MAJOR LDC DEBTORS: FINANCIAL IMPACTS OF AN OIL PRICE DECLINE

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CIA-RDP86M00886R000800020006-9
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S
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13
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December 22, 2016
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March 13, 2012
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6
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Publication Date: 
October 25, 1984
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REPORT
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Declassified in Part - Sanitized Copy Approved for Release 2012/03/13: CIA-RDP86M00886R000800020006-9X1 Central Intelligence Agency DIRWrCRAIE CF INTELLIGENCE 25 October 1984 Major LDC Debtors: Financial In>pacts of an Oil Price Decline Sumnary Assuming that a small decline in world oil prices - say $2/bbl - etnnerges from the 29 October CF'HC emergency meeting, we believe the financial impacts an most key LW debtors will be moderate. Certainly a nadmr of I10C debtors - notably Brazil, the Philippines, and South Korea - would obtain significant savings on their oil import bills. In addition, we believe most oil-exporting debtors would be able to menage the drop in foreign exchange earnings they would incur, because they have adequate financial resources. Sven with a small price drop, however, Egypt and Nigeria would confront serious new financial strains because of their high dependence on oil export earnings coupled with currently tenuous financial positions. Finally, over the medium term all of the debtors would benefit fran sanenhat faster growth and easi of interest rates, which probably would be prated by a lower oil pries. 25X1 If a major oil price drop were to occur, the implications for sane other oil exporters also became serious. With a drop in oil prices to around $20 a barrel, for ez?ple: o Mexico would lose $5 billion in foreign exchange earnings. Such a drop would result in a substantial increase in banker resistance to signing an to the new multi-year rescheduling package and lead to a renewal of credit difficulties for Mexico. o Venezuela would see its exports drop by $4 billion. Even with its ample reserves of $12 billion, we would expect (raeas to experience even greater difficulty than currently in obtaining mw money. This n>Eirorandutn vas prepared by 25X1 25X1 conamics Division, Office of Global Issues. The information contained herein is updated through 25 October 1984. Camuents r my be directed to Grief, Economics Division, 25X1 25X1 GI M 84-10196 25X1 Declassified in Part - Sanitized Copy Approved for Release 2012/03/13: CIA-RDP86M00886R000800020006-9 Declassified in Part - Sanitized Copy Approved for Release 2012/03/13: CIA-RDP86M00886R000800020006-9 25X1 o Indonesia would lose $3 billion in export earnings. Although quick inplementation of austerity measures in the past has kept up Jakarta's credit standing, this position could erode following such a sharp oil price decline. Disruptions to the international financial system fran sharply lower oil prices also could occur in other countries that are less dependent on oil earnings. For example, Peru and Argentina already are in desperate financial straits. A reduction in their export earnings, which would follow an oil price decline, could push than closer to the brink of declaring a imratorian With respect to the oil-importing Ids, a decline in oil prices would not be enough by itself to substantially ease their debt problems. Most of the larger debtors - particularly in Latin America -- are unable to attract any new lending fran foreign creditors outside of their debt restructuring packages. Moreover, capital flight remains a problem as does a lack of foreign direct investment. Still, to the extent that faster ? growth and an easing of interest rates result from a lower oil price, the combination could lead to sane easing of financial pressure. Declassified in Part - Sanitized Copy Approved for Release 2012/03/13: CIA-RDP86M00886R000800020006-9 Declassified in Part - Sanitized Copy Approved for Release 2012/03/13: CIA-RDP86M00886R000800020006-9 25X1 Major LDC Debtors: Financial Impacts of an Oil Price Decline Introduction OPEC's benchmark oil price is again in jeopardy. In early 1983, a British price cut, coupled with a precipitous drop in Nigerian production, triggered a $5.50 per barrel reduction in Nigeria's official price. OPEC responded by dropping its benchmark price from $34 to $29 per barrel. Last week, first Norway and then the United Kingdom reduced their official prices in reaction to weak spot prices. To avert a buyer exodus, Nigeria followed with a price drop of $2 per barrel, undercutting Norwegian and UK prices by 65 cents. OPEC has called a meeting for 29 October to determine their response. A sustained decline in oil prices of $2 per barrel, or even more if OPEC discipline unravels, would have large repercussions on some LDC debtors. Major oil-exporting debtors would face substantial reductions in their export earnings and hence their ability to meet debt obligations. At the sane time, oil-importing countries would realize savings on their oil bill. In any case, world oil price shifts will introduce an important new element into the unfolding financial outlook for LDC debtors. LDCs: Current Financial Situation Even though some progress is being made, the LDCs continue to be affected by severe debt problems. Total LDC external debt continues to grow; we estimate it will hit about $750 billion by yearend 1984. Growth has slowed from previous years -- both because of lower LDC external financing requirements and the reluctance of commercial banks to lend to financially troubled countries -- but debt service ratios remain very high for sane of the key debtors (Table 1). Moreover, the-need for economic adjustment in debt- troubled countries has pushed a record number of LDCs to implement austerity programs under the guidance of the INF. Overall capital flows continue to be a problem for LDCs, particularly Latin America. Extensive capital flight over the past several years -- we estimate it may have reached $100 billion during 1979-83 -- has slowed but is still occurring. In addition, foreign direct investment remains stagnant, and prospects for future growth are not good. These factors, combined with the dropoff in bank lending, are raising serious doubts among financial analysts about the ability of Latin American s to resume economic growth and development any time soon. Several positive actions, however, recently have emerged. Creditor banks have granted multi-year debt restructurings to Mexico and Venezuela, an indication that creditors are roving toward a longer term approach to debt problems as opposed to annual restructurings. According to many forecasters the Western economic recovery, led by the United States, should continue through 1985 and should boost LDC exports as well. Moreover, interest rates have declined slightly in the last month . Softer oil prices are also aiding the oil-importing LDCs. 25X1 25X1 Declassified in Part - Sanitized Copy Approved for Release 2012/03/13: CIA-RDP86M00886R000800020006-9 Declassified in Part - Sanitized Copy Approved for Release 2012/03/13: CIA-RDP86M00886R000800020006-9 25X1 Table 1 KEY DEBTCPS : DEBT SERVICE RATIOS, 1983 Debt Service/ Exports (Percent) Interest Exports Argentina 70 40 Brazil 75 43 Chile 61 34 Ecuador 48 26 Egypt 33 15 Indonesia 19 11 Mexico 65 31 Nigeria 21 10 Peru 65 30 Philippines 41 28 South Korea 20 12 Venezuela 31 18 Ratio of total debt service (medium- and long-tern principal repayments plus interest payments of all maturities) to exports of goods and services. Ratio of total interest payments to exports of goods and services. Declassified in Part - Sanitized Copy Approved for Release 2012/03/13: CIA-RDP86M00886R000800020006-9 Declassified in Part - Sanitized Copy Approved for Release 2012/03/13: CIA-RDP86M00886R000800020006-9_X1 Oil Price Outlook Recent reporting suggests OPEC will try to support the current $29 benchmark price. OPEC's success in maintaining the benchmark in the immediate period will depend on whether Nigeria can be persuaded to rescind its price reduction and whether OPEC members can agree to and irmlement production cuts in line with market requirements. We believe OPEC will have a difficult time maintaining the current benchmark price. First, there has been a steep decline in non-Communist oil demand since 1979, spurred by price-induced conservation and substitution. Second, oil inventory reductions and increased production from non-OPEC producers have added to supply. Despite OPEC's attempt to reassert control over prices through production ceilings, most members have been unwilling to adhere strictly to production and pricing guidelines. As a result of these factors, spot oil prices have been soft and have undermined official prices. OPEC's current enormous production overhang of sane 9 million b/d of surplus available capacity will continue to encourage cheating among members, maintaining davnward pressure on oil prices. Conseauently, we view a drop in OPEC prices of $2/bbl or so as quite possible. We believe there is a smaller chance that oil prices over the next year 25X1 could plummet, perhaps to around $20 per barrel. This could occur in at least a couple of ways: o OPEC collectively could reach the conclusion that current oil prices are much too high fran the view of their best long-term interests. At current prices, continued conservation and substitution adjustments, as well as production increases in non-CPEC countries, are keeping the market for CPBF oil flat. A substantial price reduction would alter these trends. 1/ o The conflict of interests among OPEC members could increase dramatically, resulting in a further loss of production discipline. For example, the major debtors in OPEC -- Nigeria, Venezuela, and Indonesia -- have a great incentive to over-produce. Collectively they now have about 0.7 million b/d in surplus capacity. Additional supplies on the market would place more downward pressure on prices and threaten OPEC's already tenuous March 1983 accord. Foreign Trade Impacts The impact of any oil price decline on the major IM debtors will depend chiefly on their foreign trade position in oil. In the short run any oil price decline will reduce the foreign exchange earnings of the oil-exporting countries, while resulting in savings on the oil bill of importing countries. LDC debtors such as Indonesia, Mexico, Nigeria, and Venezuela .L' According to embassy reporting, a Nigerian official has suggested that CPBC should "fight back" against the Norwegian, British, and other high cost producers by taking advantage of OPEC's low production costs throu h flowing the current artificially high price to fall. Declassified in Part - Sanitized Copy Approved for Release 2012/03/13: CIA-RDP86M00886R000800020006-9 Declassified in Part - Sanitized Copy Approved for Release 2012/03/13: CIA-RDP86M00886R000800020006-9 25X1 would find themselves with less foreign exchange to meet their import spending and debt service obligations. South Korea, the Philippines, and other debtors highly dependent on oil inports would be able to increase imports of non-oil goods and perhaps improve their debt service record. The foreign trade impacts would not end here, however, as any oil price decline would start up a global adjustment process that would involve further trade shifts and require probably two or more years to work out. To quantify the inpacts of oil price declines on key debtors, we have made the sinplifying assumption that export and import volumes stay constant at 1984 levels. We then calculated the dollar inpacts of two scenarios which should bound any price decline: a price reduction of $2 per barrel and a reduction of $9 per barrel (Table 2). The Losers. If prices decline only $2/bbl, we anticipate that of the major debtors only Egypt and Nigeria would experience increased financial problems. With this price fall, Egypt's oil earnings would fall by $160 million, representing almost 5 percent of total exports. Nigeria's losses would be $800 million or 5 percent of total export earnings. Given a price fall of $9 per barrel, almost all of the oil-exporting debtors would face serious problems. The revenue losses of Mexico would be $5 billion, 20 percent of exports, while losses in Nigeria and Venezuela would amount to around $4 billion, representing 25 percent of their exports. These countries and other oil-exporting countries would have essentially four options for adjusting to these revenue losses: o Cut inports. o Draw down foreign exchange reserves (including foreign assets). o Increase foreign borrowing. o Delay foreign debt service payments (run arrearages). In most cases, countries would choose some combination of these policies depending on their credit standing, foreign exchange reserve level, and ability to manage import cuts. Thus, such troubled debtors as Mexico and Nigeria probably would have little success in borrowing additional new funds unless special help was provided. At the sane time, according to press reports, Mexico has foreign exchange reserves of about $7 billion and Venezuela of $12.5 billion, which could provide a cushion if desired. Alternatively, a decision to maintain reserves would, as in the case of simply low foreign exchange holdings, imply some canbination of import cutbacks and arrearages on debt payments. Delaying debt payments could be the preferred option, especially for countries like Nigeria that alre have made substantial reductions in imports. 2/ We are assuming across-the-board cuts in oil prices even though prices for different types of oil may not change uniformly. Thus, for some countries such as Mexico, the revenue loss may be less because of their export product Declassified in Part - Sanitized Copy Approved for Release 2012/03/13: CIA-RDP86M00886R000800020006-9 Declassified in Part - Sanitized Copy Approved for Release 2012/03/13: CIA-RDP86M00886R000800020006-9 Major LDC Debtors: Impacts of Alternative Oil Price Declines Net Oil Exports a Net Oil Trade Estimated 1984 Balance, 1984a Impact of (thousand b/d) (million US$) Oil Price Declines on Trade Balance (million USS) Argentina Brazil Chile Ecuador Egypt Indonesia Mexico Nigeria Peru Philippines South Korea Venezuela 5 52 -456 -4790 -67 -700 145 1300 218 2200 934 10,000 1550 15,275 1120 12,800 50 -200 525 -2100 -5720 13,300 >f -$2/bbl of -$9/bbl -5 -15 +330 +1500 +50 +220 -110 -480 -160 -720 -680 -3070 -1130 -5090 -820 -3680 -40 -160 +150 +400 +660 +1810 -4260 Declassified in Part - Sanitized Copy Approved for Release 2012/03/13: CIA-RDP86M00886R000800020006-9 Declassified in Part - Sanitized Copy Approved for Release 2012/03/13: CIA-RDP86M00886R000800020006-9 )X1 Debtors with excess oil productive capacity would have the additional option of increasing their oil exports, although such a move would almost certainly risk an unraveling of prices. Of the major LDC debtors, Nigeria currently has about 500,000 b/d of surplus productive capacity and Venezuela and Indonesia each have about 100,000 b/d. 25X1 The Winners. Sane of the major LDC debtors are heavily dependent on oil imports and would realize substantial savings if oil prices decline. Brazil and South Korea would save $0.3 to 0.4 billion dollars each under a $2 per barrel price decline, and about $1.5 billion dollars each under a $9 per barrel price decline. These countries and others that are net oil importers would also face sane policy decisions. o In particular, there would be an excellent opportunity to raise goverrrnent revenues relatively painlessly by imposing a tax on each barrel of oil that matched any price decline. Danestic oil prices would be maintained, thus not disturbing investment projects and energy consumption patterns which depend on a roughly $30 per barrel oil price. Governments especially in need of funds, such as Brazil and the Philippines, could find this tax policy attractive. o Alternatively, sane countries could choose simply to pass the full oil price reduction to their danestic economies. The oil bill savings would allow greater imports of other goods. At the same time, the oil price decline would also encourage a greater volume of '1 imoorts. especially after an adjustment period of several years. 25X1 Second Order Effects. LDC debtors that sell substantial amounts of goods to oil exporting countries could find markets in these countries diminishing following an oil.price decline. At the same time, however, markets in the oil importing countries, including most of the gym, would be expanding with the increased purchasing power of consumers in those countries. Thus, although initially exports to the oil producers might drop faster than new exports to oil-importing countries would increase, after a year or two these effects would tend to cancel each other out. Because most of the OBm imports oil, any price decline will tend to stimulate the OD(D economies: consumers' purchasing power would increase, producers' energy production costs would fall, and hence demand for and production of non-energy goods would grow. Greater OBCD growth would lead to greater demand for imports, including from LDCs. Although the diverse composition of LDC exports makes it difficult to assess which countries would benefit most from C EM growth, export oriented countries such as South Korea and Bra it would be in t position to gear up for increased export demand . Interest Rate Impacts An oil price decline could have an effect on interest rates. Over the longer run, interest rates reflect both real supply and demand conditions for credit as well as the anticipated rate of inflation. A falling oil price would reduce the component of interest rates that reflects future inflation. Declassified in Part - Sanitized Copy Approved for Release 2012/03/13: CIA-RDP86M00886R000800020006-9 Declassified in Part - Sanitized Copy Approved for Release 2012/03/13: CIA-RDP86M00886R000800020006-9 25X1 While increased real incases in the OECD could lead to greater savings and hence a tendency for lower interest rates, such incase growth also would result in greater credit demand so that these effects would tend to wash out. Furthermore, credit demand could grow faster than savings if some of the oil-exporting countries were able to continue to increase their borrowing as Overall, however, it seers likely that, if anything, interest rates would tend to fall with an oil price decline. Sane analysts have predicted that a $2 per barrel oil price cut would lead to a 1-percentage-point drop in interest rates. In this case, all of the major LDC debtors would gain, particularly those with proportionately large debts at floating interest rates, such as Argentina, Brazil, Mexico, and Nigeria (Table 3). A Closer Look at the Oil-Exporting Debtors The impact of lower oil prices would vary among key oil-exporting debtors. Mexico would be hit hard by lower oil revenues, largely because the country still has little roan to maneuver. Imports have been cut to the bare minimum over the past three years, and non-oil exports -- although growine -- would not be able to pick up the slack generated by large oil revenue losses. Mexico recently reached preliminary agreement with its bank advisory carmittee on a debt restructuring, but the package must-still be signed by all creditor banks. A small drop in oil prices could be absorbed by Mexico because sane cushion has been built into-the restructuring package, but a large price decline would pose serious problems. Many banks -- same of which are already reluctant to participate in the restructuring -- could find it even harder to justify their participation. In the worst case, Mexico would be unable to meet its interest payments, which would put a large burden on major creditor banks. Venezuela probably would be able to absorb a small drop in oil prices because of its relatively better financial position. Foreign exchange reserves remain high, and the recent restructuring package with commercial banks will reduce debt service requirements over the next several years. The package likely will be signed by the individual banks because of its overall benefits for both creditors and debtor. Banks, however, could be reluctant to participate in new loans over the medium term should Venezuela not take actions such as drawing down reserves to make up for the loss in revenues Iran oil exports. 25X1 Indonesia also would be able to adjust to a small price decline, although at sane cost to its economic growth prospects. Although Jakarta could not expect much help from non-oil exports, the government could reduce spending on development projects as it did in 1983. This in turn would bring about a reduction in imports of capital and intermediate goods which would offset the 25X1 We estimate that CPEC states together will borrow $8 billion from banks and official creditors this year. Indonesi Alfferip, and Saudi Arch= account for most of the borrowin . Declassified in Part - Sanitized Copy Approved for Release 2012/03/13: CIA-RDP86M00886R000800020006-9 Declassified in Part - Sanitized Copy Approved for Release 2012/03/13: CIA-RDP86M00886R000800020006-9 Major Debtors: Impact of an Interest Rate Decline Net Savings fran a One-Percentage-Point Drop in Interest Rates (Million US$) Argentina 310 Brazil 780 Chile 130 Ecuador 50 Egypt 30 Indonesia 50 Mexico 710 Nigeria 120 Peru 50 Philippines 130 South Korea 220 Venezuela 210 'These data are derived fram the change in net debt (gross debt less deposits) that is on floating interest rates. Declassified in Part - Sanitized Copy Approved for Release 2012/03/13: CIA-RDP86M00886R000800020006-9 Declassified in Part - Sanitized Copy Approved for Release 2012/03/13: CIA-RDP86M00886R000800020006-9 25X1 loss in oil revenue. Foreign exchange reserves also provide a cushion in the near term. Even with a sharp drop in oil prices, Indonesia would not have immediate debt repayment problems because of the favorable structure of its repayment schedule. Moreover, creditors likely would respond favorably to an Indonesian cutback in spending so that the country's credit rating would not be severely altered. Egypt could be hard hit by falling oil prices because of its precarious financial situation. Banks currently view Egypt as a below average credit risk, and a loss of oil incase -- which accounts for over 60 percent of exports and over 20 percent of exports of goods and services -- could lead to debt repayment difficulties. Cairo would press the United States even harder for debt relief on Foreign Military Sales credits and might have to seek rescheduling from other private and official creditors. A significant reduction in prices could also interrupt Egyptian oil exploration efforts, hindering the future growth of oil production. Moreover, deepening financial problems in Persian Gulf countries could reduce the need for Egyptian migrant labor. Nigeria currently is under serious financial strain. Lagos has major debt servicing problems, with a large build-up of arrearages on short-term and dwindling foreign exchange reserves. If its recent oil price cut is maintained, the annual loss in export earnings would be some $800 million, according to our estimate. Reduced oil revenues would put increased pressure on Lagos to cut spending and reduce imports and to reach agreement with the IMF on a standby arrangement. The impasse with the Fund likely will continue through yearend, however hAnaune of the nt's unwillingness to implement a devaluation. Ecuador probably would be able to absorb a all drop in oil prices. Quito is close to reaching a new standby arrangement with the I1V1W which will be followed by bank negotiations on a debt restructuring and new money. Ecuador's economic tears has been cooperative with the IMF and will probably take the steps necessary to adjust to lower oil export revenues. A large fall in oil prices, however, could make creditors reluctant to provide new money, since sane banks already are balking at increasing their exposure. Implications We believe lower oil prices would on balance contribute appreciably to a more robust world economy, especially after an adjustment period of several years. OIXD growth would be promoted and interest rates probably would ease. However, some LDC debtors that depend heavily on oil exports would be in a nuch rrore precarious financial situation, particularly if an oil price decline were substantial. Egypt, Mexico, and Nigeria are especially vulnerable because of their lack of maneuvering roan; Egypt has few alternative exports, Mexico already has severely cut imports, and Nigeria has large arrearages and dwindling foreign exchange holdings. The risks of a moratorium on debt service payments by one of these countries thus would increase if oil prices were to plummet. Initially these countries probably would start to run more arrearages in their debt payments and also attempt to negotiate much improved debt terms and new credit. However, private creditors would be very reluctant to extend new loans after a Declassified in Part - Sanitized Copy Approved for Release 2012/03/13: CIA-RDP86M00886R000800020006-9 Declassified in Part - Sanitized Copy Approved for Release 2012/03/13: CIA-RDP86M00886R000800020006-9 fall in oil prices. Only relatively small amounts of forced new lending would be likely as creditors attempted to protect outstanding loans. Disruptions to the international financial system fran lower oil prices 25X1 also could stem from sane other countries that are less dependent on oil earnings. For example, Peru and Argentina already are in desperate financial straits. Even a small reduction in their export earnings, which would follow an oil price decline, could rush than closer to the brink of declaring a rmrator i urn on debt payments. 25X1 With respect to the oil-importing LDCs, a decline in oil prices would not be enough by itself to substantially ease their debt problems. Most of the larger debtors -- particularly in Latin America -- are unable to attract any new lending fran foreign creditors outside of their debt restructuring packages. Moreover, capital flight remains a problem as does a lack of foreign direct investment. Still, to the extent that faster OEM growth and an easing of interest rates result fran a lower oil price, the combination could lead to sane easing of financial pressure. We expect creditors to look at the oil-importing LDCs more favorably in the event of lower oil prices, but this could be overshadowed by lender concern for the financial situation of the major oil-exporting debtors. Mexico, in particular, would attract lender attention because of the size of the country's debt and the inplications for the international financial system as a whole. Thus, the overall positive impact on oil-importing LDCs probably Declassified in Part - Sanitized Copy Approved for Release 2012/03/13: CIA-RDP86M00886R000800020006-9 25X1 Declassified in Part - Sanitized Copy Approved for Release 2012/03/13: CIA-RDP86M00886R000800020006-9 Next 1 Page(s) In Document Denied Iq Declassified in Part - Sanitized Copy Approved for Release 2012/03/13: CIA-RDP86M00886R000800020006-9