between constrained
borrowing from abroad and the growing deficits. Econanic recession
constrained internal savings, while higher foreign interest rates and
over-valued official exchange rates often led to large-scale capital
flight. We estimate capital flight from Latin American LDCs may have
exceeded $100 billion during 1979-83.
When borrowing could no longer support their government deficits, some
debt-troubled LDCs resorted to inflationary financing through substantial
increases in the darnestic money supply. This sudden expansion of money and
credit could not be absorbed through real economic growth, and domestic prices
were forced up at a correspondingly rapid rate. Particularly sharp
accelerations in monetary expansion have occurred in Argentina, Bolivia, Peru,
and the Philippines; in each country, money stock growth has nearly tripled
since late 1982.
Current Developments
There are few signs that monetary inflation in key debtor countries is
likely to abate quickly:
o Argentina's recent IMF accord calls for reductions in government
deficits as well as money supply and inflation. The reluctance of the
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goverment to cut social programs will almost certainly keep the 1984
and 1985 public sector deficits above those forecast by the
government. Likewise, pursuit of monetary discipline is complicated
by the pervasive indexing of the Argentine economy and inflationary
expectations. Wage adjustments in excess of targeted inflation have
already raised IMF concern. Nonetheless, inflation slowed somewhat in
October and November, and recent monetary tightening could dampen
inflationary fires for the time being.
0 Ithe monetary expansion
necessary to finance recent economic measures taken in Bolivia could
push inflation to an annual rate of over 2000 percent by vearend. For
example, the government has recently granted a 659 percent increase in
the minimum wage to persuade the powerful labor organization to end
its general strike. Many businessmen are telling US officials that
massive wage hikes in the face of price controls are squeezing
profits, stopping some production, and helping to hankruot sane
businesses.
o Although Mexico's 1984 public sector deficit remains near 1983 levels,
there has been a near doubling of the rate of monetary growth. With
increases in the money.supply and the government's canmitment to stem
the decline in real wages, we expect Mexico City to be unable to meet
its 1985 inflation target of 35 percent.
o Brazil's attempts to tighten fiscal and monetary policies under its
IMF accord have had little evident effect on inflation thus far.
Brazil's highly indexed.econanv and inflationary expectations are
keeping consumer price inflation above 200 oercent for the second
successive year. The flrbassv reports that fighting inflation has
25X1
25X1
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become the current military government's top economic priority, but it
is too early to tell what positions might be taken by the new civilian
government next year. Sane Brazilian analysts predict that the
civilian government's growth strategy could boost inflation to 250-to-
300 percent. The presidential candidates of both the government's
party and the opposition advocate dismantling the indexation system
but concede that it will require considerable time to do so.
Implications
If permitted to proceed unchecked, continued upward spirals of money
supply growth and price inflation can undermine the economic foundations of a
society. Even at moderate annual rates, chronic inflation relentlessly
dilutes the value of financial assets, fixed salaries, and other cash
transfers. This induces consumers to spend quickly before prices rise and to
live on borrowed money rather than saving funds of their own. Accordingly,
the diminished levels of investment increasingly flow to speculative ventures
at the expense of productive enterprise. As a result of these distortions, an
economy becomes less productive and less efficient, economic growth falters,
and economic inequality increases. The stronger the inflation and the longer
its duration, the more severe are these effects.
In particular, the persistent and/or recurrent high inflation may present
serious political and social challenges in several key LDCs. The failure to
control monetary inflation in Argentina and Bolivia could produce prolonged
economic chaos and increased political unrest. In both countries, economic
demands of powerful labor organizations significantly impede. government
attempts to devise viable austerity programs and hring down povernment
deficits. Nbreover, labor unions and other important economic players appear
to have diminishing confidence that their governments have workable plans for
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reducing inflation. Other countries that face political and social fallouts
from inflation include Peru and the Philippines, where economic deterioration
and existing political unrest reinforce each other, and Mexico, where social
strains could intensify if living standards continue to fall.
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TROUBLED LDC DEBTORS: RECENT TRENDS IN INFLATION AND MONEY SUPPLY
BRAZIL
ARGENTINA
PERCENT CHANGE OVER
PREVIOUS YEAR
o a a
MEXICO
BOLIVIA
500 -1 PERCENT CHANGE OVER
O 4 q
PERU
120
PERCENT CHANGE OVER
4PREVIOUS YEAR
PHILIPPINES
PERCENT CHANGE OVER
PREVIOUS YEAR
CPI
MONEY SUPPLY
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Central Intelligence Agency
Washington. a C.20505
DIRECTORATE OF INTELLIGENCE
Developing Countries: Policies Toward Foreign Direct Investment
Summary
we doubt that foreign direct investment will soon play a
greater role in the total financial flows to developing
countries, even though declines in commercial bank lending and
aid will tend to heighten its importance. In a review of recent
diplomatic and open-source reporting, we find that some countries
-- for example South Korea, Chile, and Jordan -- are taking new
action, or considering taking new action, to encourage foreign
direct investment. However, often for political or tax-raising
purposes, nations such as Mexico and the Philippines are taking
steps discouraging to foreign investors. Given the continued
importance placed on such non-economic issues by governments, we
believe that most developing countries will avoid making
substantial policy shifts favoring foreign investment over the
This memorandum was prepared by Development
Issues Branch, Office of Global Issues. The information in this
memorandum is updated through 12 December 1984.r
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DEVELOPING COUNTRIES: POLICIES TOWARD FOREIGN DIRECT INVESTMENT
SOME COUNTRIES TAKE POSITIVE ACTIONS
Most of the developing countries that have recently taken steps to
attract more foreign investment have granted special incentives to attract
new capital and technology into targeted areas.
South Korea liberalized its foreign investment policy in July by
revising the Foreign Capital Inducement Law. The revised law opens up the
computer and robotics industries to foreign participation, eases
restrictions on remittances, and streamlines the approval process for
investments in which the foreign partner holds a minority share. We judge
these new rules reflect Seoul's belief that foreign direct investment will
enhance.long-term growth by introducing advanced technology into the
country.
Chile is attempting to reverse the 60 percent reduction in foreign
direct investment in 1983 by improving its already liberal investment
policy, according to the US Embassy. For example, earlier this year a new
mining code was enacted which places constraints on expropriation and gives
foreign owners the same rights as natives to buy and sell mineral
concessions. In addition, steps have been taken to establish overseas
promotion missions to attract new foreign investors.
According to press reports, Jordan now has legislation in place whereby
foreign direct investment in approved projects will be exempt from customs
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duties on machinery and spare parts. Some income tax relief also has been
granted to foreign investors, with greater tax savings if the investment is
made outside Amman. As specified in this legislation, proposed projects
that use local capital and labor and introduce foreign technology are most
likely to be approved.
The US Embassy reports that the government of Zaire is planning to
publish a revised investment code in the near future. The new code
provides for tax exemptions on imports and exports, property, corporate
earnings, and expatriate salary transfers for new or expanded foreign
investment.
A policy paper to be presented to Kenya's cabinet by the end of the
year will recommend new incentives for foreign investors, according to
press reports. Proposed new incentives include exemptions from duty and
sales taxes on equipment purchases by foreign investors and a five-year tax
holiday if the investment is in the agro-processing, export manufacturing,
or fishing sector. If the proposed policy is approved, changes in the
Foreign Investment Protection Act are likely to be legislated in 1985.
Although Andean Pact countries are formally bound by a treaty agreement
that establishes unified foreign investment regulations, Ecuador, Colombia,
and Peru have recently relaxed these regulations to attract additional
foreign capital. Quito has already eased profit repatriation and ownership
rules, Bogota has offered tax breaks for export-oriented firms and
liberalized controls on profit remittances, and Lima has doubled remittance
allowances. The other members of the pact, Venezuela and Bolivia, have
taken no action, although Caracas would grant new incentives if the treaty
is modified, according to the US Embassy.
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While we find few developing countries actively working to attract new
foreign direct investment, a number of countries actually have taken
actions discouraging to foreign investors. These actions often have been
driven by concerns over foreign economic domination or a need to raise tax
revenues.
Mexico recently enacted decrees applicable to the automotive,
electronics, and pharmaceutical industries which tighten state controls of
the manufacturing and marketing activities of foreign-owned firms. These
actions were apparently motivated by fear of foreign economic domination in
these industries. Mexico sometimes has been willing to grant exemptions to
controls for investment in export-oriented firms and to acquire new
technology. For example, Ford late last year secured an agreement for a
$500 million assembly plant, receiving both financial incentives and an
exemption from local ownership controls. In another case, however, IBM's
attempt to reach a similar agreement involving a facility to produce
personal computers might fall through, according to press reports. Despite
some cases where exemptions have been granted, we believe that traditional
Mexican concern about the risks of foreign investment will generally result
in maintenance of tight state controls.
Under an IMF-supported restructuring of the tax system, designed to
increase revenues, the Philippine Board of Investment recently rescinded
all tax and duty incentives given to regional headquarters of foreign
companies. Since headquarters offices usually have few fixed assets,
largely business machines and computers, these offices can be moved
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relatively easily. Hence, we believe some firms may consider moving their
regional headquarters to nearby locations that continue to grant such
incentives, namely Singapore and Hong Kong.
Changes in Indonesian laws are causing investor concern. Although new
tax laws enacted earlier this year increase depreciation allowances and
should prove beneficial to foreign-owned businesses in the long run, the
elimination of tax holidays has led to an immediate decline in new
investment applications, according to the US Embassy. A new law requiring
unions in foreign-owned firms has led one company official to say he will
recommend to corporate headquarters that plans for future investment be
halted. These changes have produced uncertainty about Jakarta's future
actions concerning foreign investment policy, adding to the negative
impact..
Over the near-term, increases in foreign direct investment in most
developing countries will continue to be limited by tight state controls
and depressed economic conditions. Despite pockets of change, we believe
most developing countries will continue to be reluctant about actively
encouraging foreign direct investment on a substantial scale.
Considerations other than the benefits of foreign investment -- such as
fear of foreign economic domination or a desire to protect a domestic
industry -- will continue to dominate the views of many of these countries.
Secondly, apart from the role of foreign investment policies, success or
failure in attracting investment will still depend upon other factors,
including the economic growth outlook of the country, exchange rate and
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trade policies, and political stability. In countries such as Chile facing
low economic growth, foreign exchange problems, and political unrest, the
overall investment climate will restrict new ventures even with substantial
changes in investment incentives.
Moreover, the relatively small scale of foreign direct investment
suggests that in general developing countries will have to look to other
remedies for managing the recent cutbacks in bank lending and other capital
flows (Figure 1), even if foreign direct investment increases. Since 1970,
according to OECD data, foreign direct investment in developing countries
has averaged about $12 billion per year, with no noticeable trend either up
or down. In the meantime, other financial flows fell by about $21 billion
in 1982. Thus, even a doubling of foreign investment would only offset
roughly half of the decline in these other sources of capital.
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FIGURE 1
DEVELOPING COUNTRIES: ROLE OF FOREIGN INVESTMENT
100
1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982
? TOTAL FINANCIAL FLOW IS THE SUM OF OFFICIAL DEVELOPMENT
ASSISTANCE, EXPORT CREDITS. BANK LOANS, FOREIGN DIRECT INVESTMENT, AND
OTHER FLOWS.
SOURCE: OECD
TOTAL FINANCIAL FLOW
FOREIGN DIRECT INVEST.
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