EFFECT OF ECONOMIC PROBLEMS ON THE NEGOTIATING STANCE OF ISRAEL, EGYPT, AND SYRIA

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP85T00875R002000010015-9
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 14
• Document Creation Date: December 12, 2016
• Document Release Date: September 6, 2000
• Sequence Number: 15
• Publication Date: March 4, 1974
• Content Type: MEMO

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OF ISRAE.L? EGYPT. &'' SYRIA. ' 'MAR ?4+ SECR~TINFCI ':01 OF 0~1;
 CIA Control No. 9371
4 March 1974
Effect of Economic Problems on the Negotiatin
Stance of Israel, Egypt, and Syria
We do not believe that Israel, Egypt, and Syria
will encounter economic problems great enough to pressure
them into making major concessions in the coming peace
negotiations. Each country has the assurance of foreign
financial backing that would see it through short r'-n
domestic economic constraints.
Israel will be able to. expand defense output,
sustain basic civilian needs, cope with high inflation,
and improve its foreign reserves position with the
receipt of $2.2 billion of projected aid from the US..
Egypt can maintain and possibly increase
output beyond the 1972 levels on the basis. of aid
already received and that pledged by other Arab states.
Syria's largely self-sufficient economy can
cope with existing economic problems, including
the reconstruction of war damage, with the help
of funds from other Arabs.
The economic incentives for an early peace settlement
are stronger for the Arabs t!:an for the Israelis, although
each would benefit in the long run. Egypt would gain
some $300 million annually in oil revenues 'with the
return of Sinai. Syria could resettle about 170,000
refugees, reduce unemployment, and increase national
output. On the other hand, the loss to Israel of the
Sinai oil and of its territorial defenses in the East
and the West would greatly increase oil import costs
and defe;me expenditures.
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Date Impossible to Determine
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Over the longer run, Isre.--1 also would derive economic
benefits from a peace settlement. Resources could be
shifted from defense to the civilian economy and trade
benefits would be derived from improved relations with
the Arab states. Peace also would restore a climate
for increased foreign investment in all three countries.
Introduction
Israel, Syria, and Egypt are under varying degrees
of economic pressure to reach accommodation of their
---differences and to move to a final peace settlement.
However, US aid for Israel and Arab and Soviet aid for
Egypt and Syria have minimized the impact of eccnomic
problems on peace negotiations. The following describes
briefly each country's economic position and its relationship
to a negotiated peace.
Israel
Israel's principal economic problems since the
October war have stemmed from the mobilization of reservists
and.the diversion of resources from development to defense.
Man-6ower? shortages caused by mobilization and the loss
of Arab workers continue to affect output but are not
as severe as in November and December 1973. With
disergagement at Suez, Israel now has about 100,000
reservists mobilized -- half the wartime level -- and
more than half of the Arab workers have returned. The
downturn in output that resulted from the reduced labor
force has been.overco*: e partly by increased labor productivity.
Even if Israel were to demobilize rapidly, however,
labor constraints are likely to be a proble: for the
Israelis for some time.. to come.
he burden cf. large defense spending during 1974
and 1975 will hang over the economy regardless of what
happens in' the'peace negotiations. Defense expenditures
in 1974 are ter.tativoly set at $4 billion, more than
half of the thhtal budget and nearly half of projected
G:;?. By contrast, Israel spent $1.6 billion, or. under
2O of GNP, on defense last year. Military imports in
197` of $2 billion will be four times the pre-war level.
Projected e:.:perditurea of $1.5 billion on imports, and
local defense production in 1975 probably will rennin
high even if a peace settlement is concluded. The
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Israelis will depend even more- on an- expanded IDF when
defense barriers affo_de6 now by the occupied territories
are no longer available for defense.
US aid is covering the foreign exchange costs
of maintaining an enlarged defence establishment.
The domestic economy has undergone some belt tightening
and cuts have been'made in output of civ:.liaz goods.
The government has reduced civilian demand by cutting
the development budget, collecting new taxes, and selectively
lowering subsidies -- or raising prices. The extent
to which Israel has to cut civilian demand will depend
on the levels of US aid and on the amount of funds
collected from World Jewry.
The Israelis have indicated a willingness to negotiate
the return of territories captured in the 1967 war.
The loss of the economically important Sinai oil fields
probably would be tied to assurances from the US of
oil supplies or an oil purchase agreement with tha
Egyptians. The Israelis would like also to have assurances
of continued access to Arab workers from the territories.
Arabs and Israelis both stand-to gain from this transfer
of labor. -
In the long run, Israel stands to gain from a
peace settlement the chance to reduce defense costs,
to increase trade with neighboring Arab countries and,
to a lesser extent, increased incentives for foreign
investors.
Egypt .
So long as Arab subsidies of about $250 million
annually are maintai'.ned, Cairo can pursue its aiplonatic
goals for ayear or more unhampered by-serious economic
problems. Egypt is now experiencing considerably less
economic hardship than during the immediate pre-war
years when a severe economic downturn was in progress.
Thanks mainly to extraordinary aid receipts during the
fourth quarter of 1973; Egypt in in a position to maintain
1972 output levels for about two years and may even be
able to achieve a modest amount of economic growth.
During the course of negotiations Egypt will be
.otivated strongly to regain lost assets on Sinai, and
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 -to secure at least the illusion of permanent peace for
economic as well as political reasons. At current oil
pricos, annual proceeds from Sinai oil fields would
total more than $ 300 million. This surr., plus Suez
Canal revenues, SU:NIED pipeline revenues, and Khartoum
aid would close Egypt's payments gap and permit a 6-7%
annual economic growth. If the risk of war is reduc+.d
by a settlement, private investment and loans from
multi-lateral Arab lending agencies could replace zhartoum
aid, cancelling much of the uncertainty and almost all
of the political log-rolling formerly associated with
Egypt's heavy dependence on bi-lateral aid. On economic
grounds radical Arab fears that Cairo is inclined' to
sacrifice Palestinian interests for a unilateral settlement
are not completely unfounded.
Even with disengagement accomplished, Egypt is still
too dependent on external economic and military aid
to freely pursue its own inclinations. So long as any
threat of war exists, tolerable relations must be maintained
with the only reliable source of arms, the Soviet Union.
Cairo will be even more.obligated to the affluent Arab
states on whom they depend both for arms purchases
and for balance of payments support. Lack of agreement
among Arab states on some issues allows Egypt considerable
room for both political and financial maneuvering,
On other issues, such as recognition of the Palestinian
state, on which-there is greater unanimity, Egypt could
be forced by economic necessity to.yield to thz.prevailing
Arab view.
Over the longer term, mounting economic problems
could reduce Egypt's latitude and greatly harden its
point of view. If accumulated assets are expende.d
?j before peace is assured, greater dependence oa bilateral
aid could increase Egypt's vulnerability to Arab pressures.
Should mounting tensions in the area discourage private
investment or prolonged stalemate discourage Arab aid,
as in the previous inter-war period, Egypt's economic
prospects in 18 to 24 months could worsen rapidly.
Syria-
Syria's posture toward negotiations with Israel
is l ar fly unaffected by internal economic develep.mants.
Da a :us wants to avoid repetition of the destructive
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October conflict that resulted in losses roughly equal
to one tear's national output. But given the desire
for peace, the Syrian leadership is not under any economic
pressure to arrive at a settlement which would dilute
the objectives for which it want to war.
One of its prime objectives is return of all captured
territories, including the Golan Heights and the city ?
of Qunaytirah. Although primarily of political importance,
the territorial reacquisition would yield some economic
dividends to Syria. The resettlement of a reported
170,000 refugees from the area would reduce unemployment
and contribute to increased domestic output and income.
The government currently is restoring the war damage
inflicted on the electric power-and petroleum sectors.
it is also pushing ahead development programs for road
and rail construction' and the important Soviet-aided
Euphrates Dam and irrigation project. Continued mobilization
o. Syrian armed forces places little strain on the labor
force since high unemployment prevails. Inflation associated
with sliortages'of food and other goods exists, but, as
during the war, Syria's populace appears willing to share
such hardships as part of the struggle against Israel.
With abundant Arab funds at-its disposal and continued
large support from. the USSR and Eastern Europe, Syria
is in a good position to cope with its economic difficulties.
Syria will not be pressured by threats of cutting
off aid. The aid donors have mixed attitudes regarding
negotiations with Israel and, even an obdurate stance
by Syria, is unlikely to find all donors allied in
withholding aid. Political rather than economic pressure
probably would be relied upon by the individual countries.
Thus, fo%' exa-!ple, if the Soviets withdrew economic and
military aid -- an unlikely scenario given Moscow's
desire for a favorable image with the Arabs --, Syria
probably would receive substantial aid inflows frcm
ot-her quarters, notably Libya and Iraq. The Saudis,
;ho reportedly have offered some $1 billion in aid,
conceivably also would support a strong Syrian stand
on r. gotiations particularly one calling for return
of east Jerusalem.
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CONFIDENTIAL -
ISRAEL:. ECO::O::IC IMPACT OF THE WAR
Conclusions
Israel has no short-term need for additional
foreign financial aid beyond credits to finance
military imports. The bvla:nce-of-payments surplus
for 1973 will almost certainly increase as a. result
of the war because foreign remittances will rise
more than the current account deficit. In the
longer term the need for aid will depend on the
amount and terms of.arms purchases. Aid needs for
the, civilian economy will be negligible unless
mobilization continues for many months. Even in
this event, the Israeli's would pay much of the
current cost of military readiness by reducing
domestic investment and consumption.
The Economy Before the War
Israel's economy was in a strong position be-
fore the war, with growth of real GNP projected at
about 8% for 1973, after nearly doubling during
1969-72. Foreign exchange reserves had ached
US $1.5 billion in September 1973, about $300 mil-
lion above the level at the end of 1972 and equal
to more than one-third of annual imports of goods
and rtervices. Inflation, which had reached an
annual rate of 20%l was the principal economi^
problem and was caused by high domestic demand,
nearly full utilization of productive capacity, and
rising import prices.
The outlook for'the balance of payments remained
good in 1973, although it was unfavorably affected
by inflation. After marked improvement in 1971-72,
the current .account deficit was increasing in 1973
as a result of booming imports, while capital
account earnings were running below the previous
year. Nevertheless, Israel, thanks to large bor-
rowing, continued to acaunulate foreign exchange
reserves.
The longer term trends in the Israeli balance
of payments were healthy. Exports were increasing
faster than imports, and the current account def-
icit was expected to decline after 1974 ..-._.Although-' - =-
CONFIDENTIAL
.:' ....., . 01.5319
imp I
1
ateImpossible to Determine
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COiMDEN'TIAL.
Israel's foreign debt had risen sharply during the.
years since 1969 and at the end of 1972 stood at
$4.2 billion,, the largest per capita debt in the
world, servicing of the debt was not creating any
difficulties. The ratio of debt service to export
earnings was declining, and debt service payments --
about $600 million in 1972 -- were more than offset
by the inflow of unilateral transfers. With bond
sales also likel,j to remain at high levels, Israel's
prospective balance-of-payments surplus in 1974 and
1975 seems likely to exceed the level of US aid.
Million US S
1972
1973
1974
1975
1
Goods and services
-1,103
.1,550
-1,350
-1,150
'I,
Unilateral transfers
1,054
S65
1,000
1,050
Capital account
331
?288
S00
450
US assistance
440
547
450'.
350
Increase in reserves
722
150
600
700
Economic Impact of the War
The Israeli economy has been disrupted, but
not severely, by the war. There has been virtually
-no war damage. The callup of reservists, which
.together with the loss of Arab labor from the oc-
cupied territories, cut the civilian labor force
.by about 25%, and the sequestering of trucks by
the military caused some economic disruption.
Adjustments have since been made, however, including
a return of critical workers to their jobs and a
substantial increase of the number of women and
.-teenagers iz1 the labor force. Although some serv-
ices, such as tourism and the construction industry,
have been hit hard, other industries and agriculture
appear to be producing near pre-war levels. There
has been no rationing of consumer goods and services.
Israeli-officials have estimated the value of
lost production at $14 million a day, or nearly
2
CON!' .o IJENTIAL
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CON t?'TDE:,;TIAL
$100 million a acek. This would mean more than
$5 billion at an annual rate, or two-thirds of the
G: P of $8 billion. Beyond the first few days of
the war, this rate of loss is obviously greatly
exaggerated. Although aggregate figures?are not
available, a more reasonable estimate would be a
drop of 20~? in civilian production, or less than
$30? million a week. As indicated below, the*in-
crease in demos tic military expenditures, excluding
military it orts, is probably running at an annual
rate of sc::.e $1 billion, or some 12% of GNP. The
civilian labor force probably has not been cut more
than 15%, representing much less than full mobiliza-
tion. A 20, drop in G"? appears to make ample
allowance not only for diversion of resources to
military use but also for some continued disruption
of economic activity.
The supply of trucks probably is the most trouble-
some bottleneck in the Israeli economy. With many
civilian trucks being used by the army, the civilian
economy is short of convenient transportation and
the Israeli government is trying to import trucks
on a priority basis. The supply of petroleum con-
stitutes a'potential problem. Closure of the Bab ate..
Mandab Strait has stoppad petroleum deliveries to
Eilat from Iran. During the fighting, petroleum
tankers also stayed away frari Israel's Mediterranean
ports. Israel's petroleum stocks, however, amounted
to more than 16 weeks of supply at the beginning of
the war, and if major fighting does not resume,
Israel can import sufficient petroleum via the
Mediterranean.-
Dry cargo ships are entering and leaving Israeli
ports, although there was a slowdown during the
fighting. There appear to be no serious actual or
potential shortages of imported goods.
The government's Ministerial Economic Committee
has assigned priorities for keeping the economy as
close to normal as possible during the war. Pri-
orities include preserving export markets, com-
pleting housing for high priority. groups (immigrants
from the USSR who have continued arriving during
the ear), finding now sources of financing, and
returning key workers from military sezvice. To
ease the transportation bottleneck, the government
has allocated 1,400 heavy-.duty trucks for civilian
3 .
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CONFIDENTIAL
distribution and is seeking to import 2,500 trucks
on a priority basis. The Bank of Israel has agreed
to an extension of credit to ease short-term liquidity
problems.
Cost of the War
Israeli statements on the cost of the war have
varied considerably; the most often quoted figures --
$250 million a day and $2 billion in the first week
of the war -- seem exaggerated. Israeli officials
apparently lumped together the direct and indirect
military costs of the war and the economic costs,
including the value of output lost and losses of
foreign exchange earnings. The major costs will
be for the replacement of military equipment and
materiel, the impact of which will be spread over
a. number of years.
Our preliminary estimates place the value of
Israel's losses of major military equipment at a
minimum of abort $325 million. Expenditures of
military supplies and supporting equipment would
add considerably to these costs. Before the war,
Israel had contracted to purchase from the United
States about $500 million worth of military equip-
ment, including 48 F-4 and 42 A-4 jet aircraft
valued at about $300 million, to be delivered out
of FY 1974 Foreign Military Sales funds. Since
the war began, the United States has approved for
sales to Israel $825 million in military supplies
of which $500 million to $600 million has been
shipped.
Israeli officials have reportedly put a price
tag of between $2.5 billion and $3.0 billion on
the replacement of its 1973 losses and the purchase
over the next three years of additional armaments
needed to maintain military parity with the Arabs.
Israel would like to double its air force to 1,000
aircraft and-raise its tank inventory to 4,000
vehicles. Beyond'`nis, the Israelis plan to in-
crease their dornes,__.c military production. They
have tentatively set a goal of supplying'ohe-half
their military equipment needs from domestic de-
fense industries, compared with about 30% now coming
from domestic industries.
CONFIDENTIAL
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 CONFIUEN'rIAL
Before the October war the 1973 defense budget
was estimated to be $1.6 billion, of which about - ?
$540 million was for imported weapons. The domestic
component of-defense expenditures has probably at
least doubled -- an increase of some $1 billion.
Personnel expenditures have about tripled (from
$22-0--million- to nearly $700 million) as the force
level rose to 300,000 men. Operating costs too
will be much higher, and procurement from domestic
defense production could reach about $750 million
a year with these industries operating at full
capacity, compared with $450 million last year.
Finz.acing the War
Israel has moved rapidly to mobilize domestic
and foreign resources to pay for the war. The
government has issued bonds that all citizens and
businesses must buy and is raising additional reve-
nue through voluntary bond drives. These two
sources are expected to bring in $500 million.
The government also has ordered cuts in the develop-
ment budget that will save $60 million.
.If the.cease-fire holds, the balance of payments
should end the year in surplus because, with both
imports and exports lower, the trade and services
account should not change much, while there will
be a large increase in contributions from abroad.
Exports of most goods and services have continued
during the war, except those goods exported through
the port of Exlat which remains blockaded. Agra.-
cultural exports hava not been hurt; the important
citrus crop is only now being harvested, and fresh
produce has been exported by air. Exports of in-
dustrial products, except diamonds, slowed appre-
ciably during the first week of the war, but have
since recovered.. Tourism, off an estimated 75%, is
the only important source of earnings adversely
affected to date. Demand for civilian imports has
fallen off, but imports of military-related goods
such as trucks and raw materials for defenst indus-
tries are rising. The increased costs-of war-risk
insurance, which is being borne by the government,
would add slightly to the import costs.
S
CONFIDENTIAL
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 C
The pre-war Israeli projections of the balance
of payments for 1973 anticipated -receipt of $350
million in personal remittances and another $318
million in bond sales. ,Such of this probably was
collected before the war. Since the war, the
government has projected new goals of $1,250 mil-
lion for personal remittances and $750 million for
bond sales abroad through the end of 1974. If we
assume that half of the new total will be collected
by the end of 1973 and that other receipts remain
as projected, the total of unilateral transfers
and capital inflows for 1973 could be more than
$2.0 billion.
Prospects for the Economy
Although the Israeli economy is unlikely to
experience serious difficulties in the next few
months, a number o uncertainties make it difficult
to estimate the longer term impact of the war. In
ary.case, the economy is unlikely to expand as
rapidly as it did after the 1967 war, un en there
was much unused capacity and a clear victory greatly
stimulated consumer demand and business expectation.
If the war ends with a definitive settlement
and a favorable security environment, economic growth
will resume and the long-term outlook will be favor-
able. The need for aid would depend on the amount
and terms of arms purchases; aid for the civilian
economy would be negligible. The proposed $2.2 bil-
lion US credit for Israeli military purchases would
provide a military establisvaent -considerably stronger
than at the outset of the war, but perhaps not as
strong as the Israelis now think they need. It
could increase projected debt service payments of
principal and interest by as much as $514 million
a vaar on hard terms or $286 million on soft terns.
The debt service to exports ratio at the estimated
post-war export levels would be 50% with credit on
hard terms, about the same as the average ratio
?during 1956-61.
If Israel is forced to maintain large forces in
place for an uncertain cease-fire, military aid
would be unchanged, domestic output would be re-?
duced, new investment expenditure outside of arma-
ments would be sharply curtailed, and personal con-
sumption reduced somewhat. Foreign exchange needs
s
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CON1' 1WEN'TIALL
would be little affc:cte-3, however, because demand
'for civilian imports -;ro?ild be held down as well.
Israel would, minimize t;1e l;ize of the armed forces
by relying heavi:I.y on imported mechanized equipment
rather than infantry.
Between these two extremes, many scenarios are
suggested that would involve varying levels of
mobilization and of c,-:)s;:s l;o the economy. Included
among these would be pLn exl:ension of the Arab oil
boycott tha_ cou:.d -.po3s::bl;~ exert pressures on all
EC countries to i:educr, ;:heLr trade with Israel.
Arab boycotts ha're riot been effective in the past,
although they lacked th{: leverage now afforded by
oil. The Israel s , . h,pwe;vea: , have always been re-
sourceful in mak4ng a44jjistments in their foreign
markets.
GDNFIDEIJNTIAL
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 W. J. Thcraas McAndrew
ief,, Ne East Di
MEMORANDUM FOR: of
fice of Research. andian
Rnalyais for Near East and
South Asia, INR
Depar`irent of State
The attached infcrmation on econenic dislocations
in Israel is a follow-up to what
provided you by phone Thursday afternoon per
your ..'equest.
l
Chief, Near East/Africa Branch
Developing Nations Division
Office of Econcnic Research
Central Intelligence Agency
22 November 1974
A E
11LPLACCS FbAM 10.101
W" I CN MAY at USED.
OER/D/NE: jlb/5741 (22 November. 1974)
/ONM N0.
1 AUG ?A '01
Distribution: (S-Project' 6633)
Orig. & 1:- Addressee
.1 - 'D/OER
1 - Acting Chief., D/D '
StAP/C
2 - DINE
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