INTERNATIONAL ECONOMIC & ENERGY WEEKLY

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP88-00798R000200210005-4
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 44
• Document Creation Date: December 27, 2016
• Document Release Date: April 18, 2011
• Sequence Number: 5
• Publication Date: January 17, 1986
• Content Type: REPORT

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** THE ATTACHED IS A;HECORD COPY OF THE IEEW **
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Directorate of
Intelligence
Weekly
International
Economic & Energy
t
DI IEEW 86-003
17 January 1986
Copy627
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Secret
International
Economic & Energy Weekly
17 January 1986
iii Synopsis
1 Perspective-Western Europe's High-Technology Policy Still
Lacks Direction
3 West Germany: Changes in Telecommunications Policy
7 South Africa: Prospects for Debt Negotiations
17 International Gas Markets: A Year of Progress
23 Israeli Exports: The Challenge of EC Expansion
27 Briefs Energy
International Finance
Global and Regional Developments
National Developments
Comments and queries regarding this publication are welcome. They may be
directed to Directorate of Intelligence, telephone
Secret
DI IEEW 86-003
17 January 1986
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International
Economic & Energy Weekly 25X1
Synopsis
1 Perspective-Western Europe's High-Technology Policy
Still Lacks Direction
ness remain a mixture of ambitious goals and modest achievements
West European cooperative programs to improve technological competitive-
West Germany: Changes in Telecommunications Policy
reforms.
Bonn has proposed several modest changes to its telecommunications policy
following a December US factfinding mission on the West German telecom-
munications market. West German telecommunications officials probably
hope these incremental concessions will defuse pressure for more fundamental
South Africa: Prospects for Debt Negotiations 1 -1
keep debt negotiations going.
Proposals by South Africa and bank creditors to reschedule $14 billion in
currently frozen debts are far apart, but President Botha's speech opening
Parliament later this month probably will contain enough positive elements to
hamper development.
The conflict between the Tamil minority and a Sinhalese majority in Sri
Lanka is becoming increasingly costly to the national economy and the
economic well-being of both groups. Although the economic outlook would
improve if a peace settlement is reached, structural inefficiencies, external
debt, and the dependence on world commodity prices would still severely
International Gas Markets: A Year of Progress
1986.
The year 1985 saw a major expansion of demand and trade in both West Euro-
pean and Asian gas markets. We believe that this improved outlook still could
be undercut by declining energy prices, especially if oil prices collapse during
Israeli Exports: The Challenge of EC Expansion
about one-third of total Israeli exports.
The vital EC market accounts for roughly 15 percent of Israel's GDP and for
iii Secret
DI IEEW 86-003
17 January 1986
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International
Economic & Energy Weekly
17 January 1986
Perspective Western Europe's High-Technology Policy Still Lacks Direction
West European market.
West European cooperative programs to improve technological competitive-
ness remain a mixture of ambitious goals and modest achievements. Most
West European leaders consider European-wide cooperation necessary to
bridge the "technology gap" vis-a-vis the United States and Japan. They have
had difficulty, however, arranging funding and setting aside short-term
national interests. Consequently, many of Western Europe's high-technology
research programs-in particular, ESPRIT, RACE, BRITE, and, more
recently, EUREKA-take shape, slowly. They lack the specific product goal
that was characteristic of Airbus and the European Space Agency's (ESA)
Ariane-two projects generally cited as West European successes. Moreover,
companies will continue to face problems translating technological advances
into commercial products unless further steps are taken to create a unified
marginal research they would not do without government support.
ESPRIT-the EC program in information technologies-highlights the diffi-
culty of getting West European companies to work together. A committee of
businessmen and academics recently pointed to progress on several projects
and on setting European standards for computer software but could cite no
major technological breakthroughs. The program still has not established an
overall data transmission system because of disagreement on what equipment
to use. Companies, in any case, are reluctant to share technical information
with research partners that are competitors outside ESPRIT. Also, firms from
the less-advanced EC countries are seeking to upgrade their technology
through ESPRIT and are focusing on technology sharing rather than cutting-
edge research. Several firms probably are using the program to finance
its aims.
RACE-an EC initiative to create a unified West European telecommunica-
tions network by the end of the century-almost certainly will face severe
funding difficulties. The program is in a preliminary phase but spending is
slated to rise steeply once it formally begins. With EC officials already
struggling to finance the current research budget, the major expenditures
envisioned for RACE may be cut back sharply. In addition, RACE faces an
uphill battle against traditional procurement practices that heavily favor
domestic producers. EC efforts to harmonize technical standards across
member countries for telecommunications equipment, for example, have been
ineffective. BRITE-the EC program to apply advanced technology to
traditional industries-is also unlikely to get the funding needed to carry out
1 Secret
DI IEEW 86-003
17 January 1986
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For EUREKA-the latest European-wide high-technology initiative-the
major West European countries are trying to emulate the ESA approach by
keeping it out of the EC framework. They also wish to make it a program for
product development rather than fundamental research. Western Europe-
including non-EC countries-has approved the general concept of EUREKA
and has selected 10 preliminary projects, but its funding, organization, and
aim are still being worked out. If EUREKA focuses on a few key areas of
dual-use technology, it could bolster West European competitiveness in the
civilian and defense sectors. Nonetheless, political differences are likely to slow
the program,. and funding problems may transform it into a series of measures
designed merely to spur joint ventures among West European firms. The
common perception of EUREKA as an alternative to participation in SDI
research underscores the ambivalence of West Europeans toward joint projects
with their main industrial rivals. West Europeans want the technological
spinoffs of such cooperation, but fear that their best scientists will wind up
working for non-European competitors.
Despite mixed results to date, some progress on West European research
cooperation and creation of a more unified West European market seem likely.
West European countries already are moving toward the following goals:
elimination of intra-European trade barriers by 1992, greater deregulation of
capital markets, provision of tax incentives to innovative firms, and the
development of European-wide technical standards. The outlook for accom-
plishing these aims is brighter now than just a few years ago, but implementa-
tion will be a long process.
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West Germany: Changes in
Telecommunications Policy
Bonn has proposed several modest changes to its
telecommunications policy following a US fact-
finding mission in December on the West German
telecommunications market. While these changes
are an encouraging first step, the United States will
pursue further market-opening measures. The
United States, as well as France and Japan, has
been eager to increase sales to the West German
telecommunications market-the largest in West-
ern Europe, but one that has remained relatively
closed to foreign suppliers. We believe that West
German fears of protectionist legislation in the US
telecommunications sector prompted their recent
concessions. West German telecommunications of-
ficials probably hope these incremental concessions
will defuse pressure for more fundamental reforms.
A closed US market would hurt West German
equipment manufacturers, who view the United
States as a major export market.
The Deutsche Bundespost-Industry Relationship
West Germany's postal and telecommunications
authority, the Deutsche Bundespost, has come un-
der increasing criticism both at home and abroad
for its continuing monopolistic hold over telecom-
munications. The Bundespost's monopoly is part of
the West German constitution and gives the
Bundespost exclusive rights to establish and oper-
ate public telecommunications systems. A high
degree of cooperation exists between the Bundes-
post and its four major West German electronics
and telecommunications equipment suppliers: Sie-
mens, Standard Electrik Lorenz, Telenorma, and
Deutsche Telefonwerke. These firms supply rough-
ly 90 percent of the Bundespost's annual procure-
ment, which in 1984 totaled over $5 billion. In
addition, the Bundespost often works out product
specifications in advance with these favored
suppliers.
Bundespost certification procedures have also
worked to the advantage of domestic supplier firms.
According to Embassy reporting, all vendors to the
Bundespost must first have their equipment tested
and certified by the Bundespost's Central Telecom-
munications Licensing Office to ensure compatibil-
ity with the public network. This licensing group
only considers certification requests from West
German citizens and firms, or a foreign firm with
an established subsidiary in West Germany. The
working committee that sets the technical stan-
dards against which all products are tested is
funded by and composed of this same group of
supplier firms.
The US Embassy confirms that US telecommuni-
cations firms have been adversely affected by
Bundespost regulations and practices. A large US
computer company reports that it could not get
sales approval for a digital private branch exchange
for two years because the Bundespost had not
written a regulation to cover the new technology. In
another case, a US data base supplier was not
permitted to offer its product to customers of the
public switched network because of the Bundespost
monopoly on all domestic dial-up networks.F__-]
German Responses to US Concerns
The West Germans have made it clear that they
feel no pressure to follow the US lead in large-scale
deregulation of the telephone system. They did
offer the following general responses to US ques-
tions on existing Bundespost policies:
? Liberalization. There is a significant amount of
domestic interest in reexamining the role and
structure of the Bundespost. A high-level inde-
pendent commission composed of business, indus-
try, and political leaders is currently examining
the options for a new telecommunications policy,
and will report its recommendations to the gov-
ernment in 1987.
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DI IEEW 86-003
17 January 1986
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Secret
? Trade. West German officials claim they are
puzzled by simultaneous US moves toward liber-
alization and protectionism. In light of the pend-
ing US legislation, such as the Danforth and
Wirth-Florio telecommunications bills, the US
charge that the West German market is closed
does not impress the German telecommunications
authorities. In addition, the West Germans point-
ed to the US trade surplus in the telecommunica-
tions sector as an indicator of West Germany's
open markets.
? Prospects for Competition. West Germany justi-
fies its monopoly practices on political and legal
grounds. Because the Bundespost is charged by
law with providing a public service, it must make
telecommunications services available at the
same price to all users. This results in consider-
able interregional subsidies. The Bundespost stat-
ed that fulfilling its social mandate is therefore
inconsistent with the introduction of competition.
? Standards. A Bundespost representative ex-
plained that the West German standards-setting
committees mirror the technical committees of
the International Standards Organization (ISO).
These committees are voluntary organizations
funded by the major West German electronics
and telecommunications companies. As a mem-
ber of the European Community, West Germany
is also intent on working toward a common
European standard for telecommunications prod-
ucts and network interface, which limits their
ability to respond directly to US appeals.
? Procurement of telecommunications equipment.
A Bundespost spokesman claims that Bundespost
procurement is nondiscriminatory, with domestic
and foreign firms treated equally. Foreign firms
have generally received positive consideration by
the Bundespost when they offer a product not
usually included in the West German firms'
product lines.
Liberalizing Measures
Despite these differences of opinion, the West
Germans offered the US delegation a list of eight
liberalizing measures at the conclusion of the
Proposed Changes in West German
Telecommunications Policy
Category
US firms will be allowed to
participate in Bundespost
tenders offered through the EC.
The West Germans are opening
10 percent of terminal equip-
ment procurement for purchase
outside West Germany.
The Bundespost will support ef-
forts to initiate discussions be-
tween the United States and the
EC aimed at reaching agree-
ments in the new GATT round
regarding coverage of telecom-
munications equipment under
the government procurement
code.
The approval procedures of the
Central Telecommunications
Licensing Office will be
expedited.
The Bundespost will consolidate
all of the type approval proce-
dures into one regulation.
Enhanced services After harmonization of tariffs
(in 1988) the Bundespost will
liberalize the provision of en-
hanced services.
Customer premises The technical specifications for
equipment private branch exchanges will be
revised to permit greater ap-
provalfexibility. The manda-
tory leasing of the primary tele-
phone instrument from the
Bundespost will be eliminated in
1988. Technical specifications
for modems will be revised and
harmonized.
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conference. Among these changes, West Germany
now will open 10 percent of government contracts
for telecommunications equipment to foreign firms
by offering them through EC channels. West Ger-
many has also pledged to support US efforts to
include telecommunications equipment under the
government procurement code of the GATT in the
upcoming round. Should the code be revised to
include telecommunications equipment, the Bunde-
spost would be required to consider foreign and
domestic bids equally. In the area of enhanced
services, including high-speed data, data base re-
trieval services, and information processing, the
Bundespost has hinted that in 1988 following tariff
harmonization-the standardization of West Ger-
man communications charges-it will allow the
private sector to compete in the enhanced services
market. The Bundespost has also offered two mea-
sures to help simplify the type approval process
necessary for meeting technical standards.
Unanswered Questions
These changes to current telecommunications
policy represent some progress but still leave sever-
al points unclear. On the issue of terminal equip-
ment procurement, Bonn has not stated whether
the 10-percent share means a guaranteed percent-
age of foreign purchases or merely the percentage
of tenders that will be published outside West
Germany. Moreover, we do not know the range of
terminal equipment products to be included under
this measure. For 1988, when provision of en-
hanced services may be liberalized, it was not
stated whether the private-sector firms must be
located in West Germany. An important barrier to
the liberalization of enhanced services is West
Germany's policy of tariff harmonization through
volume charging. Volume charging, which prices
according to the amount of data transmitted, could
make the provision of enhanced services unprofit-
able for private firms. Moreover, the timetable for
the implementation of the liberalizing measures is
uncertain. The government commission investigat-
ing telecommunications issues will not report its
recommendations on a new policy framework until
1987. By leaving December's proposed changes
West Germany: Projected Growth Thousands of units
in Terminal Market
Telephone
31,000
36,000
Telex
160
170
Teletex
72
72
PCs
TVs
unscheduled, the Bundespost may be trying to
avoid a potential conflict with the commission's
report.
Good Timing
These West German policy changes may be a
response to domestic and international pressures for
deregulation of the telecommunications industry.
Following the AT&T breakup and the privatization
of NTT in Japan, many traditional post and tele-
communications monopolies in Western Europe are
reconsidering their structure. We believe additional
pressure to reevaluate Bundespost policies is com-
ing from domestic groups and the EC Commission.
Strong differences exist between the German Eco-
nomics Ministry, which favors free trade, and the
Bundespost, which is eager to hold on to its monop-
oly. The West German delegation was cochaired by
these two ministries. There also is pressure from
the EC Commission for West Germany to liberal-
ize the provision of customer premises equipment,
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 We believe that further liberalization of the cus-
tomer premises equipment market is likely, but we
do not expect any significant policy changes before
the 1987 report is issued. Other opportunities for
US vendors may come in enhanced services such as
time sharing, electronic mail, and local area net-
works after 1988. Freedom for private firms to
offer these services over the public switched net-
work, however, depends on a limiting of the
Bundespost monopoly. If the monopoly were limit-
ed, the Bundespost might offer only the basic
telephone service and supply the physical network.
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particularly modems. The customer premises
equipment market, which includes telephones,
desktop terminals, printers, and other peripherals,
is expected to show significant growth in the next
few years. West Germany had long defined mo-
dems as part of the network and not as customer
premises equipment, allowing the Bundespost to
tightly control modem sales and specifications. We
believe the announcement that the Bundespost "has
the intention of liberalizing and harmonizing the
requirements for modems" is a response to EC
concerns. Nonetheless, the EC, while supporting
efforts to establish a unified European telecom-
munications market, is critical of US attempts to
negotiate bilaterally with member states.
~ The
Bundespost is likely to continue to oppose the
limitation of its monopoly, because potential lost
revenue may diminish subsidization of basic phone
service.
West Germany's willingness to discuss regulatory
and market issues attests to the growing domestic
interest in telecommunications reform. Continued
reform of the Bundespost's monopoly, however, will
depend chiefly on a strong political consensus in
West Germany. Whether or not this consensus can
be achieved remains to be seen. Nonetheless, be-
tween thorough reform of the Bundespost's monop-
oly and the present highly restrictive regime, we
believe there is room for some accommodation of
US concerns.
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South Africa: Prospects
for Debt Negotiations
continues.
Proposals by South Africa and bank creditors to
reschedule $14 billion in currently frozen debts are
far apart, but President Botha's speech opening
Parliament later this month probably will contain
enough positive elements to keep debt negotiations
going. In addition, Pretoria's recent decision
against widening its debt moratorium and restraint
on foreign currency controls suggest a desire to
begin the long return to normal international finan-
cial relations. Even with progress in debt talks,
however, South Africa probably will become in-
creasingly economically isolated as long as unrest
Status of Negotiations
debt standstill until 31 March.
After last October's brief and inconclusive first
meeting between South Africa and its commercial
bank creditors, both sides agreed to meet again in
November. South Africa's debt mediator, Swiss
banker Fritz Leutwiler, postponed the meeting
until early this year, however, probably in the hope
that a decline in black unrest or possible progress
on reform after the South African Parliament
convenes this month would improve Pretoria's
standing with the international financial communi-
ty. With no possibility of a debt rescheduling
accord before South Africa's self-imposed 31 De-
cember deadline on its debt repayment moratori-
um, Pretoria last month unilaterally lengthened the
Despite its lengthening of the moratorium, Pretoria
resisted adding other loans to the standstill-which
many local observers had expected. With almost
half the country's loans being repaid normally, and
interest payments continuing on credits included in
the standstill, South African officials had indicated
the moratorium was yielding little foreign exchange
breathing space-fueling concerns that additional
debts would be drawn into the moratorium net.
Pretoria's decision probably reflected a desire to
South Africa is poised for a weak recovery this
year with about 3 percent real GDP growth. Sus-
taining the upswing beyond 1986, however, proba-
bly would require successful negotiations with
foreign creditors to reschedule the $14 billion in
debts that are now frozen. Failure to do so, or to
avert tougher sanctions, will lower growth pros-
pects over the next few years, adding to tensions in
black townships, where over 1,000 people have died
in 16 months of rioting.
A strongly negative foreign reaction to Botha's
speech could bring on tougher sanctions and move
South Africa more rapidly toward a siege econo-
my. The exchange value of the South African rand
probably would fall sharply, leading Pretoria to
move quickly to set a fixed exchange rate, further
limit imports and overseas payments, and probably
reschedule foreign debt unilaterally. Foreign com-
panies would skirt foreign exchange controls, for
example, by overcharging South African subsidiar-
ies for products.
Under these extreme circumstances, the decline in
foreign and domestic business confidence probably
would kill South Africa's tepid recovery, leaving
the economy to plod along for several years, with
an increasing number of skilled whites leaving in
the face of declining economic opportunities. In
turn, declining black living standards would influ-
ence many of them to accept the argument of
militants that majority rule is needed to secure
economic gains.
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South Africa: Foreign Debt Structure'
Principal repayments
blocked under
moratorium
Interbank
loans 37
Private-sector
debt 9
Public-sector
debt II
0 Structure of the estimated $23.7
billion foreign debt as of August 1985.
I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I
0 1983 84 85
role as the marketing agent for South African gold
mines, now will retain the foreign currency earned
national financial relations.
South Africa
Reserve Bank
obligations;
other public-
sector debt 18
Public-sector
bonds 13
Private- sector
trade debt
and bonds 12
avoid further piquing creditors, expedite a debt
accord, and begin the long return to normal inter-
Pretoria also has shown restraint in its approach to
tightening foreign currency controls. With the val-
ue of the South African rand still under downward
pressure-despite central bank intervention, the
debt moratorium, and the reintroduction last Sep-
tember of a penalty rate for capital outflows-
many South African economists expected Pretoria
to peg the exchange rate to the dollar. Instead, the
government only modestly tightened currency con-
trols. Exporters are now obliged to convert foreign
currency earnings to rand within seven days of the
delivery of goods, while the Central Bank, in its
Principal repayments
permitted under
moratorium
South Africa: Exchange Rate Trends,
1983-85
from gold sales, paying the mines in rand.
Debt Proposals Far Apart
South Africa's first debt rescheduling plan, pre-
sented in December, essentially proposes to extend
the current debt moratorium until 1990. In an
attempt to make this suggestion more palatable to.
foreign creditors, Pretoria's plan would allow them
to roll over maturing blocked loans to new South
African borrowers, or to transfer the frozen funds
to South African banks and obtain in return five-
year promissory notes, according to government
documents.
Not surprisingly, bank creditors have dismissed
Pretoria's proposal as unrealistic
n a ltlon
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to the economic considerations, foreign banks also
continue to face the dilemma of balancing a solu-
tion to South Africa's financial crisis against a
desire to avoid being viewed as cooperating with
Pretoria. Consequently, 10 key bank creditors have
put forth their own debt plan, which calls for South
Africa to repay 10 percent of frozen debts by
yearend. Bankers would then review the country's
financial position before determining a repayment
plan for 1987. Creditors probably believe that a
single-year rescheduling would have the advantage,
of appearing to keep South Africa on a tight leash.
The 10 banks also suggested Pretoria consider a
Paris Club rescheduling of foreign-government-
guaranteed debt-primarily trade credits exempt
from the current standstill-but Pretoria so far has
been careful to avoid entangling foreign govern-
ments in the debt standstill, and in our view would
do so only under extreme financial pressure.
country can repay.
Pretoria's proposed four-year standstill probably is
intended partly to signal to bankers that the coun-
try will not cave in to foreign pressures, but it may
also reflect caution about the rate at which the
debt repayment obligations not
moratorium fall due this year.
covered by the moratorium could place heavy
strains on the foreign payments position this year.
South Africa probably posted a healthy $2 billion
current account surplus for 1985, but, with in-
creased imports likely to accompany the modest
economic upswing expected this year, the 1986
surplus could be pared to about $1.7 billion.
Against this, about $2 billion in trade credits plus
another $1.6 billion in other loans outside the
Reserve Bank Governor de Kock is optimistic that
most expiring trade credits will be renewed, but US
Embassy and press reports indicate South African
commerce is feeling the pinch of curtailed trade
lines.
South Africa: Pretoria's Debt
Rescheduling Proposal, 1986-94
E:1 Current maturity schedule
Maturity schedule under
South African
rescheduling plan,
including $8.3 billion
in 1985 maturities
Despite the pressure of debt rescheduling talks and
threats of stronger Western economic sanctions,
President Botha almost certainly will not announce
reforms sufficient to placate most foreign critics
when he opens Parliament on 31 January. His
speech probably will contain enough positive ele-
ments, however, to keep debt negotiations going.
One area of possible concession is modification of
the law that empowers the government to reserve
certain residential and business areas for whites,
mixed-race Coloreds or Indians, although Botha
will not scrap this law altogether. The banks have
little to gain by breaking off debt talks as long as
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Secret
public pressure is manageable and South Africa
remains current on its interest payments. Pretoria,
for its part, probably recognizes bankers' political
sensitivities and may be willing to negotiate on the
basis of last month's bank proposal.
Even with progress in the debt negotiations, howev-
er, South Africa probably will become more eco-
nomically isolated as long as the unrest continues.
After a likely one-year debt rescheduling expired,
South Africa and its creditors probably would be
faced in subsequent negotiations with even greater
pressure for major political concessions. Mean-
while, continued unrest probably would spark new
calls for tougher Western economic sanctions.j
/measures to insu-
late South Africa from foreign economic pressures
include building a natural-gas-to-oil conversion
plant, creating phony export and import companies
to avoid trade restrictions, and promoting a
security-related domestic electronics industry.
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Sri Lanka: Economic Problems
and Communal Conflict
The conflict between the Tamil minority and a
Sinhalese majority in Sri Lanka, rooted in deeply
contested political and ethnic issues such as power
sharing and the preservation of distinct and sepa-
rate cultures, is becoming increasingly costly to the
national economy and the economic well-being of
both groups. So far, Tamil areas in the north and
east have been hit hardest, but the insurgents are
threatening tea exports, Sri Lanka's major foreign
exchange earner, and other economic targets in the
Sinhalese south. Defense spending is cutting into
funds available for development and welfare, and
investment, tourism, and aid are falling. At the
same time, competition between Tamils and Sinha-
lese for land, employment, and development is
intensifying. Although the economic outlook would
improve if a peace settlement is reached, structural
inefficiencies, external debt, and the dependence on
world commodity prices would still severely hamper
development.
The Economic Cost of Insurgency
The two-and-a-half-year-old insurgency is exacer-
bating the problems already facing the Sri Lankan
economy. We estimate that the economy grew by
less than 4.5 percent last year-the lowest level
since 1977-in large part because of stagnant tea
production and declining output from public-sector
industries. Private domestic and foreign investment
has been deterred by a decline in the number of
lucrative investment opportunities, an overvalued
exchange rate, a deteriorating infrastructure, and
government backsliding on liberalization measures.
The current account deficit more than doubled in
1985 because of falling tea prices and a growing
The insurgency has had its greatest impact in the
economically backward Northern and Eastern
Provinces, where most of the fighting has taken
place and where most Tamils live. Embassy reports
indicate that Tamil insurgent attacks on infrastruc-
ture targets, such as roadways, railroads, and port
facilities; repeated robberies of banks and business-
es; and the general collapse of civil order have
crippled economic life in Jaffna, the major city in
the north. Products normally supplied from Jaffna
to the rest of the country-fish, salt, and cement-
are in short supply throughout Sri Lanka.
Fishing, a major part of the economy in the north,
has been hit hard. Sri Lanka's total fish catch
dropped by 23 percent in 1984, and the government
estimates another 10-percent decline for 1985.
Coastal fish catches in the northern and eastern
regions have suffered from the increased Sri Lan-
kan naval surveillance, Army attacks on fishing 25X1
villages, and the flight of Tamil fishermen to India.
Blocked transport links with Colombo and periodic
militant attacks on rice farmers have disrupted
production, milling, and marketing in the north and
east, resulting in near famine conditions in parts of
the Eastern Province. The government imported
200,000 metric tons of rice in 1985 to bolster
national stocks.
Tamil militants have recently begun at least one
form of economic warfare against the central gov-
ernment. One group in January 1986 claimed to
have contaminated an undetermined quantity of Sri
Lankan tea with cyanide. Although no poisoned tea
has yet been found, the threat prompted a major
Secret
DI IEEW 86-003
17 January 1986
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India
Palk
Bay
G u l f
of
Mannar
Tamil-inhabited area
Sinhalese-inhabited area
Limit of Mahaweli Irrigation Program
O Tea-growing area
0 50 Kilometers
0 50 Miles
Trincomalee
Bay
(under QQ5 inches of
precipitation per year)
of
Bengal
WET ZOAI,~
over 65 inches of
precipitation per year)
Indian Ocean
Northern
Province
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Private transfers, net
137
203
265
274
277
280
Overall balance
-216
-31
-20
0
304
-20
a Based on CIA estimates and preliminary data from the
Government of Sri Lanka.
Australian purchaser to cancel imports of Sri Lan- Program has been reduced, and the budget for
kan tea; other buyers are also assessing their 1986 indicates additional cuts will be made in
purchases. Tea trade accounted for approximately development.
30 percent of Sri Lanka's 1985 export earnings.
Growing Spending Strains
The cost of the counterinsurgency effort has begun
to cut into economic development. Following sever-
al supplementary appropriations from Parliament
in 1985, total allocations for defense reached about
$230 million-85 percent greater than the original
budget and almost 170 percent more than in 1984. Foreign Investment, Aid, and Tourism
Defense expenditures-more than half of which are
earmarked for Army and police pay-are now the Although the militants have not yet launched at-
second-largest item in the budget and account for tacks against foreign companies operating in Sri
10 percent of government spending, compared to 3 Lanka, the general instability has taken a toll on
percent in 1982. Spending on some rural develop- foreign investment. The government maintains that
ment projects, public-sector industries, social wel-
fare programs, and the Mahaweli Development
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Sri Lanka:
Approved Industrial Investments
That Include Foreign Participation
Number of Projects Sri Lanka: Tourism, 1978-85
Greater Colombo 40 44 18 16 13 15
Economic Commission
Outside
Greater Colombo
Economic Commission
foreign investors continue to show interest in Sri
Lanka, but admits their numbers have been re-
duced. potential
foreign investors in the important textile sector are
reluctant to begin new projects, and the US Embas-
sy reported that a West German-Swiss partnership
withdrew a $10 million commitment to a construc-
tion project in Trincomalee in mid-1985 in the
wake of growing guerrilla operations in the Eastern
Province.
The communal conflict has also caused some cuts
in foreign aid. Diplomatic reporting indicates Can-
ada-a major donor to the Mahaweli Irrigation
Program-decided in early 1985 to withhold funds
earmarked for the next stage of the irrigation
network to protest alleged human rights violations
by government security forces.
Tourism Receipts
Million US $
0
Tourists
Thousands
I I I I
0 1978 79 80 81 82 83 84 85,
Lobbying efforts by Tamil support organizations in
Western Europe threaten to harm Colombo's rela-
tions with its principal European donors
The tourist industry, held up not long ago as the
success story of Asian tourism, has been a major
casualty of the insurgency. Earnings have declined
from a peak of almost $150 million in 1982-
before the conflict worsened-to less than $100
million in 1985. The total number of tourists
declined from 407,000 in 1982 to about 320,000 in
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Secret
1984, and arrivals from January to November 1985 More Problems Down the Road
were about 20 percent lower than the correspond-
ing period in 1984. We see two possible scenarios for the Sri Lankan
mance lags.
The insurgency is fueled in part by Tamil percep-
tions of Sinhalese economic discrimination. Tamils
claim that, since the early 1970s, successive Sinha-
lese governments have denied Tamil areas a fair
share of central government development outlays,
restricted access to government jobs, and denied
Tamils the benefits of newly irrigated lands. In our
view, the failure of the Jayewardene government
over the last four years to address these economic
grievances and to fulfill promises of limited autono-
my to Tamil areas has heightened Tamil frustra-
tions and strenghthened Tamil civilian support for
the insurgency. Prospects for reconciliation of these
issues are dimming as overall economic perfor-
of the government's Sinhalese constituency.
The settlement of newly irrigated lands is the most
divisive economic issue. Jayewardene's decision in
1977 to accelerate the Mahaweli Program is part of
the government's desire to find new land for Sinha-
lese farmers by irrigating sparsely populated areas
of Sri Lanka's extensive dry zone. Mahaweli is
intended to provide increased domestic food pro-
duction and promote production of traditional cash
crops for export-both important political demands
Tamils.
Tamils argue publicly that Colombo's land settle-
ment policy perpetuates economic discrimination,
leaving Tamil farmers to cultivate the economically
less viable lands. Embassy reports indicate that,
while new Sinhalese settlements have drawn fre-
quent insurgent attacks, the militants have not yet
attacked the Mahaweli Program's network of ca-
nals and dams, suggesting they are reluctant to
sabotage an economic asset that could be vital to
economy in 1986. In the first and slightly less likely
scenario, Indian mediation efforts could lead to a
partial settlement between the government and
moderate Tamil groups that would grant some
political autonomy to Tamils, but not enough to
defuse hardliner demands for a separate state.
Such a settlement would have only a limited posi-
tive impact on the Sri Lankan economy. In our
view, Colombo would be forced to maintain high
levels of defense expenditures to protect against
militants who rejected the settlement, as well as to
rebuild the central government presence in the
Northern and Eastern Provinces. As a result, we
doubt that investors and tourists would return
quickly.
The second and more likely scenario entails a
collapse of negotiations and a resumption of full-
scale fighting. Under these conditions, the econom-
ic costs of the insurgency to the government would
grow. Damage to Sri Lanka's agricultural output,
fish catch, economic infrastructure, tourist indus-
try, and foreign investor and donor confidence
would become more pronounced. The government
would probably continue its military buildup, forc-
ing higher budget deficits and further cuts in
economic development programs.
In either scenario, the most hardline Tamil groups
are likely to attack economic centers in the Sinha-
lese south in a bid to force further concessions from
Colombo.
Moreover, sabotage of foreign-owned
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Secret
businesses or attacks on hotels in the south could
erode Sinhalese confidence in the regime and jeop-
ardize the country's efforts to rejuvenate its eco-
nomic liberalization and diversification programs.
The Tamil militants are also likely to continue to
attempt to disrupt Sri Lankan tea exports.
Even if a comprehensive peace settlement is
reached, overall economic performance is unlikely
to improve significantly any time soon. Economic
growth will continue to be plagued by insufficient
investment. The government has not shown the will
to reform and broaden the tax base; it is likely to
continue to rely on inefficient export and import
taxes. The economy will remain heavily dependent
on the world prices of agricultural commodities,
which show no sign of a dramatic increase. Govern-
ment protection and structural inefficiencies con-
tinue to plague public-sector industries and deter
new foreign investment. Repaying the large debt
will continue to be a burden at least for the
remainder of the decade.
Continuing violence, whether the result of an unti-
dy settlement or widespread new fighting, is likely
to cause Sri Lanka to turn more to the United
States and other Western nations for foreign aid to
offset mounting defense expenditures and a worsen-
ing foreign payments position. Even if the insurgen-
cy subsides, Colombo will almost certainly request
additional development assistance from the United
States and other lenders and donors to help fund
recovery costs and to meet international debt com-
mitments.
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A Year of Progress
The year 1985 saw a major expansion of demand
and trade in both West European and Asian gas
markets. Gas deliveries under existing contracts
with the USSR rose about 17 percent over year-
earlier levels. As a result of substantial progress in
the negotiations over the sale of gas from the giant
Norwegian Troll field, however, the outlook for
indigenous West European gas production-as an
alternative to Soviet supplies-is much more opti-
mistic now than it was a year ago. We believe,
however, that this improved outlook still could be
undercut by declining energy prices, especially if oil
prices collapse during 1986. In East Asia, on the
other hand, several liquefied natural gas projects
continue to be promoted as alternatives for satisfy-
ing projected demand requirements in Japan, South
Korea, and Taiwan. It appears that the Soviet
Union will be making a major effort to obtain a
commitment from Tokyo this year for the purchase
Indigenous Supply. The year opened in an atmo-
sphere of growing pessimism as an apparent British
Gas Corporation decision to purchase gas from
Norway's Sleipner field in the North Sea collapsed
as a result of London's objections to the terms of
the agreement, its impact on the UK balance of
payments, and upward revisions in estimates of UK
gas reserves. Development of Sleipner consequently
has been deferred.
London is expected to reenter the import market
for natural gas within a few years, despite the
official position that indigenous supplies will be
sufficient to meet future demand. These imports
could come from Sleipner, but, should a cross-
channel pipeline be constructed linking Britain to
the continental pipeline system, gas imports from
the Soviet Union cannot be ruled out.
of gas from Sakhalin Island.
The European Gas Market
Demand. We estimate consumption in Western
Europe during 1985 grew about 7 percent over
year-earlier levels, due in large part to continued
substitution for oil, the unusually cold European
winter, and some modest improvement in the West
European economies. For the year, consumption
reached a record level of approximately 235 billion
cubic meters (bcm), according to our estimates. The
greatest increases were recorded in:
? Italy, where consumption is rising to accommo-
date the volumes contracted from both the USSR
and Algeria.
? Austria, which is taking planned increases in
Soviet gas.
? The United Kingdom, where natural gas usage
continues to expand in the residential and com-
mercial market.
? France, where attractive pricing for industrial
uses has permitted consumption of competitively
With the collapse of the Sleipner sale, many ob-
servers believed that the likelihood of development
of the Troll field, far larger and more costly to
develop than Sleipner, had been diminished. In
May, however, negotiations for the sale of Troll gas
to a consortium of continental gas buyers began,
and all sources report that they are progressing
well, despite the fact that price terms have not been
settled. According to Embassy reporting, a contract
for as much as 15 bcm of gas annually, beginning
in the mid-1990s, may be signed this year. If
agreement can be reached, this first phase of Troll
production could meet about 7 percent of expected
continental gas demand in 2000. While sales at this
level would still allow some increase in Soviet
contracts by the end of the century, they would also
enable the West Europeans to meet their Interna-
tional Energy Agency commitment to limit supplies
from any non-OECD source to less than 30 percent
of consumption. Should negotiations for the sale of
priced contracted Soviet, supplies.
Secret
DI IEEW 86-003
17 January 1986
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West European Gas Production,
Consumption, and Imports, 1985 a
Billion cubic meters
(except where noted)
Total Source Amount Share of Total
Consumption
(percent)
West Germany 16.5 51.1 34.6
Consumption minus production may not equal imports, because of
losses in production and transmission, exports and reexports,
and/or storage programs.
b Net exporter.
35.3
15
26.2
11
20.1
9
Netherlands
15.0
29
USSR
14.0
27
Norway
5.5
11
Denmark
0.1
NEGL
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to increase its gas sales substantially.
Troll gas founder, Moscow, as the lowest cost
supplier with spare export capacity, is well placed
when these extended contracts expire
In midyear, the Dutch reached agreement with
their French, West German, Italian, Belgian, and
Swiss customers to extend the current contracts,
due to expire in the early 1990s, until after the turn
of the century. This revision occurred as part of
normal three-year contract renegotiations. The new
contracts ensure that Dutch gas will continue to
account for about 20 percent of other continental
gas users' consumption during the remainder of this
century, and preclude the purchase of significant
amounts of additional Soviet gas. Unless the Dutch
again revise their estimates of remaining gas re-
serves, their current policy is to phase out exports
tration.
Price Developments. Natural gas prices continued
to fall in Western Europe as a result of oversupply
and the general decline in energy prices. The
current Dutch price, for example, fell to about
$3.50 per million Btu, compared to a peak of over
$4.00 per million Btu in late 1983. Market pres-
sures also forced Moscow to lower its gas prices to
comparable levels, and both Norway and Algeria
are expected to follow suit in ongoing negotiations.
West European buyers of Norway's Statfjord gas,
which began flowing on 1 October, are pressing
Oslo for price cuts when full contract volumes
become obligatory on 1 February 1986. The origi-
nal price for Statfjord gas when the contract was
signed in 1981 was $5.50 per million Btu, but
clauses linked to oil prices have since reduced it to
about $4.55 per million Btu. In order to move the
gas during a four-month testing period, the Norwe-
gians discounted the price by 20 percent to a level
roughly comparable with prevailing Dutch and
Soviet gas prices. Industry sources suggest that, if
the Norwegians insist on returning to the $4.55
price on 1 February, the buyers will either invoke
hardship clauses in their contracts that allow price
renegotiation or submit the matter to binding arbi-
Imports. Soviet gas exports to its current West
European customers-Austria, Finland, France,
Complicating any Norwegian gas assessment is the
subsidence problem at the main Ekofisk produc-
tion complex. Troll development may hinge on
correction of this problem because the Ekofisk
complex is a key link in the West European gas
distribution system. Subsidence occurs when a
petroleum reservoir compacts as a result of the
withdrawal of oil and gas from a structure. As the
Ekofisk platform sinks, equipment on the lower
,deck is threatened by waves. Following a determi-
nation in June that the seabed had already sunk
about 2.5 meters, scheduled deliveries were re-
duced by 25 percent until October 1987 to allow
time to correct the problem. We estimate that the
maximum shortfall to the continent will be about
3.5 bcm annually, and the operator is scrambling
to obtain additional gas from Statfjord or perhaps
Heimdal, either to make up the shortfall or to use
for reinjection to stem the subsidence, according to
Embassy reporting. Norway's European customers
are using reduced Ekofisk deliveries as leverage in
Troll negotiations in an attempt to obtain better
contractual and security provisions, according to
the trade press. Norway, moreover, is concerned
that this incident is damaging its image as a
reliable supplier, according to industry journal
reports.
Italy, and West Germany-increased by about
17 percent in 1985 to over 35 bcm and may have
earned Moscow roughly $4 billion in hard curren-
cy. Soviet gas now covers about 25 percent or more
of the consumption requirements of these five
countries, but no more than 14 percent of total
energy requirements for any of the group. As
scheduled under a 1981 contract, Moscow became
the sole supplier of natural gas to West Berlin in
October. No new gas contracts were signed during
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West Europe Gas Trade: Selected Export Sources, 1985
Soviet Exports
35.3 billion cubic meters
Dutch Exports
32.4 billion cubic meters
Austria 13- 39 Italy 15 -
France 23 France 17
Algerian Exports
20.1 billion cubic meters
Spain 7
Luxembourg
8
France 40
Libyan Exports
0.9 billion cubic meters
the year, however, despite frequent discussions with
Turkey and talks with Greece:
? Turkey has agreed in principle to buy 1.5 bcm of
Soviet gas beginning in 1987, rising to 6 bcm per
year by 2000. According to Embassy reporting,
Ankara may soon sign a 20-year contract that
could earn Moscow up to $750 million annually
at current prices if deliveries reach peak levels.
? Negotiations with the Greeks for an initial 2 bcm
per year of Soviet gas, rising to 4 bcm per year by
2000, began in late November.
France 8
West Germany
21
United
Kingdom
52
If Turkey and Greece agree to purchase Soviet gas,
each will be nearly 100-percent dependent on Mos-
cow for their gas supplies, although gas accounts
for only about 5 percent of their total energy
requirements.
Algerian gas deliveries to Western Europe, on the
other hand, rose only 7 percent, with all of the
increase the result of a 30-percent rise in deliveries
to Italy through the Trans-Med pipeline. Although
Algeria and Spain ostensibly settled their liquefied
natural gas (LNG) contract disagreement early in
Norwegian Exports
26.2 billion cubic meters
Belgium/
West Germany Luxembourg 8
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the year, shipments remained constant at about 1.5
bcm. Madrid had agreed to purchase 3.2 bcm per
year at a price of about $3.90 per million Btu.
Japanese Gas: Production,
Consumption, and Imports, 1985
Algeria also began renegotiating its natural gas
contracts with Belgium and Italy at the end of the
year, with France to follow during 1986. The
process is expected to be difficult and to drag on for
at least six months. With gas prices falling in
Western Europe, Algeria is under considerable
pressure to agree to a more realistic price to retain
its European customers
=Algerian gas costs European customers as
much as $1.00 more per million Btu than gas from
alternative suppliers. Brussels is seeking either a
cut in price or a stretching-out of contracted vol-
umes over additional years, while Rome is asking
for a reduction in price, now that the Italian
Government subsidy on Algerian gas has been
removed.
The Asian Market. This market is dominated by
Japan. We estimate that Japanese consumption
totaled about 40 bcm in 1985, an increase of about
11 percent, largely as a result of new gas-fired
electric power generating facilities coming on
stream. While Tokyo's anticipated gas needs are
covered until the mid-1990s, new projects are under
consideration for the years thereafter. At midyear,
representatives of eight Japanese utilities initialed a
contract with six Australian suppliers to import
8.5 bcm of LNG annually beginning in 1989. This
Northwest Shelf project is currently under con-
struction.
Still under active consideration by the Japanese are
future LNG supplies from the United States, west-
ern Canada, the Soviet Union, and others.!
Recent Japanese press articles allege that Tokyo
and Moscow are about to conclude an agreement
on the long-delayed Sakhalin gas project. Japan
reportedly will import 4.3 bcm of gas a year,
Total Share of Total
(billion Consumption
cubic meters) (percent)
Malaysia
Abu Dhabi
United States
6.4
2.9
1.4
15.4
7.0
3.4
beginning in 1995, and finance 50 percent of the
project's construction cost.
he US
Embassy in Tokyo says that Japan's Trade and
Foreign Ministries, the private Japanese consor-
tium for the project, and the utilities all have
strongly denied the press reports. The utilities
probably will not make a final commitment to take
the gas until a formal price agreement is reached.
Should bilateral relations warm, the Trade and
Foreign Ministries may urge the utilities to begin
negotiations on price, quantity, and delivery.
South Korea has joined the ranks of Asian import-
ers of LNG, with first deliveries from Indonesia
expected this month. Indonesian supplies are con-
tracted to expand to 2.8 bcm annually. According
to the trade press, South Korean gas consumption
could eventually rise to over 7 bcm per year in the
1990s. Construction of an LNG receiving terminal
is under way in Taiwan, with a contract for 2.1 bcm
per year of Indonesian LNG expected to be signed
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soon. Some industry observers see LNG demand in
Taiwan rising to as much as 10 bcm per year in the
1990s. Future growth in the Asian market is
expected to be readily met by expansion of existing
or planned LNG projects.
Outlook and Implications
While the outlook for West European gas security
has improved, we believe that falling energy prices
could undercut the gains of the past few years. In
the current market, buyers may delay concluding
contracts hoping to negotiate better terms at a later
date. Furthermore, a significant price decline could
make expensive North Sea gas development pro-
jects uneconomic, opening the door to greater
Soviet imports. If the Troll negotiations are unsuc-
cessful, West European gas-consuming countries
may face difficulty in living up to their Internation-
al Energy Agency commitment not to become
unduly dependent on non-OECD producers. In the
Asian market, Japan and other LNG importers are
well placed to secure additional LNG from a
variety of suppliers in the Middle East, Asia, North
America, and Australia. Because of the abundance
of proposed projects, US firms will face stiff com-
petition in their attempts to market Alaskan natu-
ral gas.
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Secret
Israeli Exports: The Challenge
of EC Expansion
make their export goods more competitive.
Israel's export sector faces new challenges in the
wake of the accession of Spain and Portugal to the
European Community (EC). The vital EC market
accounts for roughly 15 percent of Israel's GDP
and for about one-third of total Israeli exports.
Recent promises by EC leaders to maintain tradi-
tional trade patterns with Israel will only partially
allay the concerns of Israeli exporters. To improve
the long-term outlook for export growth to the EC,
Israeli producers must reduce production costs to
Recent Developments
maintain Israeli market access.
According to press reports, EC foreign ministers
formally agreed in late November 1985 to begin
negotiating new trade and cooperation agreements
with 11 Mediterranean countries, including Israel.
The negotiations are scheduled for sometime this
spring-with the agreements to be effective over a
four-year period-and will focus on lowering tariffs
on Israeli agricultural exports to preserve their
competitive position in the EC market. At the end
of the four years, the EC Commission will decide
whether these arrangements need to be modified to
reached before accession.
The commitment to begin negotiations was a vic-
tory for Israeli officials who had lobbied intensively
over the past year for protection of their EC market
share following the entry of Spain and Portugal.
These efforts culminated with Vice Prime Minister
Shamir's barnstorming trip to Europe last summer,
during which he gained support from some govern-
ment officials for trade concessions. According to
press reports, the West German and Dutch Govern-
ments were particularly adamant in insisting that a
trade arrangement between the EC and Israel be
The negotiations are vital to Israel, which conducts
over one-third of its total trade with the EC. Israel
has sharply pared its overall civilian trade deficit
Israel: Exports to and Imports
From the EC, 1981-85
O Exports
during the past two years, but export growth to the
EC has been stagnant. Indeed, Israel's trade deficit
with the EC remains significant-averaging $1.4
billion between 1980 and 1984. This poor perfor-
mance may be attributable in part to the high value
of the US dollar, in which many Israeli export
goods are quoted.
The Agricultural Sector
While virtually all of Israel's export sectors depend
on EC markets, their dependence is most pro-
nounced in farm products-EC members purchase
about 75 percent of Israel's agricultural exports.
These farm product purchases totaled $488 million
Secret
DI /EEW 86-003
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Israel: 1984 Agricultural Exports to the ECe
United Kingdom
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in 1984 and accounted for the employment of
15,000 to 20,000 workers-roughly one-fifth of
Israel's total agricultural labor force.
The Israelis are particularly concerned about com-
petition from Spain and Portugal in citrus and
vegetable exports. Israel's avocado exports to the
EC totaled $46 million in 1984, and orange exports
totaled $37 million. Currently, Israel enjoys a cost
advantage in avocado production over Spain and
Portugal. This advantage, however, may deterio-
rate unless Israeli farmers are willing to implement
improvements in production technology to maintain
their advantage.
Israeli farmers are further concerned with the EC's
progress toward agricultural self-sufficiency.
Spain's winter orange crop, for example, may bring
the EC much closer to self-sufficiency in orange
production, damaging Israeli prospects for addi-
tional growth in orange exports to the Community.
On the other hand, cotton exports-whose 1984
value surpassed citrus and vegetable exports-may
get a shot in the arm from the entry of Spain and
Portugal. These two countries imported about $63
million worth of uncombed cotton from Israel in
1984, with Portugal importing about $58 million.
With lower tariffs for shipments to Spain and
Portugal, these sales may help offset declines in
other agricultural commodity exports.
Other Key Industries
Israel is also concerned about its textile and cloth-
ing industry, although these exports are less threat-
ened by Spanish and Portuguese competition. Ex-
ports of clothing and other apparel to the EC
totaled about $196 million in 1984. These exports
are of higher quality and appeal to a more upscale
market than Spanish and Portuguese goods. Israel's
efforts to increase sales to the EC of lower quality
textile goods, however, may be harmed because of
Israel's relatively high input costs-especially for
labor-which make Israeli export prices less com-
petitive than those of Spain and Portugal.
Prospects for increased sales to the EC of high-
technology items such as laser surgery equipment,
diagnostic medical instrumentation, and fiber-optic 25X1
communications equipment-in which Israeli firms
are at the forefront of world technology-are favor-
able. The entry of Spain and Portugal will give
Israeli goods an additional boost as these two
countries bring their tariffs in line with Community
levels. Exports of resistors to the EC, for example,
should greatly increase and in the process provide
additional employment opportunities for Israeli
workers. Israel also will soon have the capacity to
produce computer chips-from initial design
through production-which should further bright-
en the outlook for high-technology exports to the
EC.
25X1
25X1
The proposed current accord with the EC will
provide only a temporary reprieve for Israel. For 25X1
many industries it may only help preserve the
status quo, which has not been particularly good.
To expand export sales to the EC would require
several fundamental changes. For agriculture:
? At present, two separate boards handle export
merchandising. Merging these boards would help
reduce operational costs.
? Accelerating the trend toward greater automa- 25X1
tion would reduce the reliance on labor for gains
in production. Since 1970, Israel's net agricultur-
al capital stock has increased at an annual rate of
0.9 percent, while labor has decreased 0.4 percent
annually.
The textile and clothing industries also must move
toward capital-intensive operations, reducing de-
pendence on labor for additional growth. Ongoing
structural changes in the textile industry that are
reducing the number of firms but increasing indi-
vidual firm size will permit greater economies-of-
scale.
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Although policies aimed at boosting exports are
widely endorsed, political realities are likely to
hinder quick movement on this front. The Israeli
public has tolerated six months of relatively tough
austerity, but patience may be wearing thin. The
current difficulty in further cutting next year's
budget suggests the government may soon ease up
on austerity. In addition, US Embassy reporting
indicates that Prime Minister Peres is still search-
ing for a way to call for a new national election or
form a new, Labor-led government without Likud
before he trades places with Likud leader Shamir
next October. Because economic policies needed to
boost exports would add to Israeli unemployment-
already at a record rate of almost 8 percent-Peres
is very likely to refrain from pushing for such
measures in the near term.
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Energy
Spot Oil Price Spot crude oil prices dropped by over $1 per barrel last week to as low as $24
Developments per barrel, as supplies continued to outstrip demand.
Prices for most crudes are now more than $2 per barrel below average
1985 prices and down $5 per barrel from late November levels. Mexico,
Venezuela, and Egypt have lowered their prices in response to competitive
market pressures-Mexico is considering a more flexible market-related
pricing policy, according to press reports. Both OPEC and non-OPEC
production soared in the fourth quarter of 1985 and arrival of a significant
portion of this oil in the consumer market will put additional downward
pressure on prices during the next several weeks.
Iranian-Brazilian Iran and Brazil will meet in late January to resolve an oil price dispute that
Oil Barter Problems has caused Brazil to restrict liftings of Iranian oil. Under a $425 million barter
agreement signed last July, Brazil takes 32,000 b/d at spot prices and
13,000 b/d at official prices.
countries are likely to resolve the dispute because both want to expand
economic ties; Tehran needs to retain oil buyers and Brazil views Iran as a lu-
crative market, particularly for foodstuffs.
Development of A recent Gulf-Canada test well in the Beaufort Sea indicated a potential
Beaufort Sea Closer capacity of over 35,000 barrels per day, which, in combination with nearby de-
posits, brings the Beaufort region to the threshold of development. Production
in the Beaufort field, however, requires the construction of a 650-kilometer
pipeline to northern Alberta. Because of the pipeline's cost, the harsh climate,
and environmental concerns, a significant long-term decline in oil prices
probably would threaten development, despite the promising tests. In that case,
the major oil firms almost certainly would attempt to persuade Ottawa to
subsidize the Beaufort project. Though budgetary constraints would weigh in
their decisions, we believe Ottawa would probably provide some funding to
further its goal of developing the Arctic.
Secret
DI IEEW 86-003
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Australian Australian coal exports in 1985 are estimated to have hit a new high of more
Coal Exports than 87 million metric tons, up 14 percent over 1984 volumes. At these levels,
Continue To Rise Australian coal exports will, for the second consecutive year, top exports by the
United States-historically the world's largest coal exporter. Steam coal
exports to Japan rose 34 percent compared with year earlier levels while
shipments to Western Europe increased by about 5 percent. Coking coal
exports also rose-but by only 3 percent. Australian coal producers are
expected to benefit from some importers' decisions to stop purchasing South
African coal.
France Finds Coal Atic, the French coal-buying agency, has signed a three-year contract to
To Replace South purchase 1 million metric tons of coal annually from Colombia beginning in
African Supplies 1986 as well as a contract to buy 200,000 tons of coal from a Canadian
company in the first quarter of 1986. Both suppliers gained entrance to the
French market after Paris announced its refusal to renew expiring South
African coal contracts for 3.9 million tons a year. At annual rates, these new
contracts replace about half of the South African imports. France is not
expected to seek additional contracts as nuclear power continues to replace
coal in the electricity sector.
New Pakistani A large coal deposit recently discovered in Chitral adds to Pakistan's estimated
Coal Find coal deposits of more than 1 billion metric tons-102 million tons are proved
reserves-according to press reports and official sources. Despite these
reserves, Pakistan mined only an estimated 2 million tons in FY 1983/84, and
coal accounts for only 7.4 percent of the country's energy supply. Coal
development has been slow because of a lack of infrastructure-such as good
roads to some remote deposits-poor-quality deposits, and few thermal power
plants. Pakistan faces serious and growing energy shortages that are likely to
further disrupt both agricultural and industrial production, but lacks the
technical and financial resources that would be required to exploit its coal
reserves.
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17 January 1986
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UAE Gas Flow Natural gas is due to start flowing this month from fields in Sharjah to
to Dubayy Imminent industries and utilities in Dubayy, according to the Sharjah government. Up to
2 million cubic meters per day will be delivered under the terms of a deal
signed last May, and volumes could be expanded to nearly 3 million cubic
meters daily. According to the trade press, the price is estimated at $1.25 per
million Btu. Sharjah is expecting 1986 revenues from the Dubayy purchase to
amount to $25 million.
Switzerland Signs Swissgas and West Germany's Ruhrgas have agreed on a new long-term
Natural Gas Contract natural gas supply contract to the year 2005. Deliveries of North Sea gas from
Ruhrgas will run at an annual volume of about 600 million cubic meters per
year, with an option to increase to 1 billion cubic meters annually. The present
Swissgas-Ruhrgas contract, signed in 1977, expires in 1988. As of that date,
Ruhrgas will also begin deliveries of 360 million cubic meters per year of
Soviet gas, or about 18 percent of Switzerland's gas needs. West German and
Dutch natural gas currently meet about 8 percent of Switzerland's total energy
consumption and gas requirements are expected to be fully covered to the end
of the century and partially thereafter.
subject to tough price and quantity negotiations.
bother utilities continue to balk at taking Sakhalin gas or are willing to
import a token amount. If Moscow has officially pushed the initial delivery
date back from 1990 or 1991 to 1995 or beyond, however, we believe the
utilities may be more agreeable, but any prospective settlement still would be
strongly denied the press reports.
kyo, however, says that Japan's Trade and Foreign Ministries, SODECO (the
semiprivate Japanese consortium for the project), Kansai, and Chubu all have
Shifting Japanese Recent Japanese press articles alleging that Tokyo and Moscow are about to
Interest in conclude an agreement for developing the long-delayed Sakhalin gas project
Sakhalin Gas Project may be overly optimistic. Japan reportedly will import 3 million tons of LNG a
year, beginning in 1995, and finance 50 percent of the project's construction
cost. The press reports also name the Kansai and Chubu Electric Power
Companies as having agreed to take some of the gas. The US Embassy in To-
Iraqi Debt The weak oil market probably will cause Iraq to seek another debt reschedul-
Rescheduling Likely ing in 1986 to help avoid cuts in military and civilian imports. According to the
US Embassy, Iraq has roughly $1.5 billion in debt payments due to Western
creditors this year. Most is owed to France, West Germany, and Japan, and
much of this was originally rescheduled in 1984. Several of Iraq's Western
creditors met last month to discuss a unified approach, but failed to reach
agreement, according to the US Embassy in Paris. As a result, Baghdad is
likely to be successful in rescheduling its 1986 debt bilaterally; both France
and Japan reportedly believe they can get a better deal by negotiating with
Iraq individually rather than through the "Paris Club."
29 Secret
17 January 1986
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Moroccan Problems Morocco failed last week to meet the second deadline of commercial creditors
With Creditors on a downpayment of $83 million, the initial sum due under a rescheduling
agreement signed last October. The US Embassy says Morocco hopes to pay
within a week and has requested a meeting to discuss the program. Rabat
claims the problem is the result of unexpectedly low remittances from
Moroccans working overseas.
Collapse of the rescheduling agreement would jeopardize Rabat's $200 million
IMF standby loan. According to the Embassy, Morocco is already in trouble
over its failure to meet IMF targets on spending. Even if Rabat is able to
honor agreements with the banks and the IMF, its economic options will
remain severely constricted without a marked improvement in its management
of the economy and in the world market for phosphates.
Sudanese Sudan's failure to repay by 1 January $1.9 million in US debt obligations now
Financial Problems more than 12 months in arrears has triggered a Brooke Amendment cutoff of
all new US economic and military assistance. Meanwhile the IMF will
postpone, at least until 3 February, a decision to declare Sudan ineligible for
further Fund assistance. To avoid the IMF cutoff Khartoum reportedly will
have to make partial payment on its arrears of over $200 million to the Fund
and must also implement some of the policies favored by the IMF. Scraping to-
gether a partial payment to the Fund may, in part, explain Khartoum's delay
in meeting the minor Brooke Amendment payment. Fulfilling the requirement
for policy reforms will be difficult given the recent change in Finance
Ministers and the political turmoil and indecision existing within the transi-
tional government as elections approach in April.
Global and Regional Developments
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17 January 1986
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India-Pakistan India and Pakistan agreed last week to establish the groundwork for improved
Economic Agreement economic ties. The agreement seeks to more than double government-
controlled commodity trade, renew the limited private trade Pakistan suspend-
ed in 1978, increase cross-border communications, and start joint industrial
ventures in each country. Bilateral trade peaked near $100 million in 1981 but
has since dropped to an estimated $50 million for the year ending in June and
now accounts for less than 1 percent of each country's annual trade.
both countries are considering ways to collaborate in
international economic forums and to avoid double taxation in order to
encourage cross-border investment. Many Pakistani officials and businessmen
fear India's competitive trade advantage, however, and, without sustained
high-level political pressure, overall growth in trade will probably be slow.
Eastern and Southern According to US Embassy reporting, the mid-December Summit meeting of
Africa Preferential the Preferential Trade Agreement for Eastern and Southern African states
Trade Area (PTA) in Lusaka, Zambia, was poorly attended by heads of government and
yielded few results. Only four leaders of the 15 PTA member countries-
Burundi, Tanzania, Zambia, and Zimbabwe-participated. As a result, no
decisions were taken on outstanding major issues such as a proposed reduction
in the minimum level of local ownership for firms benefitting from preferential
tariffs and the development of a framework for the reduction of nontariff
barriers. Members did agree, however, to establish a PTA Trade and
Development Bank, effective this month. We believe only slow progress toward
economic integration is likely, because the political links between PTA
members are fragile at best)
National Developments
Developed Countries
Secret
17 January /986
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Japanese-US During talks on 8 and 9 January, Washington's proposal to ban Japanese
Fishery Talks fishing of Alaskan-spawned salmon in the Northern Pacific met stiff resistance
Stalled from the Agriculture Ministry. Tokyo disputes the US claim that annual
Japanese catches of 30 million salmon include 1 million spawned in Alaskan
rivers, countering that the figure is only 400,000. Japan also objects to linking
the salmon issue to Japanese fish allocations within the US 200-mile economic
zone. A quick settlement does not appear likely and the US Embassy warns
that the issue may blossom into a major political quarrel. Japanese fishery
organizations are considering suspending imports of US fishery products in
retaliation-Japan bought about $680 million, or 57 percent, of US fish
exports in 1984. Tokyo may try to placate the politically powerful industry
with limited measures if a settlement is not reached.
Canadian Dollar
Continues
Downward Drift
Secret
17 January 1986
interest rates will slow growth and boost unemployment.
Attempts by Canada's central bank to alleviate downward pressure on the
Canadian dollar by raising interest rates are apparently failing. In recent
weeks the Bank of Canada has intervened in exchange markets-estimated
intervention was US $800 million in December-and last week raised the
discount rate more than one-half percentage point to 10.21 percent. In
addition, the major banks have raised the prime rate twice in the past week to
11 percent. Nonetheless, despite a temporary strengthening, the Canadian
dollar on Tuesday hit a new low against the US dollar. Economists are citing
Ottawa's inability to substantially cut its budget deficit, a discriminatory
foreign investment policy, and the likelihood of another large current account
deficit in the fourth quarter, to explain the recent pressure on the Canadian
dollar. If downward pressures continue, Ottawa may soon be forced to
abandon its attempts to prop up its currency because of fears that higher
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Less Developed Countries
Brazil Maintaining The director of a major Brazilian center for nuclear research has announced a
Unsafeguarded 10-percent federal reduction in personnel funding for 1986
Nuclear Research
The Nuclear and Energy
Research Institute-IPEN-is responsible for unsafeguarded, indigenous re-
search projects in uranium enrichment, laboratory-scale fuel reprocessing, and
design of a planned submarine propulsion reactor. The IPEN director very
likely will continue to use his influence to protect these research efforts.
Despite the personnel funding cut at IPEN-a result of
broader Brazilian fiscal austerity-Brasilia maintains a strong commitment to
indigenous nuclear research.
Mexico's Honda Mexico's recent decision authorizing a 100-percent Honda-owned motorcycle
Decision plant is the first indication that the de la Madrid administration intends to
keep its latest promise to open the economy to direct foreign investment. In re-
turn for waiver of the usual 49-percent foreign ownership limit, Honda is
expected to create some 1,700 jobs and generate exports of $100 million by
1992. In addition to the jobs and foreign exchange, Mexico City probably
hopes to acquire advanced technology and satisfy international creditor calls
for needed structural adjustments. For its part, Honda will be able to take ad-
vantage of relatively cheap Mexican labor and probably hopes to improve its
position in the US market.
Nicaraguan Currency The Sandinistas have further tightened their grip on domestic currency flows
Mismanagement with new regulations that attempt to force private companies to use govern-
ment-controlled bank accounts-instead of petty cash-for government-
approved transactions. Managua has justified the move by citing growing
black-market activity, soaring inflation, and excess currency in circulation.
The new policy is also designed to boost deposit levels-banks occasionally
have shut down for lack of currency-and to facilitiate tax collection. As a re-
sult, many private farmers and small businesses plan to close their accounts to
avoid the tax auditors, according to US Embassy reporting. The new
regulations will probably backfire. Any increases in bank deposits from larger
companies will likely be offset by individuals and small businesses closing their
accounts. Businesses unable to obtain materials via the black market may
close, adding to a drop in exports and further undermining private-sector
activity. Moreover, any strengthening of the cordoba due to reduced supply
will be countered by a probable rise in capital flight.
Secret
17 January 1986
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17 January 1986
Key Debtor LDCs: Real Exchange Rates
Index: 1980=100
Argentina
100
67
72
68
76
79
71
70
67
60
Brazil
100
107
116
111
110
117
123
128
112
109
Chile
100
93
96
93
95
100
95
97
90
79
Colombia
100
121
115
115
114
116
115
119
109
99
Indonesia
100
100
100
99
99
101
102
103
101
98
Malaysia
100
113
118
116
116
120
118
117
115
111
Mexico
100
75
92
85
90
93
98
104
109
92
Nigeria
100
130
178
154
178
196
185
184
172
168
Peru
100
105
104
109
105
105
101
93
87
73
Philippines
100
103
116
112
113
117
120
133
129
123
South Korea
100
101
99
97
97
100
101
102
97
92
Venezuela
100
133
96
110
85
94
101
108
109
109
Key Debtor LDCs: Average Real Exchange
Rates, 1982-85
I I I I I I 1 I I I I I 1 1
95 1982 83 84 85
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Sharp Real Key debtor real exchange rates have depreciated sharply from their peak in the
Depreciations in Key first quarter of 1985. This has resulted primarily from the rapid depreciation
Debtor Exchange Rates of the US dollar, to which most of their currencies are tied. For many of these
countries, this has reversed the real appreciations recorded in 1984 and helped
to restore trade competitiveness. We expect a continued real depreciation of
debtor exchange rates this year, although at a slower pace than last year. In
combination with an expected bottoming-out of export prices, this should help
boost the export earnings of these countries in 1986.
Oman Moving Recent personnel changes suggest that Sultan Qaboos is cracking down on
Against Corruption flagrant corruption amid growing concern over lavish government expenditures
and falling oil prices. He unceremoniously sacked the powerful head of the
Royal Court
Qaboos also re-
cently remove Minister of Communications Al Busaidi. US officials in
Muscat say Al Busaidi was allegedly awarding contracts to firms in which he
had financial interests. The changes will hearten Omani nationalists, who have
bridled at Qaboos's tolerance of corruption, but it will do little to curb
government spending. Muscat has already withdrawn about $900 million from
its general reserve fund to cover spending on the Gulf Cooperation Council
summit and National Day celebrations last November and may be forced to
borrow to finance current expenditures.
Indonesian Budget In anticipation of an additional 14-percent decline in oil and gas revenues for
Slashed fiscal year 1986, which begins on 1 April, President Soeharto last week
announced sharp cuts in the federal budget. At $19.4 billion, the new budget
represents an 11-percent decrease over the previous fiscal year-the most
austere budget since the early 1970s. It includes a cut of 22 percent in
development spending, the first such cut since 1969. The new budget
represents intensified efforts to rein in the estimated $3 billion current account
deficit and keep the country's $37 billion foreign debt in check. According to
US Embassy reporting, however, Jakarta's revenue projections may be
optimistic because its forecasts are predicated on $25 per barrel oil. The
severity of the budget cuts in any case raises serious doubts as to Indonesia's
ability to achieve 5-percent real growth over the next three years-a rate just
sufficient to stem the rising tide of unemployment.
Malaysian Financial Prime Minister Mahathir continues to delay release of the politically sensitive
Scandal May final report on the Bank Bumiputra financial scandal. According to a reliable
Afect Elections source of the US Embassy, who has read the report, it may cause serious
damage to Mahathir's government.
Mahathir probably will be
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forced to call elections within the next three months in the face of increasing
public pressure on him to disclose the report. In addition, information
potentially damaging to his administration may emerge when a key figure in
the case goes on trial in Hong Kong in March.
Good Year for the According to official statistics, national income growth in 1985 remained
East German Economy strong although the 4.8-percent increase fell short of 1984's unusually large
5.5-percent rise. Industrial production climbed 4.5 percent. The government
credited most of the gains to improved efficiency: labor productivity climbed
8.4 percent by East German measures while unit costs fell 2.5 percent. We es-
timate that East Germany's hard currency trade surplus reached $600-800
million and that hard currency debt again declined. The improved external
position probably contributed to the regime's decision to boost investment by
23 percent. Limited information suggests that real personal consumption
probably rose modestly. The acceleration of growth in the second half of the
year-national income through June was only 4.1 percent above the previous
year's level-suggests that East Berlin can achieve its 1986 growth target of
4.4 percent.
Surge in China's Chinese sales of bonds on the Tokyo market jumped from approximately
Bond Sales $10 million in 1984 to nearly $1 billion in 1985, making China the largest for-
eign borrower in the Japanese market. Offerings in yen-denominated bonds
were made by the Bank of China, China International Trade and Investment
Corporation (CITIC), and several provincial-level groups. CITIC also floated
over $100 million in US-dollar-denominated bonds in Tokyo and sold nearly
$50 million worth of deutsche-mark-denominated bonds on the West European
market. The issues generally received excellent ratings and were discounted
slightly or not at all.
China Rescues Failing China has agreed in principle to take over a financially troubled Hong Kong
Hong Kong Bank bank-the first such takeover since signing the accord to regain the territory.
According to press reports, Beijing agreed to buy majority ownership in the Ka
Wah Bank for an estimated $125 million only after attempts to find other buy-
ers fell through. China also recently offered publicly to help other Hong Kong
banks with liquidity problems. Beijing previously invested in several other
troubled Hong Kong firms but relied on the Hong Kong Government to take
over failing banks in 1983 and again last June. Beijing is anxious to promote
confidence and stability in Hong Kong's financial system. With the transition
under way, Beijing probably will find it increasingly necessary to back up with
cash its words of support for Hong Kong's economy
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alternates by lies ese cotton exporters have forced
look contract
Chinese Export Delays Shipment delays and
Worry Cotton Buyers their c
Shipment delays of up to four months are being attributed to Chinese port con-
gestion and dependence on a single rail line linking the western high-quality
cotton growing area to the east coast ports. Undesirable bale size and high
moisture content are additional negative factors. Japanese and Canadian
cotton spinners, previously attracted by the low Chinese prices, are worried
about dwindling stocks.
China Forms Venture China last week unveiled its first venture capital corporation, Ventureteconics,
Capital Company formed to concentrate investment on information technology,
biotechnology, new materials, and other high-technology areas. Two individ- 25X1
uals founded Venturetech after studying venture capital in the United States
and selling the idea to the State Council last year.
Venturetech will underwrite projects likely to
result in marketable technologies. This is another step in Beijing's ongoing
efforts to introduce market mechanisms to its industrial sector. Beijing has
been studying how Australia, Canada, and the United States use venture
capital to finance high-technology, high-risk projects.
China To Reform Beijing has formed a leading group for job title reform to coordinate
Personnel Management implementation of a new personnel management system for China's profes-
sional and scientific talent. The group will be under the direction of Song Jian,
Minister in Charge of the State Science and Technology Commission (SSTC),
and will include representatives from the Ministry of Labor and Personnel, the
State Education Commission, and the SSTC. The planned reforms will
increase the mobility of skilled personnel, link pay to performance, and
eliminate lifelong tenure and seniority. Although the reforms would improve
the work environment and speed promotion for competent workers, past
attempts to change personnel management have met resistance. Enterprises
would probably reject any attempts to deprive them of skilled workers, and
individuals would likewise protest efforts to relocate them to the rural areas
that are chronically short of talent.
37 Secret
17 January 1986
Declassified in Part - Sanitized Copy Approved for Release 2011/12/08: CIA-RDP88-00798R000200210005-4
 Declassified in Part - Sanitized Copy Approved for Release 2011/12/08: CIA-RDP88-00798R000200210005-4
Secret
Vietnamese Approach Hanoi is seeking ways to bypass COCOM restrictions and Tokyo's Policy of
Japan for Oil withholding official financial aid from Vietnam in order to obtain private
Development Expertise foreign participation in offshore oil exploration, according to a Japanese press
report. Hanoi is proposing that a Japanese oil company develop Vietnam's
offshore fields on a commission basis and, the press report speculates, the
Vietnamese will try to use Soviet aid funds for Japanese and Western
technology to speed up development of Vietnam's oil resources in the Vung
Tau region as well as in waters from Cam Ranh Bay to the Tonkin Gulf. The
press report adds that the Japanese firm is checking with US oil companies to
determine if the plan would violate COCOM restrictions. Officials of the
Japanese firm told US Embassy officials they are considering the Vietnamese
proposal
but de
th
,
ny
ey are seeking cooperation from US oil companies.
Secret
17 January 1986
Declassified in Part - Sanitized Copy Approved for Release 2011/12/08: CIA-RDP88-00798R000200210005-4
 i ii d.; I-.. i i . i.
Declassified in Part - Sanitized Copy Approved for Release 2011/12/08: CIA-RDP88-00798R000200210005-4
Secret
Secret
Declassified in Part - Sanitized Copy Approved for Release 2011/12/08: CIA-RDP88-00798R000200210005-4