INTERNATIONAL ECONOMIC & ENERGY WEEKLY

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP97-00770R000100110001-0
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 34
• Document Creation Date: December 22, 2016
• Document Release Date: June 7, 2011
• Sequence Number: 1
• Publication Date: February 21, 1986
• Content Type: REPORT

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Intelligence 25X1
Directorate of
Weekly
International
Economic & Energy
DI IEEW 86-008
11 February 1986 v
687
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Secret
International
Economic & Energy Weekly
21 February 1986
iii Synopsis
1 Perspective-Latin America: Potential Fallout From Mexico's Financial
Problems
ALA
3 Italy: Worsening Budget Deficit
EURA
EURA
11 Jordan: Keeping Its Head Above Water~~ 25X1
NESA ~ 1JX1
15 Poland: The Status of Foreign-Owned Firms~~ 25X1
EURA I I 25X1
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19 Key LDC Debtors: Limited Progress on Tax Reform
oc/ ~a
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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 o,1' Intelligence
Secret
D/ IEEW 86-008
11 February 1986
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International
Economic & Energy Weekly~~ 25X1
Synopsis
1 Perspective-Latin America: Potential Fallout From Mexico's Financial
Problems
Mexico's handling of its growing financial difficulties runs the risk of sparking
action on the part of other Latin American debtors. ~~ 25X1
Italy's continuing huge public-sector deficit, which is likely to top 16 percent
of GDP in 1986, is placing strains on the economy and the five-party ruling co-
alition. In any event, economic growth is likely to slow this year, making early
elections some time this summer a likely possibility.
7 EC Institutional Reforms Make Slow Progress
EC efforts to remove barriers to intra-EC trade and facilitate decisionmaking
following the entry of Spain and Portugal have been delayed by the Danish
Parliament's rejection of reforms adopted at the EC summit meeting in
Luxembourg last December. Once the Danish objections are resolved, these
reforms could be an important step in addressing the problems in EC trade and
competitiveness.
11 Jordan: Keeping Its Head Above Water
Jordan's abrupt economic slowdown-and the realization that renewed rapid
growth is unlikely-has prompted the government to take a more serious look
at its economic strategy. Rising unemployment and uncertainty about the
levels of foreign aid and worker remittances are among Amman's greatest
concerns.
15 Poland: The Status of Foreign-Owned Firms
Over the past several years, Warsaw has promoted the establishment of
Western-owned companies in Poland-so-called Polonia firms-as a way to
increase market supplies and generate hard currency earnings. Nonetheless,
tighter regulation has dealt a setback to government efforts to attract large-
scale Western investment.
Secret
D/ /EEW 86-008
21 February 1986
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19 Key LDC Debtors: Limited Progress on Tax Reform
Large government budget deficits are impeding needed tax reforms in the 15
countries targeted by the Baker initiative. Although a major concern is that
tax reform can reduce government revenues and worsen the deficit problem,
these efforts are also being stalled by substantial political opposition.
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International
Economic & Energy Weekly
~~
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21 February 1986
Perspective Latin America: Potential Fallout From Mexico's Financial Problems
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At the request of the presidents of Mexico and Venezuela, the 11 Cartagena
Group countries have scheduled an emergency meeting of finance and foreign
ministers in Uruguay on 27-28 February to discuss the current Mexican crisis
and measures to deal with it. Following a preparatory session on 10 February,
Uruguay's Foreign Minister Iglesias told the press that the Cartagena
countries will focus on the new problems created by falling oil prices.
Although the other Latin debtors are being publicly circumspect about
Mexico's financial plight, we believe that at the very least Mexico will draw
moral support from other Latin American countries in negotiations for interest
rate concessions and new funds. Although we judge few other Latin govern-
ments would automatically demand the same terms should foreign banks grant
the de la Madrid government interest payment relief, all debtors clearly would
view the development as an irreversible change in the debt servicing ground
The debt policies of Latin American governments are also being driven by
each individual country's financial self-interests. These, in turn, depend on the
country's balance-of-payments position and the status of its relations with
foreign creditors. Nevertheless, the same deflationary pressures that are
plaguing Mexico are also affecting other Latin American debtors such as
Venezuela and Chile. These pressures coupled with the recent precedence for
unilateral action set by Peru and Nigeria could increase the chances for other
countries taking steps on their own.
The financial crisis presently is concentrated in Mexico, but we believe it could
again engulf the region. We are particularly concerned about the consequences
if Mexico's financial predicament again causes creditors to "cut and run" by
reducing trade credits, withdrawing interbank deposits, and suspending dis-
bursements of medium-term credits to the region's other debtors. In that event
cash-flow problems will ensue throughout the region. Such actions would
almost certainly play into the hands of populists throughout Latin America
who believe that the current debt strategy is condemning their countries to
slow growth. A stronger voice for the nationalist forces in the region would not
only result in major financial setbacks for US banks but would also seriously
hurt US investment and commercial interests in the region.
Secret
D/ /EEW 86-008
21 February 1986
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Italy: Worsening
Budget Deficit
Italy's continuing huge public-sector deficit, which The 1985 Italian Budget: Revenues
is likely to top 16 percent of GDP in 1986, is and Expenditures, by Type
placing strains on the economy and the five-party
ruling coalition. Last-ditch efforts by the govern-
ment to reduce the deficit failed earlier this month Percent
when the lower chamber of the Parliament rejected Revenues
many of the modest spending cuts proposed in the Lotteries 3 -
1986 budget. To finance the deficit, Rome will
robabl have to boost monetar rowth and/or Customs and -
P Y Y g excise tuxes 7
raise already-high interest rates. Either action will
worsen Italian economic prospects. The first would Nontax
fan inflation, hurting Italy's international eompeti- revenues 23
tiveness, while the second would cut back private
investment. In any event, economic growth is likely
to slow this year, intensifying strains within the taxes on -
governing coalition over how to reduce the deficit transact;ons 2a
and making early elections some time this summer
a more likely possibility.
Other I l
Transfers to -
household and
The Italian expanded public-sector deficit'-estl- business s
mated at $66 billion or 15.8 percent of GDP in social
1985-is one of the largest in the OECD. The security a
deficit first rose above 10 percent of GDP in the
Personnel 16
mid-1970s, reflecting the impact of the 1974/75
recession. Since then, the deficit has tended to drift
upward mainly because of soaring expenditures. capital expenditures
Government outlays last year equaled about 48 I ~
percent of GDP, more than double the level in the
early 1970s.
Interest payments on the public debt are the fastest
growing element of government outlays. Total pub-
lic debt currently equals GDP, and is growing at an
' The expanded public-sector deficit comprises the borrowing re-
quirements of general government; autonomous agencies; municipal
enterprises; and ENEL, the state-owned electricity monopoly. At
the request of the IMF in 1976, Italy began using this definition of
the deficit-which is somewhat greater than the gap between
revenues and expenditures-as the target deficit because it provides
a better picture of how the government's borrowing affects the
Interest on
debt 18
average of about 6 percent annually. Interest pay-
ments on the debt have increased from 12 percent
of budget expenditures in 1979 to over 18 percent
last year.
3 Secret
D/ /FEW 86-008
2/ February 1986
Income and
estate taxes 43
Transfers to
local and
regional
__ government 25
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Italy: Government Revenues,
Expenditures, and Expanded Public-
Sector Deficits, 1971-86
Government Revenues and
Expenditures
Percent of GDP
Expanded Public-Sector Deficitse
Percent of GDP
~~~~I~~~~I~~~~I~
~ 1971 75 80 85 86 e
z This measure includes the borrowing requirements of the
general government, autonomous agencies, municipal
enterprises, and ENEL, the state-owned electricity monopoly
and results in a deficit that is somewhat greater than [he gap
between revenues and expenditures.
b Projected.'
More sluggish economic growth in the 1980s also
has contributed to the deficit by slowing revenue
growth and increasing outlays for unemployment
compensation-the unemployment rate has jumped
from 7.7 to 10.6 percent over the past six years.
According to our econometric model, every per-
centage point increase in the unemployment rate
raises the budget deficit by $6 billion.
Probably the most pervasive cause of growth in
public expenditures, however, has been legislated
increases in social outlays such as pensions and
medical programs. The government's contribution
to pensions, for example, has been increasing by an
average of 9 percent annually in real terms over the
past 15 years.
The 1986 Budget
Although the final touches are still being put on the
1986 budget, it looks as though it will call for a
deficit target of $67 billion, or about 14.6 percent
of GDP-1.2 percentage points less than in 1985.
Spending is to be restrained by very modest cuts in
pension contributions, transfers to local govern-
ments, and other social expenditures. Cabinet
members were reluctant to propose any significant
cuts to the welfare system because that would hurt
their party's chances in the next election, but even
the small savings included in the cabinet's proposal
met heated opposition in the lower chamber of
Parliament. The government several times had to
resort to open votes of confidence to get measures
passed. The larger governing parties were divided
internally on such controversial issues as raising
medical fees and reducing family allowances, en-
abling even the smallest party to block legislation
that would reduce spending. As a result, the lower
chamber added about $1.2 billion in spending to
the cabinet's original proposal.
The difficulty in implementing spending cuts has
forced the government to look to enhanced revenue
collection, concentrating on measures to make the
tax system more equitable. Although some reforms
have been enacted, tax collection continues to be
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hampered by poor enforcement, and we estimate
that possibly as much as half of Italy's potential
value-added taxes go uncollected. Reforms are
particularly difficult to achieve because the main
offenders-small businessmen and professionals-
make up a significant part of the large Christian
Democratic Party's base of support. In fact, the
1986 budget includes a revision of the personal
income tax system to compensate for recent infla-
tion, leading to a $3.9 billion reduction in tax
revenues rather than an increase.
We believe that the estimate of the budget deficit is
too low and that the actual figure will be about $73
billion-over 16 percent of GDP. The government's
ambitious target of a $12 billion reduction in
current spending probably cannot be achieved. It
includes about $3.9 billion in spending cuts that
have not been specifically determined, as well as
some other savings, such as changes in bank re-
serves and methods of calculating interest pay-
ments, that are probably superficial at best. In
addition, projected revenues are based on an overly
optimistic forecast of 3-percent real GDP growth in
1986 and on the implementation of some one-time
tax changes that have already been delayed by the
Parliament for over two years.
Implications for the Economy
We believe the budget deficit has become a serious
drag on the economy. Partly because of Rome's
borrowing requirements, domestic credit expansion
has consistently exceeded targets set by the central
bank, and this has contributed to the current
8.6-percent inflation rate. Moreover, since 1976 the
state share of domestic credit has grown from 42 to
74 percent-and these figures do not include bor-
rowing by many of the state-owned companies. The
Bank of Italy has repeatedly warned that govern-
ment borrowing is reducing the amount of credit
available to the private sector. Over the past de-
cade, private investment's contribution to GDP has
dropped from nearly 18 percent to just over 14
percent in 1984.
The large public-sector deficit also has prevented
Rome from lowering interest rates as much as other
industrialized countries. In fact, interest rates on
three-month and six-month treasury bills were
recently increased because the government has
been unable to sell enough bills to meet its matur-
ing debt. Rome is relaxing many controls on Italy's
financial markets, thus creating attractive new
investment opportunities and making it more diffi-
cult to sell government debt to the public without
raising interest rates on treasury bonds. Real inter- 25X1
est rates-now at 7 percent-are a major factor in
sluggish economic growth.
The impact of the 1986 budget deficit on the
economy will depend to a large extent on how much
of it is financed through money creation~urrently
the subject of heated debate within the govern-
ment. Since 1980 the Bank of Italy generally has
been able to limit the share of the deficit funded by
money creation and is unhappy that it has been
forced to step in recently when the Treasury could
not sell enough bonds. The governor of the central
bank has therefore called for interest rates to be
raised in order to attract new investors. Many
government officials, however, strongly oppose rais-
ing interest rates because it would increase consid- 25X1
erably the government's interest payments on the
public debt. They also fear that it might slow the
economic recovery that has depended to a large
extent on strong investment spending-although
the investment boom has been largely financed by
increased profits.
The result is likely to be a compromise involving
some increase in interest rates, but not enough to
take all of the pressure off the money supply.
Consequently, while factors such as falling oil
prices and lower real wage gains will help hold
down price increases, inflation is unlikely to come
down to the government's target of 6 percent. The
continuing inflation differential between Italy and
its major trading partners will further erode Italy's
international competitiveness. Unless offset by peri-
odic devaluations, the decline in competitiveness
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will considerably negate anticipated improvements
in the trade deficit resulting from lower oil prices
and a falling dollar. Devaluations would probably
be resisted by the other members of the European
Monetary System, who admonished Italy to shape
up its financial house when the currencies were
realigned last July. Raising interest rates, on the
other hand, will almost certainly slow investment
spending. Our econometric model suggests that
every percentage point increase in interest rates
leads to a 0.5-percent decline in the level of invest-
ment spending.
Higher interest rates and the inability to reduce the
inflation differential with its trading partners will
contribute to the expected slowdown in Italy's
economic growth this year. While real GDP ad-
vanced by 2.4 percent in 1985, it probably will
grow only 1.9 percent in 1986. As a result, the
unemployment rate-at a historic high of 11 per-
cent in the fourth quarter-is not likely to come
down much, if at all, this year.
The slowdown in economic growth will put in-
creased pressure on the government to reduce the
budget deficit and will intensify existing strains
within the coalition over economic policy. There is
little agreement among the coalition parties on how
to reduce the budget deficit-the Prime Minister,
for example, opposes raising taxes, the Treasury
Minister claims new taxes are probably necessary,
and the Finance Minister refuses to consider tax
hikes until deep spending cuts are instituted. To
attenuate the differences, Prime Minister Craxi is
likely to shuflie the cabinet later this month, but
the move may not be sufficient to reduce the
tensions, making early elections sometime this sum-
mer apossibility.
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Make Slow Progress
EC efforts to remove barriers to infra-EC trade and
facilitate decisionmaking following the entry of
Spain and Portugal have been delayed by the
Danish Parliament's rejection of reforms adopted
at the EC summit meeting in Luxembourg last
December. Danish Prime Minister Schlueter has
called for a referendum in his country on the
reforms for 27 February. If it fails and Denmark
thus is unable to sign the reform act, the rest of the
Community would be forced to renegotiate the
reforms in light of the Danish objections. Other EC
states are firmly committed to reforms because of
their potential to make EC decisionmaking more
efficient, considered essential for revitalizing lag-
ging West European competitiveness.
The Reform Package
The institutional reform package-the first
changes proposed to the EC Treaty of Rome since
its signing in 1957:
? Allows greater use of majority voting, though it
does not guarantee faster decisionmaking.
? Defines new areas concerning creation of the
internal market in which majority voting would
apply, but leaves intact the ability of one member
to block EC decisions on the basis of "vital
national interests."
Under the reform package, however, members and
the EC Commission would be given the right to sue
states abusing the veto, which should enhance the
use of the majority vote. In contrast, another
element of the reforms-granting the European
Parliament additional powers to review Council
decisions--mould even slow decisionmaking on
some issues. Moreover, the package also specifies
certain policy areas in which members retain the
The main elements oj'the institutional reform pack-
age agreed to by the EC summit meeting last Decem-
ber include adding European Political Cooperation
and the European Monetary System-both currently
informal arrangements-to the Treaty of Rome, but
locus on improving the EC decisionmaking process.
The Single European Act:
? Sets the goal of establishing a totally.free internal
market-defined as an area in which the.free
movement of goods, persons, services, and capital is
ensured-by 31 December 1992.
? Establishes that all measures harmonizing national
laws and regulations j'or the purpose of setting up
the internal market will be decided on the basis of
majority vote in the EC Council oj'Ministers and
no longer by unanimity, exceptlor matters concern-
ingindirect taxation, the budget, free movement of
persons, and the rights of employed persons.
? Allows member states to exempt themselves .from
harmonization because of major national needs-
including environmental protection-but requires
that not cation be given to the EC Commission,
which in turn must cortf~rm that the exemption is
not a means of arbitrary discrimination or dis-
guised restriction of trade; the Commission or any
member may sue before the EC Court oJ'Justice (f
it believes another member is abusing this right.
? Permits the European Parliament to review Council
of Ministers decisions-a so-called second reading.
jf the Parliament rejects a Council decision, the
Council can override the rejection by unanimous
vote. The Act also encourages cooperative efforts on
R&D, environmental protection, and social policy,
and incorporates infra-EC economic development
aid under the Treaty. The explicit goal of such
resource transj'ers is the eventual convergence of
member state economies.
right of demanding unanimity.
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Referendum on EC Reform:
The Internal Danish Situation
The minority government'slailure to win parliamen-
tary approval for the Luxembourg reform package on
21 January has endangered not only the progress of
the reforms, but also has created a hot debate in
Denmark. The Schlueter government contends that
majority voting on internal market issues will benefit
Denmark economically, and that wider powers for the
European Parliament and the formalization oflor-
eign policy cooperation will have little practical
effect. The opposition Socialist parties disagree, ar-
guing that these measures dilute the principle oj'
national sovereignty-a particular Danish concern as
one oj'the smaller countries in the Community. The
opposition also fears that environmental protection-
an emotional issue in Denmark-might not always
take precedence over the removal oj'trade obstacles.
Anticipating last month's unfavorable parliamentary
vote, Schlueter took a gamble and called a consulta-
tive referendum for 27 February to resolve the issue.
The referendum vote is likely to be a victory.for
Schlueter and strengthen his center-right coalition.
Polls indicate the electorate supports the reforms 48
percent to 33 percent. A yes vote could also help the
government put through many unpopular economic
measures necessary to address Denmark's chronic
balance-o,J=payments problems.
The prime minister and other supporters oj"the
reforms, including industry and many trade unions
normally loyal to the opposition Social Democratic
Party, are equating a no vote to a question oj'
If the reform package succeeds, it would be an
important step toward improving the Community's
ability to dismantle the myriad nontariff barriers to
infra-EC trade that are a drag on European com-
petitiveness. The political commitment to remove
these barriers by 1992 depends on a detailed
timetable of over 300 highly technical harmoniza-
tion measures, all requiring member state approval.
continued Danish EC membership, hoping to sway
votes Jrom the Social Democrats. Although none of
the political parties takes much interest in the wider
ideals oj'European integration that inspired the ECs
.founders-in.fact, most Danesfeel a greater attach-
ment to the Nordic region and its institutions-there
is little incentive for a Danish withdrawal.
The total financial benefit that Denmark derives
from EC membership is difJ~cult to quantify, but in
1983 and in 1984 direct net benefits-largelyfrom
the Common Agricultural Policy-amounted to
about $260 million a year. Community membership
brings Denmark substantial economic advantages.
Agriculture and fisheries, both crucial to Denmark's
economic well-being, would be hardest hit if the
Danes withdrew. Agricultural exports in 1985 ac-
countedlor more than two-thirds of agricultural
production and more than one-fourth ojtotal Danish
exports, of which roughly half went to EC markets.
Denmark received about $625 million in agricultural
subsidies in 1983-84, which, if lost, wouldforce a
major economic restructuring. According to the US
Embassy, foreign exchange earnings would drop by a
projected $1.5 billion, severely damaging Denmark's
credit rating and its ability to pay off its large foreign
debt. In the fisheries sector, direct subsidies are
limited, but if Denmark were excluded lrom EC
waters the Danish catch would shrink by as much as
60 percent. The direct cost would be almost $250
million in sales, and 5,000 jobs, with more employ-
ment losses in other related sectors.
Even with increased use of majority voting, it will
be difficult for the EC to meet this schedule, but
virtually impossible without it, especially with the
addition of Spain and Portugal.
The reform effort has had the support of all the
member state governments. Italy-instrumental in
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launching the effort at the Milan Summit in June
1985-and the Benelux countries have been most
supportive, but even the United Kingdom, Greece,
and Denmark, who initially opposed amending the
Treaty of Rome and holding a special intergovern-
mental conference as the mechanism for reform,
contributed constructively to the four-month-long
reform conference.
All the member states except Denmark, Greece,
and Italy signed the Single European Act reform
package amending the Rome Treaty on 17 Febru-
ary. Greece and Italy, while in basic agreement
with the Act, will withhold their signatures until
Denmark is ready to sign. The Act cannot legally
take effect until signed and ratified by every mem-
ber state, giving the Danish Parliament an effective
veto.
Should Denmark Not Sign
Although considered unlikely, rejection of the re-
form package by Danish voters in the 27 February
referendum would prevent the government from
signing the Act and thus block the reforms for the
entire Community. In that event, the EC would be
thrown into one of its periodic crises. Foreign policy
initiatives and the resolution of pending trade
disputes with the United States would almost cer-
tainly be given secondary priority. The initial incli-
nation of the members would probably be not to
reopen reform negotiations-as, indeed, EC foreign
ministers have recently told Danish Foreign Minis-
ter Ellemann-Jensen in prereferendum consulta-
tions-for fear of shattering the complicated com-
promises the reform package is based upon.
In the end, the rest of the EC would probably agree
to reopen negotiations and seek to modify the
aspects of the reform package objected to by
Denmark. If that proved too difficult, the members
might seek an informal agreement instead of a
formal treaty amendment. The Netherlands, the
current president of the Council of Ministers, al-
ready plans to persuade members on a case-by-case
basis to use majority voting before the reforms take
effect. Italy, because of strong domestic pressure to
strengthen the European Parliament, probably
would block any attempt by Denmark or any other
EC member to dilute the reform measure that gives
limited new powers to the Parliament. In any case,
a no from Denmark on reforms could further
isolate it politically within the Community, ensur-
ing that Danish concerns on key matters of self-
interest-the environment and agriculture-would
be heard much less sympathetically by the other
members.
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Jordan: Keeping Its Head
Above Water
Jordan's abrupt economic slowdown-and the real-
ization that renewed rapid growth is unlikely-has
prompted the government to take a more serious
look at its economic strategy. Rising unemployment
and uncertainty about the levels of foreign aid and
worker remittances are Amman's greatest con-
cerns. The government's efforts over the past year
suggest it is willing to lower its own sights on what
it can accomplish and look to the private sector for
help. Jordan's moves to date have been cautious,
however, and the country's economic fortunes will
remain for some time largely dependent upon for-
eign assistance.
Resource-poor Jordan relies heavily on the generos-
ity of the Gulf states to keep its economy afloat.
Arab aid and remittances from the approximately
300,000 Jordanians working abroad-equivalent to
40 percent of the total labor force-account for
nearly two-thirds of the country's hard currency
receipts. The oil price boom of the 1970s increased
these flows sharply and spurred annual GNP
growth of almost 10 percent. The recession spread-
ing through Gulf states as oil revenues fall is taking
its toll on Jordan:
? Gross worker remittances dropped about 10 per-
cent in 1985 and are not expected to pick up soon.
In fact, the increase in 1984 remittances appears
to have been an anomaly as returning workers
brought home savings. On the plus side, the
Jordanian Government is not expecting a rapid
return of the remaining workers abroad given
their high skills and education vis-a-vis other
guest workers.
? Arab aid totalled $640 million last year, less than
half that received during the peak year of 1980.
Only a successful barnstorming trip by King
Hussein last summer prevented still another de-
cline: He was able to drum up some Baghdad
Jordan: External Million US $
Economic Indicators, 1981-85
Current account
balance
Trade balance
Exports (f.o.b.)
Imports (c.i.f.)
Net services
Net worker
remittances
Unrequited
transfers
Arab aid
Official foreign
exchange reserves
Medium- and long-
term external debt
accord payments from recalcitrant donors Kuwait
and Qatar and also secured a hefty gift from
Oman.
The poor record of these two major hard currency
sources was offset somewhat by an improved trade
balance over the past three years. Exports-con-
sisting largely of phosphates, chemicals, fruits, and
vegetables-have picked up following a severe
slump in 1983, primarily on the strength of in-
creased sales to Iraq. Even some of these gains are
more illusory than real-as Amman has been
forced to extend government-guaranteed credits to
enable Baghdad to make the purchases. Imports
have dropped the past three years, but most of the
Secret
D./ IEEW 86-008
2/ February 1986
-42
-335
-389
-269
-170
-2,435
-2,488
-2,456
-2,027
-1,910
735
751
580
757
780
3,170
3,239
_
3,036
2,784
2,690
1,088
1,093
1,254
1,044
980
2JX~
875
907
909
983
920
1,305
1,060
813
714
760
1,197
953
712
593
643
1,049
848
798
500
423
2,005
2,411
2,942
3,400
3,900
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fat has been cut. The Jordanian economy still relies
heavily on imports of foodstuffs, raw materials, and
machinery, and further cuts could prove more
Jordan: Economic Indicators,
1981-85
costly to overall economic performance.
Over the past few years, Jordan has drawn down its
official foreign exchange reserves to help close its
financial gap. Reserves fell sharply in both 1984
and 1985, and the current level of about $420
million covers only about two months' worth of
imports. Jordan's credit rating has not suffered
unduly during the recent crunch, however. A $200
million syndicated loan-the third large syndica-
tion in three years-was oversubscribed last year.
Nonetheless, Amman is concerned about relying on
borrowing because its external debt has nearly
doubled since 1981 and debt-service obligations
continue to climb.
Domestic Impact
Slowing GNP growth reflects Jordan's problems
with its external accounts. Recently revised statis-
tics put annual GNP growth at about 2 percent for
the last three years-a negative per capita rate
given Jordan's population growth of almost 4 per-
cent per annum. Amman had hoped growth would
be spurred as new industrial projects came on line
in 1984. But poor world markets, in general, and
the leveling of sales to Iraq, in particular, quickly
burst that bubble. Investment, too, has suffered,
falling well short of planned levels over the past
three years.
The public is only now beginning to feel the pinch.
Much of the past decline in consumption is largely
the result of reduced imports of luxury items and
therefore has not been a significant burden. Con-
sumers also have been helped by the low inflation
rate, which shows few signs of increasing in the
immediate future. Rumors are circulating in Am-
man of a possible devaluation of the dinar, which, if
proved true, would eventually lead to price hikes.
Growth in Per Capita
Consumption
Percent
Production
Percent
Consumer Price Inflation
Percent
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The Jordanian public is worried, however, about
creeping unemployment. According to the US Em-
bassy, Jordanian officials have put the unemploy-
ment rate at about 8 percent, a high figure for a
country that traditionally prides itself on no em-
ployment problems. One Jordanian official believes
the rate could double by the end of the decade,
while a recent World Bank study projects a possible
rate as high as 30 percent because of returning
workers and an influx of new graduates. Moreover,
these rates fail to consider the large and growing
number of idle workers kept on the payrolls of
numerous government-operated enterprises.
The Government's Strategy
The government is aware that it must take a more
serious look at its economic prospects. Indeed, the
appointment of a more activist Prime Minister last
April may have been, in part, a move to help
stimulate the economy. The new government ap-
pears to recognize its financial limitations-for
example, this year's budget essentially shows no
growth-and is actively seeking help from the
private sector:
? The government rescinded a scheduled law that
would have required Jordanian majority owner-
ship of all banks, because some foreign banks
were threatening to leave.
? Amman is planning to sell some government
businesses. Talks have been under way for some
time regarding the telecommunications company,
and the government hopes some time this year to
offer the public the opportunity to buy shares in
ALIA, the government-run airline.
? Last summer the parliament approved a variety
of measures aimed at protecting local industries
and stimulating exports. Duties on luxury goods
also were increased, restrictions imposed on the
importation of many goods also produced locally,
and tax exemptions hiked for export-oriented
industries.
? The government is continuing with its plans to
have Amman replace war-torn Beirut as the
major center for services in the the region. Cur-
rent efforts focus on developing the infrastructure
needed to support such operations.
Jordan is also making job creation a high priority.
Last month the government began cracking down
on illegal workers, who constitute about one-fourth
of Jordan's estimated 150,000 foreign workers.
Among the new measures are deportation for non-
registered workers, higher fees for work permits,
increased fines on firms hiring illegal workers, and 25X1
improved monitoring at immigration points. Al-
though Jordan's 1986-90 five-year plan has yet to
be published, the Embassy reports that job creation
will be a major component. The government pro-
jects that increased investments and fewer foreign
workers will enable it to lower unemployment to an
acceptable 5 percent by 1990.
The government's economic plans are tempered by
political realities. Amman's location in the volatile
Middle East makes it hard enough to encourage
Jordanians to keep funds home, let alone entice
new foreign capital. The threat of violence already
has slowed efforts to bring service operations to the
capital. In addition, the unwillingness of many
Jordanians to invest in domestic projects will hinder
privatization efforts.
In the near term, Jordan will continue to look
outside its borders for financial help. Moves to
increase self-sufficiency are costly, and human
capital remains Jordan's principal asset. The King
has proved to be an adept fundraiser and the
Jordanians reasonably sound money managers.
Without any unexpected external shocks, the coun-
try should be able to keep its head above water.
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Poland: The Status
of Foreign-Owned Firms
Over the past several years, Warsaw has promoted
the establishment of Western-owned companies in
Poland-so-called Polonia firms-as a way to in-
crease market supplies and generate hard currency
earnings. As their numbers have grown, so has
criticism of some Polonia firms and the high wages
paid their employees. Despite the controversy and
the resulting tighter government regulation, we
expect this highly productive sector of the Polish
economy to remain active for the next several
years. Nonetheless, tighter regulation has dealt a
setback to government efforts to attract large-scale
Western investment.
Polonia firms account for a very small share of
total Polish economic activity-the approximately
640 Polonia firms produced 0.4 percent of Poland's
1984 output and employed about 42,000 workers or
0.2 percent of the labor force. These enterprises,
however, provide about 10 percent of the total
output of Poland's private industrial sector. Most of
these enterprises produce consumer goods such as
clothing, furniture, cosmetics, or leather goods,
which, though generally more expensive, are widely
preferred to the shoddy state-produced goods. In
addition, Polonia firms provide almost 25 percent
of Poland's medical and laboratory supplies, pro-
duce mine safety, environmental, and electronic
equipment, including computer components, and
many chemicals and construction services in short
supply in Polish markets.
Warsaw initially sought Polonia businessmen for
their contacts in Western markets. Polonia enter-
prises later came to be viewed as a source of
"costless" investment capital and Western techni-
cal and managerial skills. Polish officials hoped
that the firms would prod state enterprises into
more efficient production while producing consum-
er goods using scrap or surplus materials, vacant
buildings, and underutilized machinery. Polonia
firms were also expected-although not legally
required-to use their own funds to import raw
materials in short supply, thus saving Poland's
resources and hard currency.
Government promotion of Polonia enterprises be-
gan in the late 1970s, and culminated in the
legislation of July 1982, which offered foreign
entrepreneurs tax advantages and legal autonomy
far exceeding those enjoyed by private Polish-
owned firms. Provisions of the 1982 law granted
new Polonia enterprises:
? Exemption from taxation for three years.
? A 50-percent ceiling on the income tax rate
thereafter.
? Freedom to set prices and use material incentives
to increase production.
Partially offsetting these generous terms, the law
required that 50 percent of hard currency export
earnings and all domestic zloty profit remain in
Poland until the enterprise's liquidation.
Western entrepreneurs were enticed by the avail-
ability of a skilled, low-paid work force, a high
demand for consumer goods, and the prospect of
gaining access to markets in other socialist coun-
tries. During 1981-82 the number of new permits
mushroomed from 68 to 230, the number of Polo-
nia employees more than tripled, and the combined
sales revenues of all Polonia firms increased almost
fivefold. Perhaps most significant, the export reve-
nues of Polonia firms in 1982 were over 500 percent
larger than the previous year.
Success brought problems, however. In late 1982
the Ministry of Finance charged some Polonia
firms with earning "excessive" profits, transferring
Secret
DI IEEW 86-008
2I February 1986
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Secret
their profits abroad illegally, luring skilled workers
from the public sector, bidding up the prices of
scarce domestic inputs, charging "designer" prices
for their products, and neglecting their investment
obligations. Premier Jaruzelski, who had encour-
aged the formation of Polonia firms in 1982,
criticized them in February 1983 for ignoring their
responsibilities and said they would have to learn to
operate in accord with the social and economic
interests of Poland.
Consequently, new restrictions were enacted in late
July 1983. The three-year tax holiday was made
contingent on a firm's investing annually at least
one-third of its earned income. The 50-percent
ceiling on corporate taxes was raised to 85 per-
cent-although in practice reductions of up to 20
percent were allowed when the firm produced
"socially desirable goods" such as medical and
agricultural equipment. The government also or-
dered the Polonia firms to exchange 50 percent of
their hard currency earnings for nonconvertible
zloty.
The legislation apparently was accompanied by
closer scrutiny of Polonia applications. The govern-
ment granted only 117 new permits in 1983 and
142 new permits in 1984. According to Polish
statistics, the rejection rate in 1984 was nearly 50
percent. Consequently, about 700 Polonia firms
were authorized to operate in Poland by the end of
1985 compared with 1982 predictions of 1,000 such
firms by that date.
The government seems to have been successful in
channeling Polonia firms into sectors it considers
essential, such as the medical and computer fields.
Although some advocates of Polonia claim that the
new rules encourage entrepreneurs to liquidate
their operations after three years and then start
wholly new endeavors, Polish officials claim that
such behavior is acceptable since they want Polonia
firms to be temporary instruments for filling mar-
ket shortages.
Restrictions on the entrepreneurs' use of hard
currency earnings probably has, on balance,
worked against Poland's interests by reducing im-
ports of Western goods. Many state enterprises
previously obtained Western machinery and spare
parts by collaborating with Polonia firms that had
hard currency. Moreover, Polonia firms have also
been compelled to rely as much as possible on
domestic inputs, thus increasing the competition for
the country's meager resources.
The hard currency restrictions also have dampened
incentives to export to the West at a time when
Warsaw needs to maximize its hard currency earn-
ings. Thus the value of Polonia firms' exports to the
West increased only 44 percent in 1984 over 1983
levels, while the value of exports to socialist coun-
tries grew more than 450 percent. The "typical"
Polonia firm now seems to produce its main line of
output for the Polish market while exporting to the
West small quantities of unrelated goods in order to
finance imports. One good example is a firm that
produces roach traps for Polish consumers and
exports machine tool subassemblies to the United
States to finance imports of insecticide and glue.
Continued Controversy and More Regulation
Despite restrictive regulations, the controversy over
Polonia firms has continued. The frank admission
in the Polish press that Polonia firms are five times
more productive and pay wages twice as high as
state enterprises has raised the ire of political
hardliners and workers in the large socialized sec-
tor. In addition, some foreign investors who choose
to reside in Poland use their zloty earnings to
support a conspicuous lifestyle. Members of parlia-
ment cited Polonia firms as a "serious social prob-
lem" in late 1984, and trade union representatives
declared their opposition to Polonia firms in Sep-
tember 1985.
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In defense, Polish officials have publicized some
"success" stories. A recent press article credited
Polonia companies with breathing life into the
microcomputer industry, calling them the main
source of microcomputer components in Poland,
and lauding instances of cooperation with state
enterprises. Last August, the party daily contained
an article about the Polonia firm Plastomed, which
produces medical equipment and chemical diagnos-
tic reagents, and noted its contribution in meeting
health service needs both in Poland and in many
other socialist countries. Polish officials also paid
tribute, at a school dedication ceremony, to the
renovation services provided by a US-owned con-
struction firm last September.
Nonetheless, the government has further tightened
the reins. Over the past two years 40 foreign firms
have had their licenses taken away and more than
$2 million worth of zloty fines and extra taxes have
been levied. Further regulations in January 1985
increased to $50,000 the hard currency deposit
required to start a Polonia firm and also required
that the first $50,000 in profits be reinvested in the
company. A government directive issued last Au-
gust requires Polonia firms to use official govern-
ment channels to hire Polish workers-a measure
designed to prevent workers from quitting solely to
seek higher paying jobs with foreign-owned firms.
Local government authorities have further compli-
cated the Polonia business environment. Some pro-
vincial governments require that local residents be
given priority in hiring, have imposed age restric-
tions on Polonia's employees, or have tried to
ensure that local markets have a priority claim on
the firms' output. Polonia firms could probably lose
their licenses for failing to fulfill such additional
obligations.
Despite the controversy and the shifting regulatory
climate, Polonia firms are likely to remain part of
the Polish economy for at least the remainder of
this decade. Although the government will continue
to fiddle with the rules, it probably will not be
under strong pressure to make dramatic changes.
Tighter regulation has partially disarmed critics by
minimizing flagrant abuses and channeling firms
into more highly valued endeavors. Polonia busi-
nesses can still be very profitable because of tax
breaks in the first three years and because Polish
authorities have a great deal of discretion to reduce
a firm's financial obligations after the grace period,
particularly for entrepreneurs who undertake prior-
ity investments. Even many of those who dissolve
operations at the end of three years opt to remain in
Poland to start up a new venture. The lure of
profits is key, but many probably also decide to
stay because of their considerable zloty holdings
and their hard-earned familiarity with Poland's
regulatory peculiarities.
Nonetheless, the controversial environment and the
regulatory instability of the past few years have
undoubtedly had some negative impact on the
investment climate. The Polish parliament is con-
sidering ajoint-venture law aimed at encouraging
large-scale Western investment, but the Polonia
experience may dissuade some potentially valuable
investors.
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Secret
Key LDC Debtors: Limited
V
Progress on Tax Reform
Large government budget deficits are impeding
needed tax reforms in the 15 countries targeted by
the Baker Initiative.' Although a major concern is
that tax reform can reduce government revenues
and worsen the deficit problem, reform is also being
stalled by substantial political opposition. These
two constraints to tax reform could be substantially
eased if, as in the Baker plan, increased donor
assistance is made conditional upon the implemen-
tation of meaningful tax reform. Tax reforms can
increase efficiency and equity in the economies of
key LDC debtors, stimulating economic growth
over the longer term.
Several of these key LDC debtors have recently
introduced, or are presently considering, meaning-
ful tax reforms:
? Colombia has adopted major tax reforms over the
past three years. A 1983 tax reform lowered
rates, broadened the tax base, increased the
revenue-generating power of local governments,
tightened enforcement mechanisms, and intro-
duced alimited tax amnesty. Avalue-added tax
(VAT) was introduced in 1984.
? After more than four years of IMF prodding,
Morocco's proposed tax reform package is sched-
uled to begin in April with a new VAT. This is
the first of three new taxes that will replace the
existing intricate and outmoded tax system. A
corporate income tax is to be debated in parlia-
ment this spring, followed eventually by a person-
al income tax. Concern over the inflationary
Selected LDC Debtors: Budget
Balances as a Share of GDP,
1985
Equador
Brazil
Chile
Argentina
Peru
Philippines
Morocco
Mexico
Bolivia
potential of the VAT could delay its implementa-
tion. Some government officials fear local retail-
ers may use the VAT as a pretext to raise prices,
an outcome that could spark civil unrest.
? In Chile, austerity has delayed reforms of person-
al and corporate income taxes. Although Santia-
go began annual phased tax rate reductions in
1984, it announced last fall that the personal
income tax reductions scheduled for 1986 will be
suspended for two years in an attempt to meet
IMF deficit targets.
' Candidates for the Baker plan, which increases IMF lending to
LDCs undertaking important economic reforms, are Argentina,
Bolivia, Brazil, Chile, Colombia, Ecuador, Ivory Coast, Mexico,
Morocco, Nigeria, Peru, Philippines, Uruguay, Venezuela, and
Yugoslavia0
Secret
D/ /EEW 86-008
21 February 1986
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Secret
? Peru announced tax rate reductions last Decem-
ber aimed at promoting economic growth while
striving to minimize revenue losses. The govern-
ment reduced top marginal rates from 65 to 45
percent on personal income and from 57 to 40
percent on corporate income. Since then, it has
also lowered the VAT from 11 to 6 percent.
Business deductions were tightened substantially
to offset the revenue loss.
Another group of these countries has introduced
limited tax reforms while pursuing revenue
increases:
? Argentina imposed a forced savings scheme upon
producers in 1985. The government also intro-
duced progressive new taxes on transfers of
stocks, bonds, and real estate. Tax revenues in-
creased by 2.5 percent of GDP.
? Brazil's 1986 economic package closes some cor-
porate loopholes and makes individual income
taxes more progressive while seeking tax in-
creases equal to 1.4 percent of GDP.
? Mexico's 1986 budget increases tax progressivity
through a special tax on upper- and middle-
income groups and higher taxes on nonessential
goods. The government also promises to combat
tax evasion while attempting to halve the budget
deficit to 4.9 percent of GDP.
? Nigeria made minor changes in its income tax in
1985. Revenue from this source, however, re-
mains minuscule.
? The Philippines, under IMF pressure to reduce
its deficit, is working to simplify its tax structure.
A variety of minor tax changes announced in
December will probably raise revenues slightly
without introducing meaningful reform.
? Venezuela, in a recent crackdown on widespread
tax evasion, has substantially broadened with-
holding to apply to professionals and company
subcontracting. Faced with falling oil prices, the
government has also raised domestic gasoline
taxes by 30 percent.
? In Yugoslavia, where federal expenditures equal
only 12 percent of all government outlays, Bel-
grade is likely to reduce taxes on earned income
in 1986 and to increase taxes on unearned income
such as interest and rent.
? In Bolivia, the US Embassy believes this year's
most likely tax innovation may be a heavy tax on
individuals and corporations that had access to
highly overvalued central bank foreign exchange
during the Siles presidency. Because of heavy
opposition to more taxation, the government is
using nontax mechanisms to reduce sharply its
deficit as a share of GDP. One mechanism likely
to be abrogated in the Senate is the very unpopu-
lar "forced loan" that funds the retirement bene-
fits of 15,000 government workers who will be
displaced this year.
In the other LDC debtors targeted by the Baker
Initiative-Ecuador, Ivory Coast, and Uruguay-
there is little or no evidence of government interest
in tax reform.
We believe that, in response to donor pressure and
economic necessity, growing numbers of LDC gov-
ernments will seek over the next two years to
implement significant tax reform. Nonetheless, the
need to increase revenues to reduce budget deficits
may severely limit the pace of tax reform. Addi-
tional external assistance tied to reform efforts, as
proposed in the Baker plan, could accelerate tax
reform by alleviating the revenue constraint and
mollifying local political opposition.
The progress of tax reform that we foresee among
key LDC debtors may falter if economic growth in
these countries slows before their budget deficits
are brought under control, even if reform is tied to
donor assistance. In that event, a deteriorating
revenue picture would probably doom LDC tax
reform for the next several years and reduce Third
World economic prospects even further over the
longer term.
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Boom in Angolan
Oil Exploration
Energy
The director of production for Angola's state oil company expects exploration
in Angolan offshore waters to continue to boom during 1986 and 1987,
Six foreign oil companies are leading the
Largely on the basis of this exploration, some industry experts forecast anear-
doubling of Angolan production by 1990 to 400,000 to 500,000 b/d.
expansion:
? Chevron-Gulf (US) will complete atwo-year, $500 million expansion pro-
gram by the end of 1986 and is beginning seismic studies to expand its area
of production in 1987.
? Texaco (US) plans to lease an additional drill ship in April to develop a field
discovered last November.
? Conoco (US) probably will sign an exploration agreement with Angola this
month. It has released tenders for offshore seismic work and expects to drill
six exploration wells beginning in October-December of this year.
? AGIP (Italy) will employ three offshore drilling rigs to develop a field
discovered in late 1985 and approved by Angola for development in January.
? ELF-Aquitaine (France) will add two drilling rigs this summer to carry out
the second phase of an exploration program begun in 1984.
? ESPA (Brazil and Belgium) is continuing a 12-well exploration program.
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Mozambican Oil
Agreement With Iran
Zimbabwean Interest
in Oil Refinery
Development
and heavy foreign debt.
Maputo probably will accept a recent Iranian offer of crude oil, despite its re-
luctance to accede to Iran's pressure for political support in the Iran-Iraq war.
Mozambique has been desperately seeking new sources of oil since Iraq cut off
shipments in 1981, according to US Embassy reporting. The Soviet Union has
supplied 3,000 b/d-about 20 percent of requirements-since 1984. The
agreement with Iran calls for deliveries of 10,000 b/d, with payment on easy,
no-interest terms after aone-year grace period. These credit terms probably
will prove irresistible to Maputo in light of its severe foreign exchange shortage
The government is moving forward with plans to either build a new oil refinery
or refurbish its nonoperational refinery at Feruka
petroleum imports in 1984.
refinery, while estimates place the cost of modernizing the Feruka refinery at
$100-120 million. The government believes that high operating costs will be
more than offset by substantial long-term foreign exchange savings. The US
Embassy reports that Zimbabwe at present imports only refined petroleum
products and spent 16 percent of its total export earnings-$185 million-on
Kuwait reportedly has offered to assist in developing a new
Secret
Dl /EEW 86-008
11 February 1986
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Albania Seeking
Algerian Aid jor
Oil Industry
Venezuelan Debt
Rescheduling Set
also views Algeria as an acceptable partner ideologically.
Foreign Minister Malile traveled to Algeria last week-the first bilateral
official visit by an Albanian foreign minister since 1967-to request help for
the nation's troubled petroleum industry. Tirane last month reported another
drop in petroleum production during 1985 following an 18-percent decline
from 1981 to 1984. Malile's meeting with Algerian oil officials coincided with
a visit by Algerian petroleum experts to Albania. New Albanian leader Alia
has given top priority to the petroleum sector. Oil products are Albania's
leading hard currency export, accounting for 25 percent of earnings, and
provide over half the country's energy needs. Tirane apparently hopes that
Algeria, which has helped it obtain oil equipment in the past, will provide
expertise and Western technology, probably on barter terms. Albania probably
Venezuela and its creditor banks are on track to sign accords in New York on
26 February to reschedule $21.2 billion in public-sector debt,
Maturities originally due in 1982-88
will now be repaid over the period ending in 1997. Another $4.1 billion in pub-
lic debt-mainly owed to official lenders and bond holders-is not a part of
the refinancing and is bein re aid on schedule. There remains concern that
the deal could misfire. implementa-
tion would be blocked if banks holding 5 percent of the rescheduled amount re-
fused to go along. Some banks-mainly US regionals-are upset because the
government has not guaranteed the foreign obligations of certain private
principal payments due this year under the original terms.
term threat to the accords is posed by the collapsing oil market. Venezuela is
already negotiating an eleventh-hour amendment postponing $923 million in
The refusal of a US bank to participate in the revamped 1983-84 London Club
Moroccan Rescheduling debt rescheduling could sabotage the entire accord. The bank reportedly wants
more favorable terms for repayment of its $10 million loan. Embassy reporting
indicates efforts are currently under way to convince the bank to reconsider its
position, but that success is far from imminent. According to Moroccan
Minister of Finance Jouahri, if the bank persists, Rabat will take back the $83
million paid to London Club donors to inaugurate the program and will force a
complete renegotiation. Collapse of the 1983-84 rescheduling would aggravate
Morocco's already precarious financial position and further strain relations
with commercial creditors. Moreover, it could well derail the country's $200
million IMF standby and would almost certainly postpone discussions to
reschedule debt obligations for 1985 and 1986.
Secret
1/ February 1986
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Secret
East Germany
Moves To Cut
Borrowing Costs
East Germany has requested "technical adjustments" to three loans syndicat-
ed in 1984-85 for $1.5 billion. the East 25X1
German Foreign Trade Bank in ate anuary as ce cre hors to convert the
loans, much of which has not yet been drawn, to revolving credits for the entire
terms of the loans, and to reduce annual fees and interest rates. Under the 25X1
original terms, availability of undrawn funds expires next month. 25X1
most lenders will accept the revised terms and that other 25X1
Taiwan's Asian
Development Bank
Membership
syndication members will take the shares of banks electing to drop out. While
East Berlin had been accepting comparatively costly terms in order to obtain
large, oversubscribed loans, the East Germans apparently have concluded that
their improved financial health puts them in a strong position to renegotiate
better terms. Success in the effort will solidify East German 's reputation as
the most creditworthy East European country. 25X1
Governors in April.
Taiwan's leaders apparently have agreed on a strategy for staying-at least for
now-in the Asian Development Bank. Recent articles in the party-controlled
press indicate that Taipei will continue publicly to reject any name change
while tacitly agreeing to the "Taipei, China" formula supported by the Bank.
Taipei will not participate in any Bank meetings but will not formally
withdraw. The Bank cannot expel members, and Taiwan's leaders appear to
have decided that Taiwan's continued participation in the Bank outweighs any
domestic gains it would make by withdrawing to protest China's admission.
Because Taipei remains wary of appearing to have "negotiated" with the
mainland over its membership, it may still withdraw from the Bank after
Beijing becomes a member at the annual meeting of the Bank Board of
Japanese Trade Policy The report of Prime Minister Nakasone's special advisory commission on trade
Study Group Report policy-due in late March-will contain no major trade initiatives, according
to our preliminary analyses. The US Embassy expects general policy guidance
rather than specific "how to's." Recommendations will probably include tax 25X1
incentives for consumption and investment, support for international efforts to
limit exchange rate fluctuations, continued financial liberalization, and domes-
tic demand expansion. Any reference to economic stimulus, however, will be
tempered by the study group's strong support for Tokyo's five-year-old fiscal
austerity effort. The Embassy also anticipates short-term measures, such as
additional LDC financial assistance, to improve good will toward Japan in a
time of increasing trade imbalance. The Japanese press has speculated that the
group may recommend reducing the share of the current account surplus from
3.6 to 2 percent of GNP by 1990. Although Nakasone has made statements fa-
voring acurrent account target, MITI and the Finance Ministry still strongly
oppose numerical targets.~~ 25X1
Secret
21 Fe6ruart~ 1986
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Growing Chinese-
Hong Kong
Trade Ties
British and Soviets
Renew Trade Accord
Swaziland To Quit
Monetary Union
With South flfrica
Secret
2/ February 1986
may cause Hong Kong's exports to China to fall off in 1986.
Hong Kong will open a trade promotion office in Beijing later this month, the
colony's first official representation in China. A second office is scheduled to
open in Shanghai before yearend. The opening of the trade office reflects the
substantial growth in economic ties since the Sino-British accord to transfer
the territory was signed in late 1984. Last year Hong Kong's exports to China
increased 77 percent in the first 10 months of the year, counteracting a slump
in exports to other markets. We estimate that two-way trade exceeded
$15 billion in 1985, about 25 percent of Hong Kong's total trade. China
displaced the United States last year as the colony's largest trading partner.
Beijing has actively pursued closer economic links to promote the territory's
stability and prosperity, but much of the increase in Hong Kong's exports has
stemmed from China's trade decentralization, which has allowed localities to
deal directly with foreign firms. China's recent efforts to cut its trade deficit
Global and Regional Developments
gas treatment and coal gasification projects.
Moscow and London initialed a new five-year trade accord earlier this month,
signaling a mutual desire to improve bilateral relations. The pact-a 1975
agreement expired last December-presumably will be formally signed when
Foreign Minister Shevardnadze visits London this spring. The accord offers
few specifics, emphasizing instead broad areas where trade could increase,
such as construction projects. Although British trade officials do not expect
any boom in trade as a result of the agreement, they hope at least to reverse
the recent decline. According to UK statistics, bilateral trade in 1985 fell 20
percent from the previous year to roughly $1.8 billion. British firms also
calculate that the accord will help them win bids for such Soviet projects as
chemical plant construction, modernization of a textile factory, and a role in
rand last year. Lesotho probably will stay in the union.
Mbabane has negotiated a revision to the 1974 trilateral agreement with South
Africa and Lesotho that effectively will remove Swaziland from a monetary
union with those countries. Although retaining special access to South African
capital and foreign exchange markets, Swaziland will no longer be required to
back its currency 1 to 1 with the South African rand nor to accept the rand as
legal tender. Swazi officials have stated that the move-which will allow some
freedom to set interest rate policies-was prompted by the sharp decline of the
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Secret
Salvadoran
Austerity Protests
National Developments
Less Developed Countries
Both the far left and the far right are attempting to discredit President
Duarte's administration by attacking his economic initiatives. Despite the
government's efforts to cushion the impact of austerity on workers, Marxist 25X1
labor leaders have called for demonstrations today that the Embassy expects
will draw as many as 10 000 artici ants-or anizers h m w 1 in
excess of that number. the 25X1
guerrilla leaders hope to foment a general strike by spring. Conservatives have
also been vocal in their attacks on Duarte's economic policies,
Despite pressure from economic
Reluctant To
Impose Austerity
Libyan Agriculture
Hurt by Sanctions
measures and escalating guerrilla destruction of economic targets.
advisers and international creditors to stand firm, Duarte will be hard pressed
to ignore public demands as living standards are further eroded by austerity
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~~x~i
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President Cerezo is challenging his economic advisers to come up with
imaginative policies that will not require further sacrifices by the poor,
Cerezo now flatly refuses any devaluation or cuts in public services. In 25X1
contrast, he supports lowering gasoline prices because of lower world oil prices.
Cerezo hopes to meet financial requirements by hiking luxury taxes, improving
tax collection, and relying on possible increases in foreign aid. Cerezo's
populist leanings are splitting the cabinet and have encouraged the emergence
of a "social group" that is increasingly opposed to the social costs of the
austerity proposals . Cerezo's efforts to protect 25X1
the poor may win him temporary public favor, but they are likely to discourage
business leaders and international creditors, and make future economic
adjustments more painful. 25X1
. Despite earlier indications, 25X1
Libya has been forced to cancel at least one major seed order with a US suppli-
er because of US sanctions. Libya 25X1
cannot arrange legal payment under US trade restrictions for 800 metric tons 25X1
of seed for the Kufra agricultural project. The delay probably precludes
planting during the spring cycle at the desert project, which accounts for about
20 percent of Libya's annual production of beans and onions. Libya has no do-
mestic seed production capability and prefers US seed, which has superior
germination and yield compared with European stock. The anticipated
shortfall will exacerbate already serious food shortages in Libya 25X1
a recent food riot in Banghazi involving 10,000 angry 25X1
women resulte in substantial damage to state-operated facilities.
25 Secret
21 February 1986
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Secret
Moroccan Phosphate Senior management at the Youssoufia mine maintains the five-week-old strike
Strike Fading? by some 5,000 miners is winding down. Mine officials report more than 70 per-
cent of the workers have already returned to their jobs-at a rate of 100 to 200
daily-and that the majority are now indifferent to union demands. Union
leaders, however, insist the strike is far from over and are continuing to
mobilize support in country and abroad. Embassy reporting indicates that,
even if management's claims are exaggerated, it now appears unlikely that a
settlement involving any kind of union recognition-the primary objective-
will emerge. Moreover, although most detained workers will probably be
released after the strike ends, few are likely to be reinstated as the union has
demanded. With sizable stocks of phosphate on hand, the company can
probably outlast even a prolonged strike.
Pakistani-Islamic
Banking
China Controlling
Electronics Trade
returns competitive and maintain the viability of Islamic banking
government could be forced to subsidize domestic banks in order to keep
Falling dividends on non-interest-bearing savings accounts pose new problems
for Pakistan's Islamic banking system. The US Consulate in Karachi reports
that earnings on deposits in domestic banks were a maximum 7.8 percent
during June-December 1985 compared with 8.5 percent for the preceding six
months. Foreign banks in Pakistan, in contrast, are offering rates of up to 12
percent. The lower domestic bank returns probably reflect higher operating
costs and loss of funds to government bonds that pay as much as 15 percent. A
sustained dropoff in dividend rates will probably discourage new savings and
embarrass Islamabad's efforts to showcase its Islamic banking program. The
Beijing's concern over excessive reliance on imported electronics goods and its
inability to absorb foreign technology is growing.
Reportedly, of 33 imported production
Secret
2/ February 1986
1990
only traders subordinate to the Ministry of Electronics Industry may import
finished microelectronics goods, and purchases of foreign production lines
must include provisions for training and technology transfer. Greater central
control over some electronics imports will enable China to purchase more
selectively-protecting the domestic industry and curtailing substandard
imports. Attention to training personnel to operate and service imported
production lines will improve technology absorption and help China to
approach its stated goal of self-sufficiency in microelectronics production by
lines, only one is partially usable; the rest cannot be used at all. In the future
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