(UNTITLED)

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP97-00771R000707240001-2
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 38
• Document Creation Date: January 12, 2017
• Document Release Date: October 7, 2010
• Sequence Number: 1
• Publication Date: October 26, 1984
• Content Type: REPORT

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Directorate of
Intelligence
Weekly
International
Economic & Energy
Seems
DI IEEW 84-043
26 October 1984
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Secret
Weekly
International
Economic & Energy
Synopsis
Perspective-OPEC's Dilemma: Face Price Cuts Now or Later
3 Briefs Energy
International Finance
Global and Regional Developments
National Developments
11 OPEC: Price Cuts Trigger Another Crisis
17 International Financial Situation: Political Update
19 International Financial Situation: South American Financial Update
23 International Financial Situation: Latin American Capital Flight
31 Pakistan: Moves Toward Islamic Banking
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Comments and queries regarding this publication are welcome. They may be
Directorate of Intelligence
Secret
26 October 1984
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Secret
International
Economic & Energy
Weekly
Synopsis
1 Perspective-OPECs Dilemma: Face Price Cuts Now or Later
OPEC will hold an emergency session on Monday to attempt to avert another
general price decline. If OPEC does not reduce prices in the next week or so, it
probably will face another price crisis during the next year or two in the
absence of a significant supply disruption.
11 OPEC: Price Cuts Trigger Another Crisis
The latest series of oil price cuts by Norway, the United Kingdom, and
Nigeria threatens to set off a chain reaction that could cause the current oil
price structure to unravel. Even if OPEC is successful in its attempt to support
oil prices, we believe downward price pressure is likely to reappear early next
year in the absence of a significant oil supply disruption.
17 International Financial Situation: Political Update
During the past month, financially troubled LDCs have had to deal with
continued civilian opposition to austerity programs and military unrest.
19 International Financial Situation: South American Financial Update
Despite progress with the IMF and commercial banks, South American
debtors face continued problems in meeting repayments, complying with IMF
agreements, and securing debt rescheduling and new loans. Many of these
countries have reacted skeptically to last month's call by the United States for
a conference of LDC debtors and industrialized countries under the auspices of
the IMF and IBRD.
23 International Financial Situation: Latin American Capital Flight
We estimate more than $100 billion capital flowed out of 10 Latin American
countries during 1979-83-roughly half the total capital inflows during the
same five-year period. As a result, debtor nations are borrowing more just to
balance their international accounts.
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Secret
The Lebanese economy continues to deteriorate under the weight of the
political and security situation. Until the political situation begins to stabilize
and an extensive security plan is in place, the economy will remain depressed.
31 Pakistan: Moves Toward Islamic Banking
The Islamization of Pakistani society received new impetus recently with the
announcement that the banking system, including foreign banks, will be run on
a completely noninterest basis starting on 1 July 1985. In our view, the
proposed change will at least temporarily slow the investment and savings rate
and retard economic growth.
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Secret
Perspective
Weekly
International
Economic & Energy
Now or Later
intransigence could threaten any agreement.
OPEC will hold an emergency session on Monday to attempt to avert another
general price decline. Persistent weak demand and sagging spot oil prices
forced three major oil producers, including OPEC member Nigeria, to slash
prices by up to $2 per barrel last week. While short-term oil market conditions
are far less ominous from OPEC's perspective than before the March 1983
price cut, recent events threaten a free-fall in oil prices. OPEC has promised to
defend its current $29 per barrel benchmark price by cutting production, but
has not developed a concrete plan to do so. Disagreement on the details of an
approach to prop up prices could cause Monday's meeting to be highly
contentious. In particular, OPEC will have to deal with Nigeria, whose
higher winter sales. Still, OPEC's price defense will be difficult.
seasonal rebound in oil demand. The demand increase would not only help
OPEC's price defense, but also provide the members additional revenue from
OPEC has incentives to cooperate and hold the line on official prices despite
developments to date. Members certainly recognize that an official price break
could trigger a downward price spiral. They also realize that major oil
companies can ill afford to risk substantial further reductions in inventory
levels because most industry analysts, including OPEC's Secretariat, predict a
Even if OPEC is successful in avoiding a price drop this time, the organization
is far from being out of the woods. Price runups in the 1970s have resulted in
substantial investment in energy conservation. As a result, demand for oil is
likely to show only modest growth at best over the next few years. Indeed, the
strong economic recovery in the United States and Japan over the past year
has failed to. boost oil demand at the same rate as economic growth. Moreover,
non-OPEC producers will most likely capture most incremental demand,
leaving OPEC with the prospect of only a marginal increase in demand for its
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Rising non-OPEC oil supplies have forced the organization to confront the
need to more effectively coordinate pricing and production strategy with non-
OPEC oil producers. Recent OPEC success along these lines has been mixed.
OPEC apparently has gained support from less developed countries such as
Mexico and Egypt. There is little hope, however, of cooperation on production
restraint with OECD producers-where a large part of the future non-OPEC
production increase will be concentrated-or with the USSR. Without
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production cutbacks elsewhere, or an unexpected rebound in oil demand,
increasing non-OPEC output will put additional downward pressure on prices.
OPEC also will have to deal with rising output from its own members over the
next few years. Projects now under way will increase Iraq's export capability
by at least 500,000 b/d. The startup of additional Saudi export refinery
capacity by 1986 could also compound OPEC's problems if Riyadh decides to
sell its products at competitive market prices. Iran is also likely to ignore
OPEC production quotas when it needs foreign exchange to support its
declining economy. OPEC must also contend with a growing volume of natural
gas liquids (NGL). Sales of products and NGL are not subject to OPEC
pricing guidelines and provide a ready means for members to offer discounts.
Until OPEC can effectively resolve internal problems of competing self-
interests, the organization will remain under siege. We believe some type of
price reduction is almost inevitable. If OPEC does not reduce prices in the next
week or so, it probably will face another price crisis during the next year or two
in the absence of a significant supply disruption.
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Suspension of Mexican
Gas Exports
to United States
EC Energy
Import Trends
Energy
Mexico and its US customers announced this week that natural gas sales
would be suspended on 1 November. The Mexicans are now unwilling to
match lower Canadian prices, but they hope to reach a compromise in coming
discussions with US buyers to salvage this vital source of foreign exchange.
Last year, natural gas sales to the United States brought in $350 million.
Although current sales of 180 million cubic feet per day are less than 1 percent
of US demand, Mexico supplies a significant share of gas consumption in US
border states. Settlement of this issue would influence a wide range of bilateral
concerns, including long-term US access to important Mexican gas reserves.
EC imports of natural gas and crude petroleum grew significantly in the first
half of 1984 in response to the pickup in economic activity. Real GDP for the
Community was 2 percent higher in the first half of this year compared with a
year earlier, and preliminary data indicate EC natural gas consumption in the
January to June period was nearly 9 percent above year-earlier levels, while oil
consumption increased 3.5 percent. Expanding imports largely covered the
growth in gas and oil consumption-gas imports jumped more than 23 percent,
and crude oil imports advanced almost 8 percent. Algeria was the chief
beneficiary in the EC gas market, boosting its sales 29 percent. Highlighting
the increase in oil imports was the nearly 6-percent hike in EC purchases from
OPEC, the first such rise since 1979, when the EC countries began to diversify
sources of supply. With the EC economic recovery forecast to continue into
1985, EC energy demand, and, hence, imports are likely to expand further.
Optimism in Colombian According to Embassy reporting, a US oil company has made a significant
Oil Sector discovery in northeast Colombia. Preliminary estimates indicate proved re-
serves of at least 400 million barrels and production could reach about 100,000
barrels per day (b/d). Although the US oil company estimates the field could
ultimately produce as much as 220,000 to 250,000 b/d, other industry
personnel in Colombia believe these higher estimates are overly optimistic.
Bogota has awarded a $177 million contract to a Western firm for construc-
tion of a 300-km pipeline to link the new oilfield with the existing Trans
Andean Pipeline. The pipeline, however, will not be completed until at least
early 1986. Current total Colombian oil output is averaging 170,000 b/d, and
Bogota is likely to be a net exporter for 1984-the first time in eight years. Ac-
cording to estimates by the state oil company, Colombia, which has a $12.5
billion foreign debt, could increase net oil export earnings as a result of the
new discovery by between US $200-300 million by 1990.
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Global and Regional Developments
Aluminum Price Slide The dramatic fall in aluminum prices may be bottoming out in response to pro-
May Be Ending duction cutbacks, particularly in the United States, and growing demand.
Since the first of the year, aluminum prices have fallen by more than a third to
about 45 cents a pound-a level roughly 25 percent below average costs for US
producers. We believe, however, that the price rise will be neither strong nor
rapid, since there are substantial commercial stocks on the market at present.
The modest turnaround in aluminum prices will not provide much relief for
LDC bauxite producers. For Jamaica, which depends on the aluminum
industry for more than 60 percent of its export earnings, probable price gains
would be too small to offset revenue losses from the closures of US gulf coast
aluminum plants-the major market for its bauxite.
National Developments
Developed Countries
Portuguese Difficulties According to the US Embassy, the IMF refused to allow Portugal to resume
With the IM drawings under its standby agreement in September because short-term debt
at the end of July was $40 million above the Fund's 31 July ceiling of $200
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Secret
Philips-Siemens
million for the first seven months this year. Portuguese officials also admit that
they have exceeded the July ceiling on public-sector domestic credit as well
and expect to surpass the 31 December limit. Nevertheless, Lisbon hopes to
obtain IMF waivers to resume drawings in November. We expect that these
waivers would be contingent on other austerity goals that the Soares govern-
ment has not met. Additional cuts in government price subsidies promised this
fall have been put off until next year out of fear of spurring inflation and
prompting large pay demands. In addition, Lisbon has not cut public-sector
enterprises' investment programs and is not effectively supervising their
borrowing. Backsliding in these areas threatens to swell the budget deficit,
hinder the repayment of arrears owed by state firms to the private sector, and
Western Europe's two largest electronics firms, Philips of the Netherlands and
Joint Microchip Project Siemens of West Germany, have announced a joint plan to develop advanced
integrated circuits with considerable backing from their governments. The two
companies have agreed on a $300 million research project to develop and
produce one- and four-megabit random-access memory chips by 1989. Half
the financing for the research project will come from the Dutch and West
German Governments. This ambitious effort to close the gap in West
European semiconductors, however, is not likely to decrease Japanese and US
dominance in the West European microchip market.
Irish Economic
Plan Unveiled
eek an agreement with the IMF in the near future.
percent unemployment rate from rising, and reduce the chronic budget deficit.
Tax incentives for business are aimed at creating 25,000 new jobs in the
private sector. Tax increases, a 20-percent cut in government capital spending,
a proposed salary freeze for public employees, and a reduction of 5,000 civil
service jobs will be used to reduce the budget deficit. The program probably
will be passed by Parliament but will face a major test next spring when public
employees bargain for a-new contract. The plan's targets probably will not be
met, in which case the burgeoning foreign debt burden could force Dublin to
On 2 October, Prime Minister FitzGerald unveiled his 1984-87 economic plan
representing the second installment of the Fine Gael-Labor coalition's auster-
ity program. The so-called "National Plan" is.designed to maintain the Irish
standard of living, reduce the growing foreign debt burden, keep the 16.6-
Japanese Unions Demands that Japan bring its workweek into line with other advanced nations 25X1
Push for Shorter Hours . were a highlight of every labor convention this fall.
recommended that the 48-hour week be cut to a nine-
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hour, five-day workweek. Arguing that this does not go far enough, Sohyo and
Domei-Japan's major labor confederations-have asked their opposition
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party allies to introduce a bill in the next Diet session calling for a 40-hour
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week. Reduced working hours appeal to the rank and file and could also help
to cope with employment problems caused by slower growth. Labor leaders are
probably also concerned about foreign criticism that the longer workweek
gives Japan an unfair trade advantage.
Australian Investment Comalco of Australia is currently negotiating with a US firm to purchase
in US Resource Sector aluminum-processing facilities and accompanying metal inventories in the
United States for an estimated US $400 million. The move would guarantee
an American market for alumina and aluminum exports from Comalco's
Queensland operations. Comalco's action closely follows the US $2.5 billion
purchase by Broken Hill Proprietary, Australia, of an American coal opera-
tion, indicating a focus of Australian investment in US mineral resources. This
is likely to be viewed by Australian observers as an offset to the large role of
US investment in the Australian mineral-resources sector.
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Mexican Balance of
Payments Underscores
Flat Economy
Mexican
Pharmaceutical Decree
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26 October 1984
Less Developed Countries
first half of this year.
Recent data from the Bank of Mexico show that continued depressed imports
kept the current account in surplus during the first half of this year. While im-
ports increased nearly $1 billion from the same 1983 period, they are still at
$4.5 billion, less than half the comparable 1982 level. Exports during the same
period rose by nearly $1.5 billion to $11.8 billion, led by higher sales of
petroleum products, manufactures, farm products, and minerals. The deficit
on services improved by about $0.5 billion to $4 billion as payments on foreign
debt interest held steady and income from tourism and cross-border assembly
industries substantially increased. Despite the unprecedented $3.3 billion six-
month surplus on the current account, foreign exchange reserves only in-
creased $2.2 billion because of capital outflows. Capital flight remained
high-an estimated $1 billion. New bank loans largely offset rescheduled
debt-principal payments. Meanwhile, the stalled economy and fear of growing
state control are depressing foreign investment, which virtually dried up in the
velopment.
The tough regulations for Mexico's pharmaceutical industry published last
week indicate the de la Madrid administration is still unwilling to accommo-
date foreign investors' concerns. Negotiations with industry representatives in
the nine months since the regulations were first proposed failed to eliminate,
those provisions most opposed by the foreign firms. US-owned pharmaceutical
firms are especially irked that the final decree requires generic names on many
products, which will cause manufacturers to forfeit some patent protection and
will tend to reduce profits. The government will also set retail prices,
determine which drugs may be sold domestically, and directly participate in
new drug manufacturing ventures. Moreover, to protect and foster a domestic
drug industry, foreign-owned companies will be required to purchase a portion
of their raw materials from local firms and invest in domestic research and de-
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Oil Price Cuts
Pressure Nigerian
Economy
Nigeria's oil price cut will intensify the economic crisis facing General
Buhari's 10-month-old military regime and further constrict its room to
maneuver. The US Embassy in Lagos estimates Nigeria's oil revenues could
drop by as much as $250 million for the last quarter of this year. Although de-
clining oil revenues will intensify pressure on Nigeria to reach agreement with
the IMF for a major standby loan, an impasse is likely to continue at least un-
til the regime can complete its first year in power on 31 December.
Devaluation remains the principal stumblingblock to an IMF agreement, and
Buhari hopes to postpone this politically risky step as long as possible. As
economic conditions worsen and grumbling continues in the officer corps, the
regime is likely to become even more authoritarian to try to maintain control.
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Tunisian Strike
Activity
Indian Foodgrain
Prospects Near
Record Again
The US Embassy reports Tunisia's national labor union is planning a series of
strikes between now and mid-November to protest the government's failure to
implement wage hikes negotiated last spring. Strikes by automobile, steel, and
transportation workers will hurt the economy. Initial protests probably will be
peaceful, as were agricultural demonstrations last month, but a government
crackdown on union activities would greatly increase the chances for violence.
Government efforts to cope with the worsening economy, including gradual
reduction of subsidies on consumer staples, have intensified popular concerns
over wages. Unless a compromise is reached soon, wider unrest over the next
several months will intensify the confrontation between labor and government.
We expect Indian foodgrain production for the 1984/85 (July-June) crop year
to approach the 1983/84 record of 150 million metric tons. Ample rains have
brightened the prospects for a record spring wheat crop. Rice production,
however, should be slightly lower than last year's record 59 million metric tons
because of flooding in eastern India, drought in the south, and civil unrest in
Punjab. Although rice imports are likely,
New Delhi is negotiating wheat exports to the Soviet Union because
Malawi's Crops
Threatened by
Transport Difficulties
upcoming election prospects.
another good harvest would add to already overflowing domestic stocks. We
believe a favorable crop, by keeping food prices stable, will aid Gandhi's
Diesel fuel shortages in Malawi have disrupted the transport of fertilizer to
outlying regions, while gasoline shortages may soon halt farm operations.
Malawi-landlocked and largely dependent on Mozambican rail lines for
transportation of vital fuel imports-has been cut off from Mozambican ports
by insurgent attacks on the rail lines. Zimbabwe has agreed to lend over
20,000 barrels of fuel, but trucking difficulties may hamper shipments. A
South African trucking firm has donated rubberized bags that will allow
ordinary trucks to be used for importing South African oil but probably not in
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time for the October-November planting season. The completion of a 50-
kilometer road next year from northern Malawi to southwestern Tanzania will
partially offset the trade disruptions by connecting Malawi to the port of Dar
Zambian Economic Despite a new IMF agreement last July, Zambia's economic crisis continues.
Philippine Labor
Unrest Rising
Secret
26 October 1984
unions and the government.
prospects are dismal: Nearly half of the rapidly growing population lives in ur-
ban areas, plagued by high unemployment. A rebound in copper prices offers
only limited benefit because copper reserves are expected to last less than 20
years. Moreover, Lusaka's efforts to diversify exports by promoting agriculture
over mining and industry probably will continue to raise conflicts between the
Although an easing of the drought would help, the country's long-term
between the government and the labor unions
Low world prices for copper-which accounts for about 90 percent of
exports-have hurt foreign exchange earnings. Three years of drought have
frustrated recent efforts to encourage food production and diverted scarce hard
currency to food imports. As a. result, Zambian industry has been deprived of
critical imports and is operating at about 40 percent of capacity. Higher food
prices have fueled demands for wage increases and have heightened tensions
leave the economy languishing through 1985.
The austerity program being implemented as part of the economic recovery
package recently negotiated with the IMF is contributing to labor tensions in
Manila. Organized labor is pressing for a wage increase to compensate for
inflation caused by the weakened peso. Labor leaders last week participated in
a demonstration of 5,000 people in front of the US Embassy,to protest the
IMF agreement. This week taxi drivers staged. a two-day strike protesting
petroleum price hikes, resulting in two deaths and over 300 arrests. Mean-
while, according to the US Embassy, a protracted strike by militant workers at
an American-owned company is testing the government's willingness to
enforce its labor laws. The strikers so far have resisted a back-to-work order by
the Minister of Labor. Large protests will strengthen the left wing of the labor
movement and increase the prospect of violence. Even conservative labor
leaders, however, argue that the government could point to union pressures to
persuade the IMF to back down on its demand for wage restraint. Backsliding
on the austerity program at this critical point-before IMF Executive Board
approval of the standby loan-would risk delaying the IMF agreement and
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Soviet Railcar blamed railcar
Shortages Affecting shortages at Soviet ports for the recent slowdown in grain purchases.
Grain Purchases =incoming grain ships are spending an excessive three to four weeks
in port. suggests that the shortages may be
an excuse to delay additional purchases from the United States until after the
November election.
Record amounts of grain-roughly 15 million tons-have been lined up for
delivery to the USSR during October-December 1984. The port congestion, if
true, implies that Soviet measures to reduce the bottlenecks, such as the
introduction of high-capacity grain cars, have not been sufficient, and that
congestion problems could mount as the high volume of imports already under
contract continues through December. In addition, the recent upturn in Soviet
industrial activity may have resulted in competition for boxcars.
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Politburo Calls for
Increasing Use of
Organized Labor
Recruitment
percent
The 28 September meeting of the Soviet Politburo called for stepped-up use of
organized recruitment (Orgnabor) and voluntary mass mobilization of young
people (through the Komsomol) to supply urban manpower to staff major
construction projects in remote areas and to provide new plants with skilled
workers. Those recruited through Orgnabor and the Komsomol sign fixed-term
contracts, usually for two to three years, and receive substantial incentives,
such as higher wage rates, home construction loans, and training to learn allied
trades. The role of these programs has diminished steadily since World War
II, however. In 1950, for example, Orgnabor accounted for 13 percent of all.
those hired by industrial enterprises, while currently the share is only about 3
Hungarian Economic A senior Hungarian banker has told the US Embassy that Budapest wants
Objectives
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26 October 1984
closer integration of CEMA.
approval of its request for further IMF and World Bank funding before the
Party Congress meets next spring to consider major new economic reforms.
The National Bank contends that the size of new IMF standby credits is less
important than evidence of continued support from international financial
institutions. Quick conclusion of a new standby arrangement may prove
difficult. The IMF apparently is urging more fundamental reforms than
Budapest seems prepared to carry out because of concern over rising social
tensions. The bank's stress on obtaining new support from the IMF and World
Bank may be intended to deflect domestic criticism that Hungary is no longer
obtaining benefits from international financial institutions and should favor
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OPEC: Price Cuts "
Trigger Another Crisis
The latest series of oil price cuts by Norway, the
United Kingdom, and Nigeria threaten to set off a
chain, reaction that could cause the current oil price
structure to unravel. Even if OPEC is successful in
its attempt to support oil prices, we believe down-
ward price pressure is likely to reappear early next
year in the absence of significant oil supply disrup-
tion. Sluggish growth in consumption, increasing
output from non-OPEC suppliers, and attempts by
some producers to maintain market share by price
discounts and barter deals will cause continued
pressure on oil prices for at least the next two years.
The Market Setting
Following a decline of 7.5 million barrels per day
(b/d) in non-Communist oil consumption from 1979
to 1983, non-Communist oil use has increased
about 3 percent so far this year-or more than 1
million b/d-over year-earlier levels.
as much as half of this year's
? Among major barter arrangements, Saudi Arabia
will provide about 50 million barrels of crude in
payment for 10 Boeing 747 jumbo jets, according
to the US Embassy. Press reports indicate that
the UAE will exchange oil for 18 Mirage 2000
fighters from France and that Qatar is trading oil
to Japan, France, and South Korea for equipment
and construction work. Libya barters much of its
crude, including a reported 100,000 b/d to the
USSR for military goods.
? Iran and Iraq offer price discounts to maintain
commercial ties with customers. Iran pays for
war-risk insurance, and Iraq has been forced to
offer spot market sales at prices about 50 cents
per barrel below official levels to dispose of its
crude.
annually for the last several years. As a result of ? Indonesia and the UAE also offer various conces-
these factors, OPEC oil output fell from 32 million sional terms and hidden discounts. Jakarta has
b/d in 1979 to 18.8 million b/d so far this year- offered one customer crude at nearly $3 per
including about 1 million b/d of natural gas "barrel below its official price if payment is made
consumption increase to special factors, however,
such as the coal strike in the United Kingdom and
the colder-than-normal winter of 1983/1984, par-
ticularly in North America. At the same time, non-
OPEC oil supplies have risen roughly 1 million b/d
liquids.
Against this background of lackluster demand
growth and rising non-OPEC output, OPEC mem-
bers have tried to increase their individual produc-
tion levels through a variety of price-discounting
.measures that have undermined official prices. The
rising number of spot sales and barter deals have
caused buyers to shift purchases away from term
in advance.and Abu Dhabi extended payment
terms from 30 to 60 days, a move that effectively
discounts its oil by about 25 cents per barrel.
The rising supply of, and slipping demand for, light
crudes in recent years and their ready availability
deals at official prices.
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OPEC Oil Production Trends, 1972-84
Oil Production Trends
Million b/d
Arab oil embargo Iranian revolution
1-
Oil Price Trends 40
US $ per. barrel
Benchmark price falls $5 per barrel.
b Reflects government production ceilings.
c Actual contract sales prices for Arabian Light.
d Actual annual average.
Iran-Iraq
war begins
1st half
1984
OPEC available
production capacityb
Benchmark official prices
--Bench spot, priced
September
1984
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on a spot basis-particularly from the North Sea-
have especially weakened prices of these premium
crudes. Light crudes yield greater proportions of
light petroleum products such as gasoline. Invest-
ments to upgrade refineries, however, now allow
processing of less, expensive heavy crudes and the
use of heavy: refined product as feedstock. Current-
ly, the official price differential between Arab
Light-the OPEC benchmark-and Arab Heavy
crude is $3 per barrel.' The relative value of these
crudes to refiners in recent weeks, however, indi-
cates that the market differential approximates
only $1 per barrel.
Recent Price Developments
Norway's decision to reduce its oil prices-made
public on 16 October-came as a shock to the
British. London followed the Norwegian cut with a
$1.35 per barrel price reduction on 17 October.
Before the North Sea, price cuts, the pressure on
light oil prices was apparent when the UAE Oil
Minister threatened to unilaterally reduce official
prices by about 50 cents per barrel. Recent public
statements by the Minister now indicate official
prices will not change-at least until after OPEC
meets.
The Nigerian price drop of $2 per barrel undercuts
UK and Norwegian prices by 65 cents, and, in our
,
judgment, reflects an attempt by Lagos to gain .a
competitive advantage over North Sea crudes. The
move also puts severe pressure on other exporters of
light crude. The British National Oil Company
responded by advising buyers that a further price
adjustment may be forthcoming, increasing the risk
that current prices could unravel. In the wake of all
these developments, spot oil prices declined an
additional 30 cents to $2 per barrel over the past
week.
' Differentials are the margins by which prices of various crudes
differ from the price of the OPEC benchmark crude-Saudi Arab
Light 340 API. These differences reflect variations in crude quality
OPEC's' Options
OPEC's ability to forestall a price break is in
serious jeopardy. Saudi Oil Minister Yamani con-'
vened a "crisis" strategy meeting in Geneva'on 22
October with the oil ministers of at least-five other'
OPEC members and-in an unprecedented move-
with representatives from two non-OPEC-oil-ex-:-
porting nations, Mexico and Egypt. The strategy
meeting precedes a full ministerial emergency
meeting slated for 29 October. We believe OPEC
has several options as the organization confronts
the difficult issues of price and production:
? OPEC could attempt to buoy the market by
lowering its current 17.5-million-b/d production
ceiling or simply cut production below existing
levels. The Libyan oil representative announced
after the strategy session that OPEC is leaning
toward a reduction in production quota
[The US Embassy reports that
Venezuela probably is able to restrict output by
75,000 b/d. Press reports indicate that Libya also
may be willing to reduce output to defend prices.
? OPEC could try to obtain an agreement from
members to limit light oil production. This ap-
proach would at least temporarily address the
problem of excess availability of light crude oil.
? OPEC could opt to realign differentials by raising
the price of the more attractive, heavier crudes.
The differential issue is a thorny one to resolve,
but an increase in the price of heavy crudes could
help avert an official price break. Over the long
term, the relative prices of light and heavy crudes
will have to be` realigned to reflect market
realities. ' '
? OPEC could again agree to reduce official prices.
Members certainly realize, however, the- danger
of a price cut to their economies and the risk of
touching off further price cuts.
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OPEC-Non-OPEC Cooperation
members openly are critical of the recent surge in
North Sea production, and
the members could place a special tariff
on manufactured goods from non-OPEC countries
that refuse to cooperate with OPEC.
Less developed oil exporters have, for the most
part, accommodated OPEC s wishes. Mexico has
implemented a self-imposed export limit
Egypt's Oil Minister claims that
Cairo will support OPEC s efforts to uphold prices.
While non-OPEC less developed countries appear
to be more willing to follow OPEC's lead, the
organization has had minimal success in getting
the United Kingdom, Norway, and the Soviet
Union to cooperate. Yamani visited London in
August, and industry speculation that the meeting
resulted in a letter urging producers to maintain
price stability brought a public outcry in Britain.
In our judgment, Yamani's visit may have been to
provide London with an accurate estimate of Saudi
output. Britain has repeatedly vowed that it will
not reduce production to help OPEC maintain
prices. Norway's price cut-on the heels of an
invitation to attend an. OPEC Monitoring Commit-
tee meeting-raised questions about the success of
Yamani's mission.. OPEC's president recently stat-
ed that the Soviets are "in solidarity with OPEC. "
The USSR, however, has traditionally adjusted
prices to reflect market conditions rather than
reduce production or exports.
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26 October 1984
? The organization could appeal to Nigeria to raise
its price and abide by OPEC guidelines. Al-
though Nigeria might agree, a hefty financial
incentive or a substantial increase in its produc-
tion quota probably would be necessary to en-
courage Lagos to rescind its price cut. Press
reports indicate that Saudi Oil Minister Yamani
visited Nigeria, which failed to attend the strate-
gy meeting.
Although there may be some sentiment in Nige-
ria against remaining in OPEC, on balance we
believe Lagos would prefer to retain the prestige
afforded by OPEC membership.
? OPEC may be forced to give up hope of Nigerian
cooperation and close ranks to avoid a general
price decline by accepting even deeper production
cuts.
Whatever option it chooses, OPEC will need to
show strong and uncharacteristic cohesion. Because
competing interests have divided OPEC in the past,
any short-term solution could raise major problems
as members jockey to maintain market share.
FOPEC's
success in maintaining the benchmark in the imme-
diate period depends on members' ability to lower
output in line with market requirements. The ex-
pected seasonal increase in oil demand could tem-
porarily ease the need for the organization to
substantially reduce output
The
OPEC Secretariat's estimate of demand for OPEC
oil in the fourth quarter of this year is 18.3-18.5
million b/d, 500,000 to 1 million b/d below indus-
try estimates. At the same time, however, oil
inventories are unusually low for this time of year,
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to meet seasonal needs.
according to our analysis. Preliminary data suggest
oil stocks may have declined as much as 500,000
b/d in the third quarter compared to a normal
seasonal buildup. As a result, we doubt companies
are in a position to stretch inventories much further
ened.
Even if OPEC manages to hold the price structure
together now, we believe price pressures are likely
to recur over the near-to-medium term. Most in-
dustry analysts project the underlying growth rate
in non-Communist oil consumption at only about 1
percent per annum. As a result, if non-OPEC oil
production continues to climb in the next few
years-as we expect-demand for OPEC oil could
continue to stagnate. Those members of OPEC who
are financially strapped-especially Nigeria, Vene-
zuela, and Indonesia-will find it increasingly dif-
ficult to justify austerity measures to their popula-
tions in the hope of an ever distant rise in oil
revenues. In addition, opportunities for circumvent-
ing official prices-such as the sale of refined oil
products at prices tied to the spot market-will
increase. Saudi Arabia alone is expected to be
marketing as much as 500,000 b/d of refined
products by 1986. Plans to increase Iraqi oil-export
capacity also suggest that means to accommodate
at least 500,000 b/d of additional output from Iraq
must be found. We believe OPEC again will be
confronted with the need to defend oil prices,
possibly in early 1985, and the organization's abili-
ty to carry out such action probably will be less-
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International Financial
Situation: Political Update
During the past month, financially troubled LDCs
have had to deal with continued civilian opposition
to austerity programs and military unrest. Some of
these countries also have shown increased willing-
ness to turn to the Soviet Union for economic
support; Morocco has entered a union with Libya in
the hope of more aid. At the same time, some
countries have asked the United States for econom-
ic support or intervention on their behalf with the
IMF and other official and commercial creditors.
The Argentine Government announced minimum-
wage hikes that labor unions denounce as insuffi-
cient but that the IMF feels are inconsistent with
the Argentine-IMF economic agreement. Accord-
ing to the press, Peronist labor leaders are urging
unions to demand steep pay hikes. Economy Minis-
ter Greenspun, however, has already rejected simi-
lar demands by a large labor confederation. Presi-
dent Alfonsin also must deal with military criticism
of deteriorating economic conditions, labor unrest,
and military budget cutbacks. While Alfonsin has
mollified the military on human rights, labor unrest
over the economy could aggravate military con-
cerns over political stability. Alfonsin, therefore,
has reiterated to US Embassy officials his hopes for
US assistance in facilitating debt rescheduling,
encouraging foreign investments, and expanding
access to US markets.
In Bolivia, labor protests against possible austerity
measures are growing more violent, and the private
sector is increasing its criticism of President Siles.
In addition, Siles faces growing pressure from the
military, and the US Embassy predicts that he
could be ousted if he does not stem the economy's
decline. Although Siles averted one problem by
removing the unpopular Army commander, coup
plotting probably will continue as the economy
deteriorates. The US defense attache reports that
the Soviet Union's taking advantage of Bolivia's
economic crisis has offered free training for Boliv-
ian Air Force pilots, but La Paz probably will not
accept the offer.
In Peru, the probability of a coup before national
elections next April has diminished because of
recent actions by President Belaunde. His naming
of an Army general experienced in counterinsur-
gency to head the Interior Ministry should ease
military demands for more government support for
the antiguerrilla campaign. In another develop-
ment, the USSR signed agreements with Peru to
provide spare parts and replacement aircraft to the
Peruvian Air Force, but Peru's ability to finance
the deal is uncertain.
Egypt's increase in bread prices and social security
contributions led to a demonstration by textile
workers near Alexandria in which three people
were killed and 26 were wounded. The government
raised prices on basic food items to reduce the $3
billion subsidy bill. The US Embassy reports that
the plan was to introduce price increases for bread
in the wealthier sections of Cairo and Alexandria
and then gradually raise prices in other districts.
But, according to the Embassy, bread price in-
creases are more extensive than previously indicat-
ed, and flour prices are being doubled. The Embas-
sy reports widespread disgruntlement with the price
increases. It also reports that President Mubarak
does not plan to rescind the price increases, but has
directed that enough cheaper loaves be produced to
supply low-income areas. He also will convene a
conference of government ministers,. academics,
and opposition leaders to try to gain consensus on
further price increases and has ordered monitoring
of the availability of basic food items. He wants to
ensure that other price increases have high-level
approvals and that profiteering is prevented.
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In Morocco, rising prices, increasing unemploy-
ment, and reduced educational opportunities have
spawned resentment that may erupt in violence.
the public mood in
Casablanca is turning ugly. Rabat's decision to sign
a treaty of union with Libya was motivated in part
by the need for financial assistance and to find jobs
for the unemployed. Since the treaty, Morocco and
Libya have signed an agreement on movement
across their borders, and Morocco has received $50
million. Morocco also
wants to expand economic ties with the Soviet
Union. Rabat received a Soviet trade delegation,
which gained unusually prominent press coverage
and attention from high-level Moroccan officials.
Agreements on a trade pact and a joint venture to
develop Moroccan phosphate were signed, and talks
to increase oil supplies and trade continue.
The Philippines has had to cope with sometimes
violent demonstrations related to, the anniversary of
martial law, the impending Agrava Board report on
the Aquino assassination, and austerity measures
recommended by the IMF. In response to the
government's use of force, Cardinal Sin urged the
middle class to demonstrate along with student
protesters. According to the press, tax increases on
vehicles and tourism brought criticism from the
Labor Minister and strikes by bus and taxi drivers.
Marcos has repealed both increases but replaced
them with other levies.. Authorities have lifted price
controls on basic foods-including rice-and raised
petroleum prices. These and other austerity meas-
ures prompted critics of the government to de-
nounce the IMF accord as a "sellout." Trade union
leaders have argued that wages should be raised to
counter real-income erosion by inflation-now
about 60 percent and expected to rise further-and
that labor should resist the. government's pledge to
the IMF of wage restraint. If the wage-restraint
policy is enforced, it is likely that more workers will
join street demonstrations.
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26 October 1984
In other developments, press reports say that anti-
government rioting in Indonesia manifests not only
a reemergence of Islamic fundamentalism, but also
the grim life of the urban poor in Jakarta. In
Nigeria, reports of growing public restlessness and
the government's inability to face economic prob-
lems have caused the Buhari government to order
tighter security. According to the US Embassy,
Zaire's President Mobutu fears that a third year of
austerity will stir social unrest and expects the.
United States to take the lead with international,
creditors and donors to. provide the resources neces-
sary for some economic-growth in 1985.
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International Financial
Situation: South American
Financial Update
Despite progress with the IMF and commercial
banks, South American debtors face continued
problems in meeting repayments, complying with
IMF agreements, and securing debt rescheduling
and new loans. Colombia, Peru, Chile, and Ecuador
face immediate financing difficulties in part be-
cause of banker reluctance to provide credit. De-
spite temporary relief extended by creditors, Boliv-
ia remains strapped for cash. Argentina already has
been taken to task by the IMF for wage hikes that
contradict the recent agreement, but talks are
proceeding with the banks to gain access to new
credits. Bankers have agreed in principal to restruc-
ture Venezuela's debt, but they are dragging their
feet with Brazil until after the early-1985 presiden-
tial elections.
South American debtors have reaffirmed their
commitment to the collective political approach
adopted in Cartagena last June, but creditors are
undercutting this strategy. These debtors probably
doubt that they can extract adequate debt conces-
sions at the IMF/IBRD debt conference proposed
by the United States for next year. Instead, we
believe they may pursue joint political discussions
to deflect attention from the technical IMF/IBRD
debt talks. We judge, nevertheless, that the pro-
posed debt talks-together with the Mexican and
Venezuelan debt-rescheduling agreements and the
Argentine-IMF agreement-have helped ease
debtor-creditor tensions. Moreover, recent cuts in
the US prime interest rate are blunting debtor
complaints over high interest rates.
Liquidity Problems Persist
creditors extend new loans.
Lenders remain reluctant to provide credit in South
America, leaving many debtors with immediate
financial difficulties. In particular:
? Peru's interest arrears will grow rapidly unless
bankers extend debt relief.
? Bolivia will encounter difficulties meeting its new
payment deadline of 7 November.
? Chile could begin falling behind debt payments
soon if an unfavorable IMF performance review
leads to the withholding of committed and new
bank financing.
? US bank regulators may classify overdue Argen-
tine loans as substandard by the end of this
month, thereby derailing negotiations with banks.
? Colombia soon may miss debt payments unless
Country Developments
Peru's failure to make interest payments and to
comply with its IMF targets is jeopardizing com-
mitted loans and delaying debt-restructuring talks.
Some US
banks already have-placed Peruvian loans on a
nonaccrual status. Bankers want Peru to clear debt
service arrearages by drawing down reserves and
committing $100 million of a promised, but frozen,
loan.
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Financial difficulties
may intensify, possibly leading President Belaunde
to suspend talks with bankers in the hope of
rallying political support before next year's presi-
dential election.
Banks have granted Bolivia temporary financial
relief, but internal political pressures portend wors-
ening relations with creditors. Debt-rescheduling
negotiations with bankers have stalled with the
resignation of Finance Minister Bonifaz and Presi-
dent Siles's refusal to oust Communists from his
Cabinet. Banker good will eroded further when the
government failed to suspend a new bank regula-
tion increasing capital requirements for foreign
branches operating in Bolivia.
Chile's bank advisory committee appears to be
awaiting an IMF economic performance review due
in early November before disbursing $195 million
in committed loans and proposing new lending and
debt-rescheduling terms. If Chile is declared out of
compliance with its IMF program, bridge financing
will be needed to cover a possible $800 million
payments deficit and to avoid a suspension of debt
payments. Regardless of the results of the IMF
review, creditors are resisting new long-term lend-
ing to Chile in 1985 because they feel Santiago is
near default on its present loans. Unless Chile
scales back its loan request for 1985, Santiago may
lose bank support and face critically low foreign
exchange reserves by early next year.
Argentina reached agreement with the IMF on 26
September, but Buenos Aires announced wage
increases on 1 October that could violate the
agreement. Unless the government adjusts the bud-
get to compensate for excessive wage increases,
formal IMF approval of the accord, which is
scheduled for December, could be jeopardized.
President Alfonsin is under heavy political pressure
to grant large wage hikes. Without formal IMF
approval, Argentina will not receive a $1.4 billion
IMF standby loan or attract significant bank lend-
ing. Relations already are strained with US bank-
ers, who may be forced by bank regulators to
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26 October 1984
classify Argentine: loans as substandard in coming
weeks because interest arrears on private debt
exceed 180 days.
Colombia probably will not receive new loans from
banks or the IMF to ease its growing debt burden
until Bogota implements fiscal reform and clears
impediments to rescheduling private-sector debt.
The opposition Liberals, who hold :a majority in
congress, also are plaguing the Betancur adminis
tration's efforts to cut public deficits. Moreover,
Bogota's efforts to save the country's largest, private
bank and to assume responsibility for insider loans
made by the bank fell short of convincing foreign
lenders to agree to a rescheduling program or to
grant a $200 million loan. Foreign exchange re-
serves stand at $600 million, according to the US
Embassy, and Bogota continues regularly to draw
down gold holdings.
Ecuador's cash position continues to deteriorate,
while international creditors await a new IMF
standby agreement and the payment of overdue
debt.
estimated tra e
debt arrearages have doubled since April and now.
stand at $400 million. We believe that Quito
probably will negotiate an agreement by yearend,
opening the door to $350 million in commercial
bank loans.
Brazil may not be able to reschedule its debt with
international banks until after. the presidential elec-
tion in January.
Brasilia wants to launch negotiations soon to take
advantage of the favorable negotiating climate
resulting from the recent Mexican and Venezuelan
debt agreements.
\Brasilia probably will seek to win
banker approval for a multiyear rescheduling of
debt by not seeking new loans and by encouraging
banker coordination with both presidential candi-
dates.
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Venezuela reached a provisional debt-restructuring
agreement with its bank advisory committee, but
ratification by Caracas's 460 creditor banks will
take several months. The committee agreed to
reschedule $21 billion in public-sector loans matur-
ing through 1988 at an interest rate 1.125 percent-
age points above the London Interbank Offer Rate,
according to US Embassy and press reports. Bank-
ers emphasize, however, that the restructuring is
contingent on sustained progress in clearing up $1.2
billion in overdue interest on private-sector loans.
Slow progress in clearing the interest arrearages
will delay formal acceptance and implementation
of the restructuring agreement until at least next
spring.
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International Financial
Situation: Latin
American Capital Flight
The transfer of capital from Latin American coun-
tries is an important contributor to the region's
fragile debt situation. We estimate more than $100
billion of capital flowed out of 10 Latin American
countries during 1979-83 - roughly half the total
capital inflows during the same five-year period.
Losses actually exceed the initial amount of capital
outflow because income on these assets is not
repatriated. As a result, debtor nations are borrow-
ing more just to balance their international ac-
counts.
Press reports indicate the principal safehavens for
the funds have been the United States and Western
Europe, particularly Switzerland. Individuals, do-
mestic companies, and multinational corporations
have moved money out of Latin America into bank
accounts, real estate, Eurobonds, and other invest-
ments. The United States is particularly attractive
because of high interest rates.
Much of the drain of Latin'American capital has
been caused by the political and economic turmoil
and uncertainty in debtor countries. Government
economic policy decisions also have invited capital
flight. Artificially low domestic interest rates, often
below the rate of inflation, discourage saving at
home. Overvalued exchange rates make dollars and
other hard currencies a bargain. Fear that the peso
is becoming overvalued is encouraging further capi-
tal flight from Mexico this year, according to press
reporting.
Estimating Capital Flight
To calculate capital flight, we estimate the in-
crease in a country's external debt and foreign
direct investment and then add its current account
balance and subtract the change in foreign reserve
holdings. The result is our estimate of capital
flight. We believe this methodology provides a
better estimate than the traditional indicator of
capital flight-the errors and omissions balancing
item. Nonetheless, our estimates probably are low.
We believe that other forms of capital flight not
picked up by economic data are significant. For
example, a company can underinvoice its exports
and deposit the balance in a foreign bank account.
In addition, some Latin American exports are
never recorded at all-notably drugs-and the
proceeds are not repatriated.
The Long Road Back
The IMF has recommended economic reforms that
could help to stem further. capital outflows and
possibly encourage some repatriation of the flight
money. Under IMF-supported adjustment pro-
grams, Latin American countries have sharply
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Latin American Capital Flight
Estimates: 1979-83
Increase in Current Change Capital
External Debt Account in Official Flight
and Direct Balance Reserves
Investment
devalued their currencies and raised domestic inter-
est rates. Countries also have imposed exchange
controls to stop the cash outflow. Our data show
that capital flight from Latin America has fallen
from its highest yearly level of about $31 billion in
1981 to an estimated $25 billion last year. If IMF-
supported programs fail or if economic adjustments
trigger social unrest, however, we believe another
surge of capital from these troubled countries will
result.
Experts are divided over whether or not Latin
American countries will be able to lure flight
capital back home. Some believe that with the
correct economic policy mix and several years of
political stability flight capital could be a potential
source of funds. Considering the vast amounts of
Latin American assets abroad, even a modest
return of capital would ease the debt servicing
burdens of financially troubled countries and per-
mit the use of domestic savings as a base for
domestic development.
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Lebanon: Worse Off
Than Ever
The Lebanese economy continues to deteriorate
under the weight of the unstable political and
security situation. Loss of government revenues
because of militia control over numerous ports,
inability to collect direct taxes, and Israeli control
of the south has led to runaway deficit spending
increasingly financed by borrowing from the cen-
tral bank and commercial banks. Industry is oper-
ating at a fraction of preinvasion levels, and agri-
cultural production has been hurt. Unemployment
is a serious problem for the first time. Falling
exports and the drop in overseas remittances have
led to large current account deficits. International
reserves have fallen and the Lebanese pound has
tumbled to record lows, thereby fueling inflation
The previously strong optimism of the Lebanese
business community has been undermined by the
internecine fighting over the past year. Until the
political situation begins to stabilize and an exten-
sive security plan is in place, the economy will
remain depressed. In the meantime, government
and foreign payments deficits will worsen, inflation
will increase, and capital will continue to flee the.
country.
Government Borrowing Soars
The security situation in Lebanon is forcing the
government to resort to increased borrowing to
finance its operations. Customs duties, the largest
source of government revenue, totaled $38.5 mil-
lion ' for the first eight months of this year, down.
78 percent from the same period last year. Illegal
ports are flourishing, depriving the government of
import duties. In addition, only limited revenues
are accruing to the Lebanese Government from
trade in Israeli-controlled south Lebanon. The gov-
ernment also lacks the means to collect direct taxes
that use to make up its other large source of funds.
According to Embassy and press reporting, various
militias operate at least eight illegal ports, includ-
ing one in Beirut. These ports reportedly charge a
flat fee of $860 per shipping container, compared
with legal port charges of up to $1,720 per contain-
er. Even with higher shippers' insurance premiums
and longer waiting times, the illegal ports offer
substantial savings to local importers.
The government budget, approved last June, calls
for 1984 expenditures to rise by 23 percent to
nearly $2.1 billion. Actual spending will probably
total around $1.5 billion. Even so, the 1984 deficit
will exceed the government's projection of $655
million. The Bank of Lebanon (Lebanon's central
bank) estimates that the government deficit was
$480 million in the first quarter of 1984 alone.
The combination of reduced revenue and un-
checked spending has forced the government to rely
on borrowing from Lebanon's commercial banks
and from the Bank of. Lebanon. Total government
domestic debt hit $4.7 billion at the end of July, up
over 27 percent from the end of last year, and
probably will grow to at least $5.3 billion by
yearend. With the treasury currently paying 13.5 to
14.5 percent on recently issued debt, debt servicing
alone is estimated to be double current government
revenue. The Bank of Lebanon has had. to finance.
about one-fourth of this year's government borrow-
ing because commercial banks are increasingly
reluctant to absorb more of the debt.
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Official Foreign Exchange Reserves 2
Billion US $
Lebanese Pound Exchange Rate Domestic Public Debt
US cents per pound Billion Lebanese pounds
Domestic public debt
Bank of Lebanon share
a End of year, unless otherwise stated.
b Estimated. '
Foreign Payments Worsen Further
0
00 00
v C
4
Although no accurate statistics on Lebanon's bal-
ance of payments are available, the country's inter-
national accounts are clearly deteriorating. Leba-
non customarily runs a trade deficit offset by
overseas remittances and by healthy surpluses in
the services sector. Now, however, imports continue
basically unabated, exports and remittances contin-
ue to fall, and Lebanon has lost its place as a
banking, trade, and tourist center for the Middle
East.
Lebanese exports have suffered not only from the
destruction of part of its manufacturing facilities,
but also from the loss of some important traditional
markets. Saudi Arabia banned all imports from
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26 October 1984
Lebanon following the Israeli invasion, but later
started accepting goods that had been certified as
to their Lebanese origin. Iraq, another formerly
large buyer of Lebanese goods, has also cut back
purchases due to war-related foreign exchange
shortages. The disruption of traditional trade
routes to the east through Syria has also hampered
exports. In addition, agricultural exports have fall-
en not only from the loss of markets, but also due to
the destruction of productive plots and the isolation
of the agriculturally important .Bekaa Valley and
the south.
According to Lebanese statistics, industrial exports
for the first half of 1984 totaled $68 million
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compared with $172 million and $264 million for
like periods in 1983 and 1982, respectively. Agri-
cultural exports reportedly totaled $34 million in
the first six months of 1984, down 30 percent from
last year's depressed first-half figure. Total exports
this year probably will be less than $400 million.
Imports, although affected by this year's fighting,
will still total $2.2-2.6 billion.
The major change in the Lebanese balance-of-
payments picture is the drop in remittances from
Lebanese abroad. Lebanese workers, who found
employment in North America, Europe, and the
Middle East, and overseas Lebanese businessmen
who remitted at least a portion of their profits back
home used to account for a large inflow of funds
into Lebanon. Before the oil glut of recent years, it
was estimated that 200,000 to 250,000 Lebanese,
one-third of the country's work force, were em-
ployed in the Gulf states. Worker remittances,
business profits, and other unrequited transfers
provided an estimated inflow of $2.2-2.6 billion a
year before 1983. With the current poor security
and economic situation, these inflows probably
have fallen by more than 50 percent. As a result,
Lebanon probably will have a record current ac-
count deficit of $1.0-1.2 billion this year.
Industry Down, Unemployment Up
Industrial production, according to the Embassy,
has dropped 70 percent since the start of 1983. Five
months of sporadic fighting this year, a lack of raw
materials, power interruptions, the emigration of
skilled workers, and the loss of part of the domestic
sales to illegal imports are contributing to this
decline. Although there is no way to verify current
production, one indicator, industrial exports, has
Even with all the turmoil that Lebanon has suf-
fered since the mid-1970s, the country had relative-
ly low unemployment until two years ago. Foreign
workers, who used to make up a large part of the
pool of unskilled construction laborers, left the
country and have not returned. In addition, possi-
bly as many as one-third of Lebanon's indigenous
labor force has emigrated to the Persian Gulf and
elsewhere. Last, a large number of the unskilled
youth population are employed by the various
militias.
Unemployment and underemployment of workers
are for the first time emerging as major problems
for the Lebanese Government. Following this year's
fighting in Beirut and the destruction of nearby
facilities, the Lebanese Industrial Association esti-
mated that 80 percent of the factories and work-
shops still operating had dismissed more than half
their employees. The Embassy estimates that about
60 percent of the work force in the private sector
has either been laid off or is working for a fraction
of normal salary.
Israeli control of southern Lebanon has effectively
isolated that area economically from the rest of the
country. The south has traditionally relied on agri-
culture and small-scale industry. Goods were
shipped north to Beirut and east to Syria, Iraq, and
Saudi Arabia. Now the main coastal road north has
been closed, the Batir-Jazzin crossing in the moun-
tains is only intermittently open, and the port of
Sidon has been recently shut down. The trade
routes to the east have been cut since mid-1982.
Some commerce by Christian businesses apparent-
ly is still allowed between the port of Jiyah and
Beirut.
Press reporting states that industrial activity in the
south has fallen by as much as 80 percent because
of raw-material shortages and a loss of markets.
Agriculture has reportedly suffered a one-third cut
in employment due to the loss of markets, the
destruction of orchards, and the displacement of
local produce with Israeli goods. Transportation
costs have reportedly risen to three to six times
their preinvasion level, and exporters claim that the
long delays in shipping often cause the loss of
perishable items.
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Israeli control, of South Lebanon has worked to the
economic disadvantage of the Lebanese, but it has
adversely affected the Muslim population more
than the Christians. Although the Israeli Govern-
ment has forbidden the movement of Lebanese
goods into Israel, average monthly imports from
Israel reportedly total $4 million or more. Free
market imports into South Lebanon through the
Israeli ports of Haifa and Ashdod are-said to
amount to another $12 million per month.
The-Decline of the Pound and International
Reserves
The fall of the Lebanese pound over the last year
and a half has paralleled the deterioration of the
security and economic situation. Starting at 4.24
pounds to the US dollar at the end of June 1983,
the pound fell 30 percent to 6.02 to the dollar in
June of this year. Since.then 'it has depreciated an
additional 35 percent to close at 9.25 to the dollar
on 20 October: This overall fall of 54 percent in the
last 16 months reflects the changed perception of
Lebanon's future on the part of its citizens and is
an indication.of the capital flight that is now
occurring. This depreciation of the pound will
result in increased inflation due to the higher cost
of imports, with no possibility for greater exports
existing because of a lack of salable goods.
The Bank of Lebanon-has been intervening in the
exchange market since the beginning of June and is
estimated to have spent $700-800 million to sup-
port the pound. Foreign exchange reserves have
declined 50 percent since late .last year, from $1.9
billion to an estimated $900 million to $1 billion
today.; Official reserves now- equal four to- five
months' imports;-but substantial. sums of foreign
exchange are being held.by the private.sector.F__
Lebanon's commercial banks, as of:the end of 1983,
had net foreign assets of about $ 1.3 billion, and this
figure is probably greater today. 'In addition, indi-
vidual foreign exchange holdings outside the Leba-
nese banking system are substantial. Current Bank
for International Settlements data indicate that
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26 October 1984
Lebanon, as a whole, owes reporting banks around
$1.8 billion, with neatly $1.6 billion of this due
within one year. On the other hand, Lebanese
deposits with these banks total $7.2 billion, a
substantial surplus position. The Bank of Lebanon
also possesses 9.2 million ounces of gold worth
around $3.2 billion. This gold could be used, at
least in part, as security for foreign loans to finance
a part of Lebanon's massive reconstruction needs if
and when the security situation improves.
The central bank's intervention in the foreign ex-
change market has had the beneficial effect of
reabsorbing more funds than its lending to the
government put into circulation. The money supply,
therefore, has not been increased by this portion of
the government's runaway deficit spending. The
point is rapidly being reached, however, where the
central bank will no longer be willing to draw down
its foreign reserves further and will be under
increasing pressure to fund more of the govern-
ment's deficit.
Prospects
Lebanon's economic picture will remain bleak as
long as political and security conditions discourage
private investment. Following previous periods of
hostility, the Lebanese business community was
very optimistic about the future and willing to
reinvest the time, effort, and money necessary to
get the economy going again. This does not seem to
be true today. Now, a substantial degree of security
and stability will have to exist before confidence is
restored, business is rejuvenated, and before Leba-
non starts to receive the outside aid necessary for
its reconstruction. To date, very little outside aid
has been forthcoming and large-scale foreign finan-
cial assistance is unlikely even if the political
situation improves.
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In the meantime, the government will face a fiscal
crisis that can only add to the country's problems.
The central bank cannot continue to support the
pound for long and will probably be called upon to
finance an increasing share of the government's
deficit. This situation can only place additional
burdens on an economy already in poor shape. As it
now stands, industry and agriculture will remain
depressed and contribute to a growing unemploy-
ment problem; the foreign payments situation will
continue to worsen; and the inflation rate will
increase.
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26 October 1984
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Pakistan: Moves Toward
Islamic Banking
The Islamization of Pakistani society received new
impetus recently with the announcement that the
banking system, including foreign banks, will be
run on a completely noninterest basis starting on 1
July 1985. The Zia government views the move to
Islamic banking as a means to strengthen its
conservative credentials, domestically and interna-
tionally, and to boost its popularity in the upcoming
elections. In our view, the proposed change will at
least temporarily slow the investment and savings
rate and retard economic growth, even though
Islamabad is likely to allow practices that substi-
tute for interest and meet the needs of bank
customers. Many other Muslim states will be
watching how Pakistan adapts to noninterest bank-
ing. Sudan is the only other Muslim state to adopt
mandatory, noninterest banking to date. A wide-
spread Islamic banking system would complicate
the operations of international financial institutions
and customers.
Mixing Religion and Banking
The driving forces behind Islamic banking in Paki-
stan appear to be President Zia, Finance Minister
Ghulam Ishaq, the state Bank of Pakistan, and the
religious parties, including the Jama'at-i-Islami.
The US Embassy reports, for example, that Ghu-
lam Ishaq has forcefully defended interest-free
banking in talks with World Bank and IMF au-
thorities. Zia probably views Islamic banking as a
means of placating the Jama'at and other funda-
mentalist forces, as well as enhancing his ideologi-
cal credentials with other Muslim states
The proposed shift to mandatory interest-free
banking is one of a series of moves to fulfill Zia's
promises to adapt the economy to Islamic law. In
1980 the government revived the zakat (a tax on
savings accounts and other assets) and ushr (a levy
on agricultural produce), moves that were support-
Principles of Islamic Banking
Islamic banking originates from the Sharia (Islam-
ic law), which forbids the use of riba (interest). The
main principle underlying Islamic banking is the
muduraba, a limited business partnership between
one party who contributes capital and another who
contributes managerial talent and labor. The net
income is divided according to an agreed ratio.
When a bank extends a loan, its muduraba with
the customer guarantees the bank a certain per-
centage of the profit. Similarly, losses would also.
be proportionately shared. The muduraba, or
profit-and-loss-sharing concept, also applies to
savings and time deposit accounts. The bank uses
such deposits to lend money and to invest in
various enterprises. Depositors, in turn, receive a
percentage of the profits generated by the use of
their accounts. Depositors are also liable to bear
losses in the same proportion as they share profits.
Under the muduraba system, the bank becomes a
type of investment bank; it is a partner of both its
depositors and its borrowers.
ed by the major religious parties. In 1981, Paki-
stani banks began to offer interest-free accounts
and loans on an optional profit-and-loss-sharing
(PLS) basis. The rates of return for PLS accounts
have been higher than rates on interest-bearing
deposits, but, according to government figures, the
differential has been narrowing. According to US
Embassy reports, PLS accounts represent about 13
percent of Pakistan's money supply.
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Pakistani Deposit Rates
Comparable Interest-
Bearing Account
Jul-Dec
Jan-Jun
Jul-Dec
Jan-Jun
Jul-Dec
Jan-Jun
1981
1982
1982
1983
1983
1984
8.70
8.60
8.20
8.25
7.70
7.50
8.50
11.15
10.75
10.50
10.50
9.90
9.50
9.50
According to press and US Embassy reports, the
reaction in the banking community, domestic and
foreign, to the proposed banking measures has been
generally negative. Although some Pakistani bank-
ers have endorsed replacing interest with profit,
others have expressed fears that Islamization will
lead to a reduction in demand for credit and
declining bank profitability. World Bank officials
are concerned that the new measures could lead to
increasing state interference in the banking system.
The US Embassy reports that some Pakistani
bankers have been urging the government to delay
converting to Islamic banking, arguing that a long-
er transition period is needed. The Governor of the
State Bank, according to Embassy sources, has also
urged the regime to "go slow" on Islamic banking.
According to the US Embassy, US bank officials
fear that participation in PLS accounts would leave
US branches in Pakistan open to charges that they
are violating the Glass-Steagall Act of 1933, which
prohibits US banks from taking equity positions in
clients' firms. If the projected banking laws force
banks to become full partners with their customers,
US banks might cease or sharply curtail operations
in Pakistan.
US Embassy and banking officials speculate, how-
ever, that Islamic banking does not necessarily
seriously threaten US banking interests in Paki-
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26 October 1984
stan. Various substitutes for interest could be used
by US banks in meeting the letter, if not the spirit,
of the new banking proposals:
? Finance leasing. The bank leases equipment to
the customer at a markup. The difference be-
tween what the bank paid for the equipment and
what it receives in rent would be the bank's
profit.
? Hire purchase. The bank buys a productive asset
and then sells it for the purchase price plus a
percentage of the profit generated from its use.
? Service charges. Fees assessed when the customer
takes out a loan might also be allowed.
Banking and Embassy officials believe that because
the state Bank of Pakistan will have the authority
to set minimum and maximum rates of "profit," it
probably will assure a positive rate of return on
savings and investments. Administrative and ac-
counting costs for banks probably would be in-
creased, but, as long as acceptable substitutes for
interest are available, operations of US banks in
Pakistan could remain profitable
Problems of Implementation
Several operational issues remain unresolved. One
major problem is the protection of an Islamic
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banking system from fraud and collusion. Without
effective enforcement, underreporting of profits or
overreporting of losses would be common. Lack of
confidence in Islamic banking could lead to a black
market in lending money. Another potential prob-
lem is the mechanism for dealing with unprofitable
or delinquent loans. According to the US Embassy,
Islamabad has proposed "collection courts" that
would hear disputes. The penalties on borrowers
who do not repay remain undefined, however.
The threat of interference by Pakistani religious
authorities greatly concerns bankers. Thus far, the
Islamic Ideological Council (IIC) and Pakistani
banking officials have together made proposals for
the Ministry of Finance. The fundamentalist cler-
gy, however, want to abolish all forms of interest
immediately while some bankers agree in principle
with Islamic banking but want to adopt it gradual-
ly. The IIC already has recommended 39 lashes for
those paying or receiving interest. US Embassy
contacts are also apprehensive that the council
might issue decrees against such measures as mark-
ups, leasing, and service charges. The IIC, however,
is only an advisory body and President Zia can
ignore its opinions.
Finance Minister Ghulam Ishaq said that the
proposed banking laws would not be extended to
international institutions such as the World Bank
and the IMF. Nonetheless, in one case the World
Bank is rewriting a loan with Pakistan to conform
with Islamic law. Further instances could endanger
Pakistan's relationship with international lending
institutions.
Uncertainties generated by Islamic banking proba-
bly will hurt Pakistan's economic growth and for-
eign payments position, at least in the short run:
? A dropoff in savings and investments would result
in a slowdown in business activity and crimp
Pakistan's development program for 1983-88,
which relies heavily on private investment.
Proposed Timetable for Islamic Banking
1 July 1984
No loans on an interest basis can be renewed for
more than six months.
1 January 1985
All financing by banks to the government, public-
sector corporations, and joint-stock companies
must.be based entirely on Islamic (noninterest)
financing.
1 April 1985
All loans to individuals and firms will also have to
be on an Islamic basis.
1 July 1985
Banks will not accept interest-bearing deposits.
? A slowdown in private investment would force
Islamabad to seek increased official assistance.
? A shrinking of savings would cut a source of
funds to finance budget deficits.
? Instead of investing in domestic ventures, busi-
nessmen might invest overseas.
The moves toward an Islamic economy come when
Pakistan is trying to recover from the lowest rate of
economic growth since Zia came to power and is
experiencing a decline in remittances from overseas
workers
If political and religious authorities allow interest
substitutes, and if they lengthen the transition, then 25X1
the public might eventually develop more confi-
dence in the system. The government can also be
expected to take measures-such as a contingency
fund-to assure some rate of return for savings.
The Zia regime appears committed to still more
Islamization, despite the complications to an al-
ready inefficient economy. One such project, re-
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cently announced by Ghulam Ishaq, is a "Workers'
Voluntary Welfare Program," which would provide
funds for workers not covered by any existing
scheme. Although some adjustments may be need-
ed, we believe that the government will find it
politically difficult to back away from an Islamic
economy.
Pakistan's success with an Islamic economy is
likely to set an example for other Muslim nations.
Foreign bankers are anticipating the adoption of
Islamic banking elsewhere. Widespread acceptance
of Islamic banking measures, particularly among
oil-rich Arab states, would complicate international
financial transactions.
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