INTERNATIONAL ECONOMIC & ENERGY WEEKLY

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP88-00798R000400150005-9
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 36
• Document Creation Date: December 27, 2016
• Document Release Date: July 12, 2011
• Sequence Number: 5
• Publication Date: September 5, 1986
• Content Type: REPORT

Declassified in Part - Sanitized Copy Approved for Release 2012/03/07: CIA-RDP88-00798R000400150005-9
Directorate of Sccret
Intelligence
International
Economic & Energy
Weekly
5 September 1986
_Seeret---
DI IEEW 86-036
5 September 1986
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International
Economic & Energy Weekly
5 September 1986
Secret
iii Synopsis
1 Perspective?OPEC: The Saudi-Iranian Rivalry L
3 Oil Productive Capacity Outside the Persian Gulf
7 Iraq: Coping With Economic Downturn
11 Hungary: Economic Troubles Continue
15 Central America: Efforts To Revive Regional Trade
19 Briefs Energy
International Finance
International Trade
Global and Regional Developments
National Developments
Comments and queries regarding this publication are welcome. They may be
directed to Directorate of Intelligence
i Secret
DI 1EEW 86-036
5 September 1986
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International
Economic & Energy Weekly
Synopsis
Secret
1 Perspective?OPEC: The Saudi-Iranian Rivalry
The ongoing struggle for power in the Persian Gulf region, including influence
over oil market conditions, has serious implications for the West. In any event, oil
supplies will become more concentrated in the Middle East, regardless of whose in-
fluence dominates the oil market.
3 Oil Productive Capacity Outside the Persian Gulf
Oil producers outside the Persian Gulf do not have sufficient excess productive
capacity to offset a major disruption of Gulf supplies. Price pressures could build
even in the absence of an actual shortage because of uncertainties about the
duration and size of the disruption.
7 Iraq: Coping With Economic Downturn
Sharply lower oil revenues are forcing Iraq to implement austerity measures that
will cause the first significant decline in living standards since the beginning of the
war with Iran.
11 Hungary: Economic Troubles Continue
Hungary's poorly performing domestic economy and further worsening of its
external accounts this year pose mounting problems for the Soviet Bloc's most
reform-oriented regime. If Budapest continues to avoid the tough measures needed
to improve the economy, lending by Western banks is likely to decline, which could
lead to serious debt servicing problems.
15 Central America: Efforts To Revive Regional Trade
Efforts to revive Central American regional trade?which has fallen sharply since
1980?are being given new emphasis in an attempt to boost the sagging economies
of the five nations. Nonetheless, although the countries continue to recognize the
importance of maintaining good commercial relations, a lack of movement in
resolving other more fundamental eonomic problems probably will postpone any
substantial progress in revitalizing regional trade.
iii
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5 September 1986
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Perspective
International
Economic & Energy Weekly
5 September 1986
OPEC: The Saudi-Iranian Rivalry
Secret
The August OPEC agreement to cut production largely represents a temporary
lull in the struggle over oil policy between Saudi Arabia and Iran. Saudi interest in
a stable long-term market for their oil with relatively low prices contrasts sharply
with the more immediate Iranian need for high prices for economic recovery and
development. As long as the Saudis remain the undisputed leader within OPEC,
oil prices will probably remain relatively low over the next few years. A shift
toward greater Iranian influence would alter the price outlook significantly. If Iran
clearly gains the upper hand in the war with Iraq, Tehran could reemerge as the
dominant force in the world oil market.
Current weak oil market conditions and the war against Iraq have hindered
Tehran from advancing its oil policy objectives and have allowed Riyadh to
dominate the oil policy struggle in recent years. Barring a major supply disruption,
we expect prices to remain near their current level of about $15 per barrel over the
next few years. A breakdown in producer discipline could force prices even
lower?perhaps well below $10 per barrel. In the meantime, uncertainty about
producer intentions will continue to cause price volatility.
Over the next several years, we expect that current oil price levels will work in fa-
vor of a reemergence of market control by Persian Gulf producers. We believe that
Saudi Arabia and Iran will have the powerful combination of oil wealth and
military might to be particularly influential in Persian Gulf affairs. Coupled with
the conditions that gave OPEC producers market power in the past?especially
strong demand growth and limited growth in supplies from other countries?the
rivalry between Saudi Arabia and Iran will become even more heated.
The outcome of the Iran-Iraq war will play a large role in determining who
eventually has the most influence over the oil market:
? As long as the stalemate continues?or the war ends in a draw?we believe the
Saudis will have the upper hand. Riyadh will push for steadily rising prices, but
well below levels reached as recently as last year. Saudi long-term oil objectives
favor a stable energy environment to boost oil demand and slow oil and
alternative energy supply development in high-cost areas like the United States.
This would clearly increase US import dependence on low-cost suppliers such as
the Saudis.
? An Iranian victory, however, would shift the balance of power in the Gulf region
and the oil market, especially if Tehran is able to control or substantially
influence Iraqi oil marketing policies. Tehran's market power would be even
greater if it was able to influence Kuwaiti oil policy?a likely possibility with a
major victory in the war. Taken together, Iran, Iraq, and Kuwait have about 8
million b/d of oil productive capacity?enough to seriously challenge Riyadh's
dominance.
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In any event, oil supplies will become more concentrated in the Middle East,
regardless of whose influence dominates the oil market. Internal and intraregional
friction, economic problems, and acts of terrorism will continue to pose potential
threats to the security of Western oil supplies. Despite the near-term benefits, if
low prices continue for several years, there will be a greater risk that any supply
disruption will increase the economic and security consequences for the West.
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Oil Productive Capacity
Outside the Persian Gulf
Oil producers outside the Persian Gulf do net have
sufficient excess productive capacity to offset a major
disruption of Gulf supplies. Persian Gulf countries,
which export some 11 million b/d or about one-fourth
of total non-Communist oil supplies, also contain most
of the world's current excess productive capacity.
About two-thirds of the surplus oil productive capaci-
ty outside the Gulf is concentrated in Venezuela,
Libya, Nigeria, Algeria, and Egypt. In the event of a
disruption to Persian Gulf supplies, we believe current
financial difficulties would strongly motivate all non-
Gulf producers, except possibly Libya, to raise oil
production. Available excess productive capacity,
even with a drawdown of US strategic reserves, is not
likely to prevent price runups if disruptions limit
Persian Gulf exports to about 8 million b/d or less.
Price pressures could build even in the absence of an
actual shortage because of uncertainties about the
duration and size of the disruption.
Recent Losses in Productive Capacity
Available productive capacity outside the Gulf has
slowly eroded over the past year. The conventional
measure of capacity is the level that a country can
produce within 90 days of a decision to raise output.
We estimate that available productive capacity out-
side the Persian Gulf has suffered a net loss of about
500,000 b/d over the last 12 months. This dropoff is
due primarily to financial constraints, increasing well
maintenance problems, and declining production from
maturing oilfields
Nigeria's available productive capacity has declined
by about 400,000 b/d over the last year to about 1.8
million b/d
Moreover, productive capacity probably will continue
to decline because of poor maintenance practices and
the absence of significant drilling activity. Nigerian
oil officials hope to raise productive capacity by about
200,000 b/d by reinjecting natural gas
Secret
Persian Gulf Exports Million bid
90-Day
Export
Capacities
July 1986
Exports
Total
16.0
11.0
Saudi Arabia
7.6
4.9
Iran
2.6
1.5
Iraq
1.6
1.5
Kuwait
1.4
1.0
United Arab Emirates
1.6
1.4
Others
1.2
0.7
but we believe that budget constraints
and slack demand could affect these plans.
Libya's available productive capacity has fallen to
only 1.6 million b/d because of deteriorating well
performance and the need for additional drilling and
modifications to existing pumping and pipeline sys-
tems,
3
Oil production in Indonesia has risen to about 1.5
million b/d, which is the limit of the country's
available capacity, according to Oil Minister Subroto.
Our Embassy reports that achieving an additional
100,000 b/d of capacity would take at least six
months to complete.
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Mexico's oil productive capacity has slipped by about
200,000 b/d over the past year to about 3 million b/d,
based on our reservoir engineer-
ing analysis. Maintaining even this level of production
would require the overhaul of many wells and the
refurbishing of surface oil collection facilities, as well
as the discovery and development of new oilfields to
offset production declines at existing fields.
Distribution of Excess Capacity'
The largest concentration of surplus capacity outside
the Persian Gulf is in North and West Africa, which
accounts for about 1.5 million b/d. One-third of this
excess capacity is in Libya and the rest is divided
among Nigeria, Algeria, and Egypt:
? Libya could raise production by 500,000 b/d from
the present level of 1.1 million b/d within 90 days,
\Our own
analysis
Saudi Arabia and other Persian Gulf producers are
primarily responsible for the emergence of surplus
capacity in Egypt.
We estimate surplus available capacity in the West-
ern Hemisphere at roughly 1 million b/d?located
primarily in Venezuela and Mexico:
Venezuela's oil pro-
duction could increase immediately by 200,000 b/d
from the current level of about 1.6 million b/d. In
addition, another 700,000 b/d of output could be
achieved in about six weeks,
Venezuela is one of the few exporters to
increase capacity despite the slumping market.
? Mexico's spare capacity is currently about 200,000
b/d. We believe Mexico could raise output by this
amount fairly quickly. Sharp cutbacks in mainte-
nance expenditures and outlays for spare parts have
reduced Mexico's capability to sustain higher levels.
\ strongly supports this
judgment. The departure of US firms has not
affected Libyan capability to achieve this level
because non-US company personnel have routinely
performed the operations required.
? Nigeria could rapidly raise production by about
300,000 b/d to 1.8 million b/d,
although additional increases are limited by techni-
cal problems
The Nigerians have severely restricted ex-
penditures for maintenance and development be-
cause of their financial problems.
? We estimate that Algeria could increase oil produc-
tion by about 400,000 b/d from recent output levels
within a short period.
? Egypt could increase its production by about
300,000 b/d, according to the US Embassy. Mar-
keting problems caused by higher production from
' Because excess capacity is the difference between a country's
available capacity and its current rate of production, estimates are
sensitive to production fluctuations caused by market or operating
conditions.
Secret
Impact of a Persian Gulf Oil Disruption
The prospects that excess capacity outside the Persian
Gulf would be made available during a Gulf disrup-
tion are good. In general, we believe most producers?
including Algeria, Mexico, Nigeria, and Venezuela?
would be strongly motivated to raise output for
financial reasons. Libya's response to a disruption is
uncertain. Libya may not be willing to help offset a
supply shortfall instigated by Tehran, despite its
precarious financial position. As a result, we believe
less than 3 million b/d of excess capacity would be
made available within 90 days to offset the loss of
Persian Gulf oil exports.
Strategic stockpiles, including 500 million barrels
held by the United States, 129 million barrels in
Japan, and 55 million barrels in West Germany, could
play a large role in helping to offset a disruption.
Commercial stocks, are relatively low compared with
levels of a few years ago and their contribution to
offset lost exports would be limited. Saudi Arabian
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Estimates of Surplus Capacity
Million bid
Available
90-Day
Capacity
Production Including NGLa
Surplus Capacity
July 1986
Under OPEC
Quotas
Under
July 1986
Production
Under OPEC
Quotas
Total
54.05
45.71
42.46
8.34
11.59
Persian Gulf
18.40
13.50
10.98
4.90
7.42
Saudi Arabia
8.50
5.80
4.35
2.70
4.15
Iran
3.40
2.20
2.30
1.20
1.10
Iraq
1.90
1.80
1.80
0.10
0.10
Kuwait
1.60
1.50
0.90
0.10
0.70
United Arab Emirates
1.70
1.50
0.95
0.20
0.75
Qatar
0.60
0.30
0.28
0.30
0.32
Neutral Zone
0.60
0.30
0.30
0.30
0.30
Bahrain b
0.10
0.10
0.10
Non-Persian Gulf
35.65
32.21
31.48
3.44
4.17
OPEC
9.00
6.80
6.07
2.20
2.93
Algeria
1.10
0.70
0.66
0.40
0.44
Ecuador
0.30
0.30
0.23
0
0.07
Gabon
0.20
0.20
0.14
0
0.06
Indonesia
1.50
1.40
1.19
0.10
0.31
Libya
1.60
1.10
0.99
0.50
0.61
Nigeria
1.80
1.50
1.30
0.30
0.50
Venezuela
2.50
1.60
1.56
0.90
0.94
Non-OPEC
26.65
25.41
1.24
Canada
1.80
1.80
0
Egypt
0.90
0.60
0.30
Malaysia
0.55
0.51
0.04
Mexico
3.00
2.80
0.20
North Sea
4.00
3.60
0.40
United States
10.70
10.50
0.20
Others
5.70
5.60
0.10
a Based on information available as of 8 August.
b Non-OPEC.
stocks of about 70 million barrels held outside the
Persian Gulf could also help offset a short-term loss.
At a drawdown rate averaging about 2 million b/d,
the US Strategic Reserve would last about eight
months. If other strategic stocks were drawn down
over the same period, these reserves could provide a
total of about 3 million b/d in supplies.
5
Considering both non-Gulf excess capacity and strate-
gic stockpiles, additional supplies of about 6 million
b/d appear available. The psychology of the oil
market, however, requires a cushion of roughly 2-3
million b/d in available supplies to maintain stable
prices. Consequently, additional non-Gulf supplies are
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Erosion of Available Capacity Million bid
Outside the Gulf
June 1985
July 1986
Percent
Change
Total
34.5
34.0
?0.5
Indonesia
1.6
1.5
?0.1
Libya
1.8
1.6
?0.2
Nigeria
2.2
1.8
?0.4
Venezuela
2.4
2.5
0.1
Mexico
3.2
3.0
?0.2
Other non-OPEC
non-Communist
23.3
23.6
0.3
available to offset a loss of only about 3-4 million b/d
of Gulf supplies without putting severe upward pres-
sure on prices.
With Persian Gulf exports now running at 11 million
b/d, this means an export capacity from the Gulf of at
least 8 million b/d is needed to balance the market
near recent export and price levels using some combi-
nation of non-Gulf excess supplies and strategic re-
serves. With current export capacity from the Gulf
totaling about 16 million b/d, this represents a pre-
sent Gulf cushion of about 8 million b/d in surplus
capacity. Substantial damage to export systems in
Iraq, Iran, and Kuwait, and even some loss in Saudi
Arabia, technically could still be handled, but the
psychological impact of such events on the market
probably would drive prices upward. Major damage to
Saudi export facilities in addition to those of the
northern Gulf producers would go well beyond what
non-Gulf excess supplies could offset, even with the
use of strategic reserves.
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Iraq: Coping With
Economic Downturn
Sharply lower oil revenues are forcing Iraq to imple-
ment austerity measures that will cause the first
significant decline in living standards since the begin-
ning of the war with Iran. Recent debt rescheduling
agreements and large pledges of financial aid from
Iraq's Arab allies should help maintain essential war
and consumer imports. Nonetheless, Iraqis can expect
shortages of other goods until the war ends or oil
prices rebound.
Impact of Oil Price Decline
The large fall in oil prices since the beginning of the
year has left Baghdad with little recourse but to slash
nonmilitary spending, including imports and govern-
ment subsidies. We estimate export revenues?about
95 percent from oil sales?will decline to about $7.4
billion this year from $11.4 billion in 1985. Combined
with the fall of the dollar, the purchasing power of
Iraq's foreign exchange earnings probably will decline
about 60 percent this year. Just to maintain recent
import levels of military goods and food, Iraq would
have to use nearly all of its current monthly oil
revenues and financial aid from Saudi Arabia and
Kuwait. Defense expenditures have not been cut and,
in our view, are not likely to be reduced given recent
fighting, Iraq's expectation of a major Iranian offen-
sive later this year, and promised Arab aid.
Lower oil earnings have again forced Iraq to resched-
ule foreign debts. Since early this year, Iraq has
rescheduled repayment of about $4.6 billion in debt
owed its major creditors. Deals with France, West
Germany, and Japan shift repayment of debt due this
year to 1987-90, including a two-year grace period.
Agreements with Turkey, Yugoslavia, Italy, and In-
dia call for a large portion of bilateral debt to be paid
in oil./
}Press reports indicate that Japa-
nese banks will reschedule about $250 million on the
same terms.
7
Iraqi Insulation From Economic Hardships Eroding
Lower oil revenues are forcing the Iraqi leadership
into uncharted territory. Following the oil price in-
creases of the early 1970s, and in particular since the
start of the war with Iran, the regime has helped
maintain support for its policies by insulating the
public from economic hardships. Government policies
have included:
? Heavily subsidized public services, with some pro-
vided free.
? Subsidies to maintain low prices on basic necessities
such as food and pharmaceuticals.
? Price controls on many other goods.
? Gifts?or sales at below cost?of big-ticket consum-
er items to military officers, martyrs' families, and
other politically favored groups.
After oil prices peaked in 1981 and the war dragged
on, the government gradually reduced the magnitude
of its largess. Baghdad initially was able to soften the
decline by using $30 billion in foreign exchange
reserves, another $30 billion in "soft" loans from
Arab allies, and by running up foreign debts to about
$14 billion currently. Although austerity measures in
1982-83 cut imports in half, the reduction was
achieved largely by canceling, postponing, or curtail-
ing large development projects rather than cutting
consumer goods imports. This year, however, the
sharp drop in oil prices and the rising debt burden
made sustaining the regime's policies unaffordable.
Initial Confusion Delays Austerity
Initial disagreement among the Iraqi leadership over
how to respond to the collapse in oil prices delayed
austerity measures and their full impact on the Iraqi
populace. President Saddam Husayn first created a
"Presidential Committee" to make foreign exchange
allocations. This undermined First Deputy Rama-
dan's economic authority?he had long had responsi-
bility for major economic decisions?and caused bot-
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Iraq: 1986 Debt Rescheduling Agreements
and Repayment Schedule, 1987-92
Million US $
Rescheduled Payments Due in
Oil
Payments a
Amount
Rescheduled b
1987
1988
1989
1990
1991
1992
Total
310
1,323
1,111
394
186
186
1,070
4,580
France
0
125
250
125
0
0
0
500
French banks
0
0
57
114
114
114
0
400
West Germany
0
290
290
0
0
580
Japan
150
150
0
300
Japanese banks
0
0
36
72
72
72
0
250
Italy
0
0
0
200
200
Turkey
310
350
0
540
1,200
India
80
0
120
200
South Korea
83
83
83
0
250
Yugoslavia
245
245
0
210
700
a Oil to be delivered in 1986-87 in lieu of cash payments.
b Rounded to the nearest $10 million.
tlenecks in implementing austerity measures. In July,
Husayn was pressured to share more decisionmaking
and returned economic authority to Ramadan.
Baghdad probably will soon intensify spending cuts.
Ramadan?who orchestrated the steep spending cuts
in 1982-83?is finalizing the 1986 budget, and he is
expected to apply the same determination to the
austerity measures needed this year. New austerity
policies are likely to include subsidy reductions, tax
increases, and cutbacks in government development
expenditures that will hit consumers. Basic services
probably will deteriorate as development projects take
a back seat to more immediate needs: several water
supply, sewerage, and transportation projects already
have been put on hold. The prices of many goods,
including food, are rising rapidly. To try to assure
equitable distribution, Iraq's rationing program?pre-
viously limited to basic food staples?is being expand-
ed. ration cards are
now being distributed for such consumer goods as tea
and sugar.
Special groups within Iraqi society already have
begun to lose some of their perquisites. Financial
Secret
benefits given to government workers, military per-
sonnel, and families of war dead are being reduced.
The US Embassy reports that Ramadan has ordered
that cars will now be sold to senior government
officials rather than given as gifts. Ramadan report-
edly is also stopping the widespread practice of trans-
porting people to and from work at government
expense. Even Husayn seems to be curtailing his
customary largess by telling petitioners there is no
more money for him to hand out.
Financial incentives to military officers?a standard
practice in the past to reward loyalists and build up
morale?also are diminishing.
\ In
addition, benefits to families of war dead also are
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Ramadan Regains Economic Authority
Deputy Prime Minister Ramadan regained broad
powers over economic decision making at July's
extraordinary meeting of Iraq's ruling Ba`th Party.
President Saddam Husayn, who summoned the party
leaders to the surprise session, returned to Ramadan
authority that Husayn had appropriated for himself
earlier in the year. Ramadan's "victory" over Sad-
dam reflects his ability to manage Iraq's economic
affairs and control Iraq's bureaucracy.
Ramadan's power stems from his control over Iraq's
technocratic elite. His experts in key economic minis-
tries carry on the day-to-day operations of the gov-
ernment and are in charge of strategic economic
planning and budgets. These experts play a key role
in Iraq's command economy?in which practically
every area of society is bureaucratized. The First
Deputy not only directs these technocrats, but also
has been able to wield them into an effective political
constituency. According to the US Embassy, when
Ramadan imposed his campaign of "working to
rule"?he refused to carry out decrees from the
Presidential Committee without a direct order from
Husayn?activity in the economic ministries practi-
cally came to a halt.
Under Ramadan's direction, Iraq's ability to cope
with drastically lower oil prices is likely to improve.
His proven ability to direct economic ministries
should result in more effective implementation of
policies than under Husayn.
being curtailed. At the beginning of the war, the
family of an Iraqi killed in battle received a car, 3,000
Iraqi dinars (then worth about $10,000), and a plot of
land.
few "martyr" families are receiving cars and
most are being told they will get one "after the war."
Civilian Imports Likely To Be Slashed
The Iraqi economy is heavily dependent on imports,
and large cuts will further curtail economic activity
9
Iran: No Better Across the Border
Lower oil revenues have also placed a severe strain on
Iran's economy. Tehran is blaming the war and
"Western plots- in the oil market to justify its severe
austerity measures. Top priority has been given to
military and food imports at the expense of develop-
ment projects and industrial production. Lack of raw
materials and spare parts have caused factory clo-
sures throughout Iran. Over the next several months,
this could reduce industrial output by 65 percent and
double unemployment to 4 million?about one-third
of Iran's work force. Already severe shortages, in-
cluding many food items, will worsen unless oil prices
recover
Tehran appears increasingly concerned that its dete-
riorating economy could eventually hamper its war-
making ability while Arab aid and additional oil
export pipelines will bolster Baghdad's longer term
financial prospects. Iran, however, believes that the
military setbacks it has inflicted on Iraq this year
and Baghdad's current economic problems have
weakened Iraqi morale. Tehran believes this has
improved its chances of victory if it moves soon,
probably by launching a major offensive this fall. if
Iran does not make significant gains in the war over
the next year, domestic shortages and unemployment
could be serious enough to require the regime to
reevaluate its war strategy
and the availability of goods. According to the US
Embassy, Ramadan has promised to cut civilian
imports by 65 percent. The full weight will fall on
remaining development projects, imported inputs for
industry, and nonfood consumer items. According to
the US Embassy, spot shortages of formerly available
imported goods began to appear in Baghdad late this
spring. Baghdad has banned imports of luxury goods
and semifinished products
In addition, Iraq's private sector has not
received any allocations of foreign exchange for im-
ports this year, according to the Embassy. Although
the private sector represents a small fraction of total
imports, it is heavily involved in the domestic manu-
facture of consumer goods.
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Baghdad's difficulties in dealing with its foreign
creditors will add to shortages. The US Embassy in
Ankara reports that Turkey, Baghdad's second-
largest supplier in 1985, last month discontinued
export financing to Iraq because of Baghdad's de-
mand for two-year credits?Ankara is willing to
finance for only one year. \-
What's Ahead
High prices, shortages, and reduced government bene-
fits over the coming months are likely to be accompa-
nied by heightened military activity. President Hu-
sayn recent open letter to Iran calling for peace was
aimed, in part, at preparing Iraqis for the next major
Iranian offensive and high Iraqi casualties. This is
part of a government drive to encourage Iraqis to have
a more realistic expectation of future sacrifices stem-
ming from the war and low oil prices.
Secret
The large amounts of financial aid reportedly pledged
to Iraq by its Arab allies during Ramadan's recent
swing through the Persian Gulf states will ease finan-
cial pressures on Baghdad, but not remove the need
for austerity measures. Sources of the US Embassy in
Baghdad report that Saudi Arabia and Kuwait have
committed $4 billion and $1.5 billion, respectively.
The US Embassy believes the new Saudi funds are
earmarked for military equipment. This will allow
Baghdad to maintain military purchases and enable
Iraq to use other resources to continue essential
consumer imports. Although this improves Iraq's
chances of "outlasting" Iran, Iraqis will not see any
major improvements in the economy until the war
ends or oil prices rebound.
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Hungary: Economic Troubles
Continue
Hungary's poorly performing domestic economy and
further worsening of its external accounts this year
pose mounting problems for the Soviet Bloc's most
reform-oriented regime. Budapest's timid response to
the economy's troubles reflects concern that renewed
austerity would alienate large elements of society.
Decisionmaking has also been impeded by uncertainty
over the succession to aging party leader Kadar. If
Budapest continues to avoid the tough measures
needed to improve the economy, lending by Western
banks is likely to decline, which could lead to serious
debt servicing problems.
The Economy Falters
The Hungarian economy has grown slowly since the
late 1970s, mainly as a result of adjustment policies
designed to halt the growth of hard currency debt.
Sizable trade and current account surpluses in
1983-84, however, encouraged Budapest to loosen
controls on domestic credit, government spending, and
imports last year. Although these measures were
designed to allow for the first small rise in domestic
demand since 1981 and a modest increase in growth,
economic performance fell far short of plan. We
estimate that GNP declined 0.9 percent in 1985;
reflecting a sharp drop in agricultural production and
weak industrial growth. Unusually cold weather in the
first quarter disrupted production and exports and
aggravated energy shortages. These problems, cou-
pled with the continued decline of agricultural export
prices, produced a sharp deterioration in the country's
external accounts. The hard currency trade surplus
fell by about 75 percent to $295 million, pushing the
current account into deficit for the first time since
1982.
Economic performance in the first half of this year
showed little improvement. Industrial output rose only
1.3 percent in this period compared with the first half
of the previous year, which is extremely sluggish given
the much harsher weather and sharp fall in output
experienced in early 1985. Moreover, drought is
11
Hungary: Selected Domestic
Economic Indicators, 1981-85
Percent growth
1981
1982
1983
1984
1985
Gross national product
0.7
3.7
?1.0
2.7
?0.9
Industrial production
1.5
1.5
1.0
2.5
0.8
Agricultural production ?0.8
13.0
?5.8
6.4
?4.1
Private consumption
1.9
0.3
?0.7
1.3
1.1
Gross investment
?5.2
1.0
?9.3
?5.3
?4.4 .
a Preliminary.
threatening agricultural output. At the same time,
hard currency imports are growing at twice the rate of
exports. In the first five months of this year, the hard
currency trade deficit was more than double that of
the same period last year. A prominent Hungarian
Government economist recently predicted that nation-
al income will stagnate this year, while the National
Bank revised its yearend current account estimate
downward from a modest surplus to a deficit of up to
$230 million.
Poor export performance stems in large part from a
decline in earnings on oil reexports and reduced sales
to the USSR under special hard currency trade
arrangements. Both have been key props for
Hungary's hard currency trade in recent years. The
Ministry of Industry has estimated that lower world
oil prices will cost Hungary $100-150 million in lost
reexport earnings. As lower oil prices also limit Soviet
hard currency receipts, Moscow may become increas-
ingly reluctant to purchase Hungarian goods for hard
currency. Hungary's hard currency surplus with the
socialist countries has already been steadily dwin-
dling, dropping from $800 million in 1982 to $337
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Hungary: Financing Requirements
and Sources, 1980-85 a
Million US $
1980
1981
1982
1983
1984
1985
Financing requirements
4,492
4,973
4,397
3,286
3,905
4,683
Current account balance
-370
-727
-92
298
330
-457
Trade balance
276
445
766
878
1,236
295
Exports
4,863
4,877
4,876
4,848
4,965
4,415
Imports
4,587
4,432
4,110
3,970
3,729
4,180
Net interest
-409
-1,100
-976
-662
-744
-725'
Other net invisibles
-237
-72
118
82
-163
-27
Repayment of medium- and long-term debt
811
826
894
1,216
1,681
2,114
Repayment of short-term debt
3,172
3,347
2,848
1,764
2,123
1,421
Net credits to other countries
139
73
353
304
431
691
BIS payments
0
0
210
300
0
Financing sources
4,624
4,816
4,310
3,141
3,833
4,655
Credits
4,952
4,291
3,577
3,751
4,500
5,623
Medium and long term
1,605
1,443
1,068
1,276
2,643
4,014
Short term
3,347
2,848
1,764
2,123
1,421
1,705
IMF, net
0
0
235
352
436
-96
BIS
0
0
510
0
0
Change in reserves b
328
-525
-733
610
667
968
Errors and omissions
-132
157
87
145
72
28
a Trade data are on a payments basis.
b Includes change in gold holdings.
million last year. In the first five months of this year,
this trade even slipped into deficit. Without a large
surplus in hard currency trade with the socialist
countries, Hungary will no longer be able to offset its
chronic deficit in nonsocialist trade. Budapest, more-
over, may have to divert goods destined for Western
markets to the USSR to meet Soviet demands for
higher quality goods.
Foreign Debt Surge
Despite poor trade results, Budapest continues to
enjoy good access to international credit based on
success at improving its external payments situation
between 1982 and 1984. The favorable lending cli-
mate has lessened the urgency Budapest attached to
stabilizing the foreign debt. As a result, medium-to-
Secret
long-term borrowing has surged since the beginning of
1985, pushing foreign debt to a record $12.9 billion in
the first quarter of this year. After meeting debt
service payments, Budapest has used most of the
remaining borrowings to bolster its creditworthiness
by:
? Prepaying more expensive existing loans and length-
ening the debt's maturity structure. Prepayments
totaled over $500 million in 1985, including $96
million owed to the IMF, and are expected to total
about $300 million this year.
? Building up foreign exchange reserves. At midyear,
we estimate that reserves, excluding gold holdings,
were equivalent to about nine months of hard
currency imports.
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Hungary: Gross Hard Currency Debt
and Reserves, 1981-86 a
? Million US $
Gross short-
term debt ,
[1:1 Gross long-
term debt
El Reserves b
14
12
10
8
6
4
2
0
A--
1981 82 83 84 85 86c
Because a large portion of Hungary' s debt is denominated in hard currencies other
than the US dollar, we estimate the depreciation of the dollar accounts for about
35 percent of the increase in foreign debt between January 1985 and the end of
March 1986.
bIncludes gold holdings valued by Hungary at $226 per ounce until 31 March
1985 and $275 thereafter.
c First quarter.
310346 9.86
According to the US Embassy, National Bank offi-
cials are divided on the wisdom of the current borrow-
ing strategy. Although principal repayments on many
of the recent loans will not begin until the end of the
decade, interest payments will steadily rise on the
larger stock of outstanding debt. Consequently, debt
service, which reached almost 60 percent of goods and
service exports in 1985, will remain high, leaving
Budapest dependent on continued support from West-
ern bankers. Although Hungary's financial situation
appears secure this year, several US bankers have told
the Embassy that they are increasingly wary about
new lending to Hungary.
Obstacles to Recovery
Prospects of reversing the current slowdown are
clouded by Soviet trade demands?which may limit
13
Secret
resources available for domestic investment?Hun-
gary's aging industrial base, and piecemeal implemen-
tation of the regime's long-running reform program.
In fact, Hungary's adjustment strategy has slowed
industrial modernization by making deep cuts in
investment to protect consumption. In addition to the
21-percent drop in total investment over the 1981-85
period, Budapest's decision to preserve investment in
traditional heavy industries and energy at the expense
of new technologies has weakened export competitive-
ness. A vicious cycle emerged as poor export perfor-
mance forced Budapest to rein in imports of Western
capital goods, which, in turn, further weakened the
competitiveness of export industries.
A more fundamental problem, however, is the
regime's inability to push ahead with new reforms.
While Budapest gave reform renewed emphasis at the
March 1985 Party Congress, the regime has tended to
introduce measures in such a slow or watered-down
fashion that they have not significantly changed the
way the economy operates. In a June speech to the
Central Committee, Hungary's top economic policy-
maker, Politburo member Ferenc Havasi, pointed out
that the Hungarian economy still labors under many
of the same inefficiencies as other centrally planned
economies:
? A price structure that does not reflect world market
costs.
? Managerial incentives that reward volume more
than profitability and quality.
? Inadequate technological development and ineffi-
cient use of raw materials and energy in industry.
? Slow structural change combined with dispropor-
tionately large extractive and energy sectors.
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Despite signs of growing concern in government and
party circles about the economy's downward spiral,
the government's response has consisted mainly of
uncoordinated halfway measures, including an inade-
quate devaluation of the forint in February, tax
incentives for export-promoting investments, laws en-
forcing greater labor discipline, slower issuance of
import licenses, incentives to lease Western equip-
ment, and somewhat liberalized joint venture regula-
tions. Havasi's speech indicated that Budapest is
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reluctant to reimpose restrictions on investment and
imports, as this could seriously limit future growth.
The measures adopted so far, however, will not have
an impact on the country's trade accounts for some
time. Moreover, they will not produce the systemic
changes needed to sustain long-term growth.
The Hungarian leadership apparently has not reached
a consensus for more radical changes because such
actions could entail reduced political control and more
austerity that would alienate large segments of soci-
ety. Stagnating living 'standards, increasing inflation,
and income disparities have already contributed to
rising social tension. The regime's ability to provide a
firm sense of direction in economic policy is further
weakened by uncertainty over how long 74-year-old
party leader Kadar will remain in power and who will
succeed him. According to various US Embassy
sources, Kadar has been withdrawing from day-to-day
policymaking, but has been disappointed by the Polit-
buro's failure to assume more responsibility. Several
midlevel officials have complained to the Embassy
that lack of guidance from the top is accentuating the
country's economic difficulties.
Outlook
The sharp downturn in Hungary's hard currency
external accounts this year has dampened expecta-
tions for renewed growth.
While continuing to
talk about the need for more rigorous reforms, Buda-
pest probably will stick to its cautious course for fear
of provoking greater social tensions. The longer the
Secret
regime delays tough decisions, however, the worse
economic stresses will become, making it even harder
to forge a consensus on economic policy and increas-
ing the chances that banker confidence will erode.
f current trends
continue, Hungary will eventually have to reschedule
its foreign debt. Budapest would then have little
choice but to negotiate a stabilization program with
the IMF, and force the population to shoulder greater
austerity than it has in the past.
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Central America:
Efforts To Revive Regional Trade
Efforts to revive Central American regional trade?
which has fallen sharply since 1980?are being given
new emphasis in an attempt to boost the sagging
economies of the five nations.' The May 1986 Central
American presidential summit and subsequent meet-
ings have resulted in several proposals to address some
of the near-term obstacles to trade. Nonetheless,
although the countries continue to recognize the
importance of maintaining good commercial relations,
a lack of movement in resolving other more funda-
mental economic problems probably will postpone any
substantial progress in revitalizing regional trade.
Even with some success in boosting regional exports,
heavy dependence on US markets and bilateral eco-
nomic aid will continue.
Daunting Problems
Political turmoil and mounting trade and debt prob-
lems have substantially reduced regional trade in
Central America. Since 1979, the value of trade has
plunged from a high of over $1 billion to an estimated
$580 million in 1985, and another decline is likely for
1986. The 25-year-old Central American Common
Market (CACM)?the region's principal trade organi-
zation, which until 1980 was successful in promoting
free trade in manufactured goods among the five
countries?has been battered by regional develop-
ments. In an effort to boost economic growth, output,
investment, and employment, the Central American
countries have come out strongly in favor of restoring
the CACM and its moribund institutions.
Insurgencies in El Salvador, Nicaragua, and Guate-
mala remain the biggest obstacles to a resurgence of
regional trade. In addition, Nicaragua's political iso-
lation and increasing state control over its economy?
in sharp contrast to its neighbors?constrains at-
tempts to coordinate economic policies or obtain
' Costa Rica, El Salvador, Guatemala, Honduras, and Nicaragua.
Honduras formally withdrew from the CACM in 1971 but contin-
ued to participate in its regional institutions and maintain bilateral
trade agreements with the other four members
15
Secret
Central American Common Market:
Regional Exports, 1980-86
Million US $
1,200
1,000
800
600
400
200
0 1980 81 82 83 84 85 86 a
'Estimated.
311:364 9-86
foreign aid. For example, according to US Embassy
reporting, the former President of Costa Rica did not
include Nicaragua in an economic initiative he an-
nounced in July of 1985, both because of political
reasons and a realization that Managua's inclusion
would greatly reduce prospects for new financial
assistance, particularly from the United States. With
or without Nicaragua's participation, however, efforts
to revive regional trade face a number of more
fundamental impediments.
Large trade imbalances within the region make the
task of revitalizing the CACM more difficult. In
particular, the failure to maintain realistic exchange
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rates has resulted in substantial trade deficits?for
Honduras, in particular?because overvalued curren-
cies have encouraged imports and made exports less
competitive. These pressures have been exacerbated
by differing levels of industrial development and by
limited demand for each other's exports. As a result,
some countries?most notably Costa Rica?have
been able to run up trade surpluses with their neigh-
bors. At the same time, uncompetitive exports as well
as low commodity prices have led to unfavorable trade
balances with the rest of the world for every country
in the region, resulting in critical shortages of hard
currency, import restrictions, and lowered production.
Trade imbalances have led to the breakdown of the
regional payments system?the Central American
Clearing House (CACH)?decreasing both trade op-
portunities and efficiency. The CACH was set up
under the Common Market to facilitate regional trade
by allowing trade debts to be settled in local,curren-
cies, with net surpluses or deficits balanced by hard
currency payments between member countries' cen-
tral banks every six months. The inability either to
maintain balanced trade or settle imbalances in hard
currency, however, has effectively forced the member
countries to demand payment in dollars for their
exports, eliminating the use of credit lines of local
currencies through the clearinghouse. With the with-
drawal of both Costa Rica and Guatemala from the
CACH this spring, official trade in the region has
effectively been put on a cash?hard currency only?
basis. The breakdown of the payments system also has
resulted in increased barter trade throughout the
region. Honduras and Nicaragua, for example, signed
a $10 million trade agreement in June.
Unsettled clearinghouse debts will be an obstacle to
any renewal of regional trade. Embassy reporting
indicates that total accumulated debt resulting from
trade within Central America is $750 million. Al-
though Nicaragua owes by far the largest portion?
some $480 million,' other debtors in the region also
have found themselves unable or unwilling to repay
'Nicaraguan arrearages to CACM members as of mid-1986 were:
Guatemala, $170 million; Costa Rica, $200 million; Honduras, $60
million; and El Salvador, $50 million (estimated).
Secret
their smaller arrearages, which has led to increased
trade friction. Costa Rica recently halted trade with
Guatemala for several weeks because the Guatema-
lans had made little progress in repaying their $70
million trade debt. The two countries engaged in a
similar standoff for over three months in 1985.
New, Initiatives Spark Hope
Although the serious decline in regional trade has
been a topic of continuing interest in the region, the
Central American summit last May focused new
attention on the importance of maintaining and im-
proving commercial relations. The presidents ex-
pressed strong support for reviving the CACM, in
addition to calling for a united approach to developed
countries on issues such as the region's debt burden
and maintaining commodity prices, according to Em-
bassy reporting. While no specific proposals came out
of the summit, it has, in our view, generated increased
momentum to solve the problems hampering the
Common Market.
Since the summit, Central American ministers of
economy and central bank presidents have met twice
to discuss eliminating trade arrearages and restoring
the payments system. In July, the group proposed
solutions that included linking regional debt amorti-
zation to total exports and arranging partial payment
of debt in goods, according to the US Embassy. In
August, they approved the creation of a new commer-
cial instrument?the Central American Import Right
(DICA)?designed to revitalize the payments system.
The DICA will be denominated in US dollars but will
be purchased from the importer's central bank using
only local currencies at prevailing rates of exchange
with the US dollar. Although it will not be convertible
to dollars, it can be used to purchase goods from the
issuing country, or it can be sold to third parties who
want to import from that country. We believe the?
ability of holders to transfer the DICA should, at the
very least, facilitate some trilateral barter trade deals.
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Some exchange rate adjustments have also been
undertaken. Guatemala and El Salvador both deval-
ued their currencies this spring as part of their
economic programs, according to US Embassy report-
ing. Paradoxically, the demise of the clearinghouse
may also encourage efforts to adjust exchange rates to
levels more attuned to the market. Honduras, for
example, responded to Guatemala's withdrawal from
the CACH by requiring that Guatemalan goods be
paid for with foreign exchange either from Honduran
exports to Guatemala or purchased at the free market
rate in Honduras.
Nicaragua is taking advantage of the efforts to revive
trade by moving to deal with a portion of its regional
debt on a bilateral basis. Managua has approached
both Guatemala and Honduras about rescheduling its
debt. Embassy reporting from Guatemala indicates
that the Sandinistas proposed a four-year grace peri-
od, with repayment over the subsequent six years.
Although critical shortages of foreign exchange make
Managua's repayment of debt almost impossible?
even with exceptional concessions?Nicaragua's cred-
itors probably believe that they have nothing to lose
by rescheduling or accepting partial payment in
goods.
Prospects Remain Dim
We believe the CACM in some form is likely to
remain a major outlet for the regions's exports, but
ineffective trade policies and declining export oppor-
tunities will continue to reduce production and em-
ployment and constrain economic growth. Until the
underlying causes of the decline in regional trade are
addressed, progress on specific problems?such as the
breakdown of the payments system?will not be last-
ing. The creation of the DICA?although a marginal-
ly positive move?still fails to address the fundamen-
tal trade and payments problems facing the region.
For example, exporters will still probably demand
hard currency for their products if there is no third-
party market for the nonconvertible DICA.
Moreover, the existing political instability will limit
the ability of Central American governments to man-
age a regionally coordinated economic policy. Despite
the small bilateral trade deals and debt negotiations
with Managua, the Sandinistas remain politically
isolated by their neighbors, making it unlikely that
the Common Market can be revived in its original
form, or regional trade restored to previous levels.
The loss of employment and export opportunities will
contribute to the region's continuing dependence on
bilateral US assistance to provide balance-of-pay-
ments support and to maintain even small levels of
economic growth. Although the Caribbean Basin Ini-
tiative has provided new opportunities for Central
American exports to enter the US market, declining
regional markets may put additional pressure on the
United States to absorb an even greater share of
exports.
17
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OPEC Production
Update
Briefs
Energy
OPEC crude oil production averaged 20.5 million b/d in August, an increase of
500,000 b/d from July levels. Saudi Arabia increased output by 700,000 b/d-
now it must cut back by 2.25 million b/d in September to comply with the recent
OPEC accord. The Saudi increase was partially offset by a fall in Iran's output re-
sulting from Iraqi attacks on Khark Island and the relocation of the oil shuttle op-
erations several times in August. The other OPEC producers maintained July
production levels, and all appear to be taking steps to reduce liftings in September
in accordance with their new quotas.
OPEC Oil Production, 1986 Million b/d
New
Quota
First
Half
July
August
Total
16.65
18.3
20.0
20.5
Algeria
0.66
0.7
0.7
0.7
Ecuador
0.23
0.3
0.3
0.3
Gabon
0.14
0.2
0.2
0.2
Indonesia
1.19
1.3
1.3
1.3
Iran
2.30
2.3
2.2
2.0
Iraq
1.80
1.8
1.8
1.8
Kuwait a
0.90
1.4 (1.3)
1.8 (1.6)
1.8 (1.6)
Libya
0.99
1.1
1.1
1.1
Nigeria
1.30
1.5
1.5
1.5
Qatar
0.28
0.3
0.4
0.4
Saudi Arabia'
4.35
4.6 (4.5)
5.9(5.8)
6.6 (6.5)
United Arab Emirates
0.95
1.3
1.3
1.3
Venezuela
1.56
1.6
1.6
1.6
a Amount in parentheses excludes production from the Neutral
Zone, whose output is divided between Saudi Arabia and Kuwait
and included in their country quotas; the Neutral Zone has no
production quota of its own.
19
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Iranian-Soviet Iran's claim that it will resume natural gas exports to the USSR before the end of
Natural Gas this year is intended to improve Tehran's economic ties to Moscow and to bolster
Agreement its international image. Iranian media report both countries will undertake a three-
month study to determine what repairs are needed along the 1,200-kilometer
pipeline. Tehran has not used the line since it discontinued gas exports to the
USSR as a result of a price dispute six years ago. Soviet media have yet to mention
any agreement to reopen the pipeline. Iranian gas sales to the USSR are unlikely
to resume for at least the next year. Repairing the pipeline will probably take six
months to a year, and weak energy prices and the issue of who will pay for the re-
pairs may still preclude a final agreement. Iran's optimistic announcement
probably is another attempt to demonstrate that it is not isolated and can build re-
lations with an important ally of Iraq. Tehran presumably also hopes that progress
on the gas issue would improve prospects for the long-delayed meeting of the
bilateral economic commission. Any broader breakthrough in relations remains
unlikely.
New Delhi Seeks
Modern Oil Technology
Obstacles to Nigerian
IMF Accord
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5 September 1986
India is seeking to purchase Western oil equipment in an effort to increase the effi-
ciency and output of its petroleum sector. New Delhi expects to begin contracting
for up-to-date oil-metering equipment for use in two refineries late this fall.
India, which has traditionally
relied on Soviet equipment and assistance, would like to expand its modernization
program and is looking toward the West for the necessary technology.(
India hopes to maintain imports at about 40 percent of
its oil requirements, but imports are likely to account for about 60 percent of
consumption by the end of the decade because of poor prospects for additional oil
discoveries and inefficiencies in the oil industry.
International Finance
Financial officials are laying the groundwork for an IMF agreement, but President
Babangida's failure to obtain backing from the ruling military council and
continued discontent in the Army reduce the chances of reaching a formal accord.
A visiting IMF delegation negotiated a draft economic reform program with
officials in Lagos last month and expects to receive a formal request for a standby
agreement soon, according to the US Embassy. The IMF team noted, however,
that it talked only with civilian bureaucrats and did not know how receptive to an
accord the ruling council would be. 'the
government remains concerned about discontent in the military.
Even if
Babangida goes ahead with some aspects of the agreement, such as the two-tier
foreign exchange market, his willingness to accept a formal IMF program is
doubtful as long as the ruling council remains opposed. Babangida is probably
going through the motions of seeking an agreement, however, to show that the
IMF approves his economic reforms, which in turn could facilitate a critical debt
rescheduling.
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Ecuador Negotiates
$200 Million
Syndicated Loan
Tanzania's New
IMF Agreement
Quito will obtain a $200 million commercial loan in mid-September secured by
Ecuador's oil export revenues and used to help offset this year's estimated $750
million foreign payments deficit. Some of the proceeds will go toward repayment
of a $150 million bridge loan from the United States. Commercial banks from Ja-
pan, Europe, and the United States have agreed to participate in this loan
syndication. The loan may be renewed after one year. According to IMF
estimates, Ecuadorean oil prices must stabilize at $12 per barrel to prevent serious
financial shortfalls, which could require the implementation of additional econom-
ic measures such as import restrictions.
According to a US official, the IMF Executive Board approved on 28 August a
$75 million, 18-month standby arrangement with Tanzania, effective September
1986. This is Tanzania's first IMF standby arrangement since 1980 and has been
the subject of protracted and difficult negotiations. The new government of
President Mwinyi will implement drastic economic reforms as part of the IMF
arrangement. Developed country financial supporters of Tanzania have insisted on
the IMF program as a condition for continued support. Although Mwinyi is
drawing up an economic recovery plan, ex-President Nyerere, a longtime IMF
opponent, retains substantial influence. Tanzania has not demonstrated the will to
overhaul its inefficient economic system, and we believe Tanzania will be hard
pressed to sustain the IMF program over 18 months.
International Trade
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Britain May
Pull Out of
Airbus Project
Turkey Applying
for EC Membership
Kuwaiti-Soviet
Exchanges Continue
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5 September 1986
Global and Regional Developments
British Aerospace is considering pulling out of a $3.7 billion Airbus Industrie
project because of London's reluctance to pay the full British share of development
costs. The A330 and A340, which are under development by the consortium, are
medium- and long-range airliners, respectively, that would compete in the higher
capacity markets dominated by Boeing. State-owned British Aerospace is responsi-
ble for designing and developing the wings for both aircraft. The company,
however, says it will participate only if London provides roughly $1 billion to cover
costs?the government is willing to put up half that amount. London apparently
believes that space research is a better long-term investment and favors participa-
tion in the Airbus project by McDonnell Douglas, which is also developing a long-
range airliner and has held preliminary talks with Airbus. We believe the British
will not pull out because of the number of jobs involved and that a compromise re-
ducing the UK share will be reached. Because West European budgetary funds are
generally tight, Airbus would probably push to recruit other West European
aircraft manufacturers, such as Aeritalia of Italy and Fokker of the Netherlands,
if Britain abandoned the project. Although the French oppose a McDonnell
Douglas role, perhaps the biggest obstacle to a McDonnell Douglas?Airbus
agreement is that one side would have to abandon its long-range airliner program
and hence become vulnerable to policy changes by the other partner.
Ankara may apply for full EC membership at a meeting this month of the
Turkish-EC association council. Senior Foreign
Ministry officials have long recommended pressing for full membership, but Prime
Minister Ozal has been reluctant to set an early timetable. Ozal is almost certainly
aware that an application at this time would be greeted unenthusiastically because
the EC has actively discouraged the Turks from applying soon for membership.
Ankara may hope, nonetheless, to use its application as a bargaining chip to
extract concessions from the EC, including the release of approximately $540
million in aid frozen after the military takeover in 1980. The Greeks are already
objecting to revitalizing the Turkish-EC association protocol, however, and a
Turkish decision to press for full membership now could complicate these
discussions. Any rebuff by the EC could also strengthen the position of those in the
Turkish Government who want to distance Turkey from Western Europe.
Kuwaiti Foreign Under Secretary al Shaheen will visit Moscow in mid-September
for talks on the Iran-Iraq war and other regional issues. The US Embassy in
Kuwait says a second delegation will follow to discuss joint economic projects
proposed during the visit of a Soviet delegation in late July. The economic
delegation may be accompanied by the vice president of the Kuwaiti-owned, US-
based Santa Fe Company, which uses state-of-the-art US oil technology.
\These recent exchanges highlight efforts to
strengthen bilateral ties and to benefit from what both countries probably see as an
increasing convergence of interests. Moscow continues to show interest in the oil
technology Santa Fe possesses and may use the loan to finance purchases of
equipment.
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National Developments
Developed Countries
Canadian Ottawa faces a difficult choice between aiding its struggling energy sector and
Policy Dilemma containing its large budget deficit. Gulf-Canada recently shut down its operations
in the Beaufort Sea?where the company had earlier made one of the largest oil
discoveries in Canada?claiming oil prices below $20 per barrel do not justify
further development. Similarly, reports in the financial press indicate that low oil
prices may also delay development of the large Hibernia field off Canada's eastern
coast. Ottawa is attempting to maintain exploration by offering loan guarantees to
private firms?including $700 million for Hibernia?and other assistance. The
government's ability to shore up the energy sector is constrained, however, by fears
of aggravating the budget deficit and causing a sharp depreciation of the Canadian
dollar. This concern prompted Ottawa to reject calls for abolishing a revenue-
based federal tax that is expected to bring in $400 million this year, and instead
criticize Alberta for not lowering its provincial royalty rates. Although Ottawa is
presently holding the line on spending, pressure to aid the depressed energy sector
will certainly increase when Parliament returns this month.
Canada To Push
Tax Reform
Bleak Forecast for
Japanese Economy
Faced with a continuing budget deficit and stagnant employment, Ottawa has
decided to make tax reform the centerpiece of its economic agenda this fall.
Although the government probably will meet its 1986 expenditure target, sluggish
economic growth may cut as much as $1.5 billion from expected revenue; slow
growth also brought job creation to a halt eight months ago. Ottawa is unwilling to
buck the political opposition to expenditure cuts and apparently believes tax
reform offers the best chance for restoring its reputation for fiscal competence
among the business community. To buttress support for its proposals in the
financial markets, Ottawa is planning to have Finance Minister Wilson make a na-
tionwide address on the state of the economy and the government's economic
agenda later this fall. The government probably also hopes that the prospect of
lower marginal tax rates on personal incomes?and a resulting boost to economic
activity?will reverse its slide in the public opinion polls.
Our econometric model of the Japanese economy suggests that economic growth in
Japan could fall below 2 percent this year with only a slight improvement in 1987.
The economy's poor performance?the worst since 1974?is largely the result of
the 53-percent appreciation of the yen against the dollar since last summer. Yen
appreciation is cutting into both earnings and production of export-related firms?
such as autos and electrical appliance producers?and is forcing them to cut
investment spending. We expect the decline in export volumes to accelerate over
the next few months as overseas purchasers react to higher dollar prices. Indeed,
our model suggests a sharper drop in export volumes than that expected by private
Japanese forecasters. For its part, the Japanese Government is beginning to admit
that the economic outlook is dismal. According to the Japanese press, the
Economic Planning Agency will soon lower its growth forecast for the fiscal year
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Japan Grapples With
Budget Strategy
New President of
West German Union
Secret
5 September 1986
ending on 31 March from 4 percent to only 2.8 percent?implying a growth rate of
approximately 2.5 percent for calendar year 1986. The lowering of the EPA
forecast will undoubtedly add to pressures within the ruling party and government
ministries for a shift in Tokyo's austere budget stance. If Tokyo believes that the
economic deterioration will continue into 1987, the Nakasone government may
reconsider its opposition to stimulating the economy.
The Japanese press is seizing on Finance Minister Miyazawa's comment this week
that he is preparing an 18-month budget (combining the fall supplemental budget
with the budget for FY 1987, which begins on 1 April) as signaling a shift in
Tokyo's five-year-old fiscal austerity. We believe, however, that it is still too early
to tell whether the political lobbying for pump priming measures to spur the
lagging economy can overcome working-level Finance Ministry resistance. The
18-month proposal may in fact be a Finance Ministry tactic to dilute political
input into the budget process. The outcome of the debate,
is likely to be a package that
minimizes additional central government borrowing and relies instead on public
works financed by Tokyo's "second budget" as well as by local governments. The
politicians have not yet had their final say, but, in our view, the government's most
influential economic policy makers seem to be resigned to growth in the 2- to 3-
percent-range next year and prefer to rely principally on lower interest rates and
the hoped-for stimulative impact of lower energy and import prices to boost the
economy.
In October we expect Franz Steinkuhler, 49, to be elected president of IG Metall,
the largest trade union in the non-Communist world?a position giving him the po-
tential to wield considerable influence on German industrial and economic policy.
We believe he will continue the militant stance of the 2.5-million-member union,
whose strikes have occasionally shut down significant sectors such as the auto
industry. To maintain membership levels, Steinkuhler may try to organize white-
collar and technical workers in the metal industry, a move he hopes would
strengthen his and IG Meta11's political influence and popular appeal. After
assuming the presidency, Steinkhuhler will fight for a 35-hour workweek and for
protecting jobs threatened by new technology. In our view, the forceful and shrewd
Steinkhuhler will use a mixture of conflict and collaboration with management
and government to achieve his goals.
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Lisbon Raises
Minimum Capital
Requirement for Banks
Lisbon's sudden 67-percent increase in the minimum capital requirement for
banks has led the six newly established foreign banks to reconsider their
investments. The new measure essentially affects only private banks because the
nationalized banks already meet the stiffer requirement. Foreign bankers see in
the new law?one of a series of regulations favoring nationalized banks?Lisbon's
desire to protect the public banks from a competitive environment. They also feel
that the required capital level is too large for the small Portuguese market, bears
no relation to their banks' size or type of activities, and is certain to eat into profit
margins. Some banks have hinted that they may liquidate at the end of the one-
year deadline for meeting the new requirement. Foreign investment fell 16 percent
in first quarter 1986, and a further deterioration in investor confidence is certain to
hinder Lisbon's push for modernization through foreign capital and technology.
Less Developed Countries
Progress on
Lebanon's Christian
Airport
The Maronite Christian's controversial alternative to Muslim-controlled Beirut
International Airport?Halat Airport north of Beirut?may begin service soon,
according to defense attache reporting. Halat is a privately financed project
designed to facilitate international travel for the Maronite Christian community,
which currently relies on ferry service to Cyprus.
Commercial service from the airport would increase Christian self-
sufficiency and further formalize Lebanon's de facto partition. International
response has been cool thus far, and Halat still faces stiff opposition from the Syri-
ans, as well as Lebanese Muslims and Druze
Press reports in May indicate the
runway was shelled by pro-Syrian Muslim militiamen. Public Works Minister and
Druze leader Walid Jumblatt has refused to officially sanction Halat, although
Embassy reporting indicates he will not actively oppose the project.
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5 September 1986
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Djibouti To Get
French Bailout
Afghanistan's Troubled
Trade Situation
France has decided to increase its budgetary assistance to Djibouti in 1987 but
probably will require the Gouled regime to implement structural changes,
according to US Embassy reporting. The move comes on the heels of a French
assessment that Djibouti's fiscal status is unsustainable and should be corrected
while the government is still solvent. President Gouled has subsequently adopted
several belt-tightening measures that probably will pull Djibouti through 1986, but
the government will deplete its reserves and still face a severe budget crunch in
1987 without greater external assistance, further fiscal reforms, or increased
revenues. The French bailout probably will be timed to eliminate pressure on
Gouled to make politically risky reforms?such as cutting civil servants' and
military pay?before the presidential election in June 1987. After the election,
however, Gouled probably will encounter strong French pressure to trim the
bloated government bureaucracy, parastatals, and the country's generous social
welfare programs.
Afghanistan's foreign trade situation is deteriorating because of rising imports and
decreased earnings of hard currency, according to the US Embassy. Imports have
increased in recent years because of the need to feed the growing urban population
and provide capital goods to rebuild damaged infrastructure. At the same time, the
cost of imports is rising and merchants regularly pay "taxes" to insurgent forces to
ensure safe transit of their goods. Most Kabul merchants also use private trucks?
which cost 40 percent more than government trucking?to reduce the risk of
insurgent interdiction of their goods. Hard currency exports are suffering from
increased competition in traditional markets?from California raisins in the
important British market and from Indian carpets in international markets.
Afghan Regime The Kabul regime plans to relocate 30,000 families from the eastern border areas
Plans Population to the sparsely settled western provinces, according to the US Embassy. A top
Resettlement Afghan Government official claims that overpopulation and surplus labor in the
east are the primary reasons for the proposed population transfer. The plan,
however, is almost certainly part of Kabul's effort to depopulate the east in order
to eliminate the insurgents' base of support and to shut down their supply routes
from Pakistan. Heavy fighting and bombing attacks in key regions in the east have
already depopulated many areas. The official also said that, although the regime
will not rely strictly on voluntary movement, it will not use force. Few families are
likely to move voluntarily, however, and the government almost certainly will have
to exert pressure to accomplish its goals. Forcible relocation would probably
prompt many to flee to Pakistan. The government has not announced when the
plan will begin.
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5 September 1986
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Possible Chinese
Currency Moves
Communist
Hong Kong newspapers have reported that China will stop issuing Foreign
Exchange Certificates (FEC)?a convertible renminbi-denominated currency that
can be used to purchase imported goods?on 1 October. The reports state that
FECs will continue to be redeemable for foreign currency until March 1987, and
suggest China will institute a voucher system to allow foreign travelers to
reconvert renminbi into foreign currency when leaving the country. China may
also devalue the renminbi to raise the domestic price of imports in conjunction
with the FEC withdrawal. The US Embassy has reported unsubstantiated rumors
that China's currency will be devalued roughly 20 percent this fall, and that the
exchange rate may reach 4.5 yuan per dollar by yearend. China recently devalued
its currency 13.5 percent in an attempt to reduce the countiy's trade deficit and
slow the currency black market. Even with another devaluation, the withdrawal of
the convertible FEC will fuel the black market in foreign currency and pinch some
joint ventures.
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5 September 1986
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