INTERNATIONAL ECONOMIC & ENERGY WEEKLY

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP97-00771R000707340001-1
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 28
• Document Creation Date: December 22, 2016
• Document Release Date: October 4, 2010
• Sequence Number: 1
• Publication Date: January 4, 1985
• Content Type: REPORT

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Directorate of Secret-
Intelligence
International.
Economic & Energy
Weekly
4 January 1985
Seer-el.
DI IEEW 85-001
4 January 1985
Copy 680
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Secret
Weekly
International
Economic & Energy
iii Synopsis
Perspective-LDC Economic Challenges in 1985
OGI
11 /Argentina: The Financial Struggle Ahead
ALA
15 / LDC Debtors: S
OGI
/Developing Countries: Policies Toward Foreign Direct Investment
Energy
International Finance
Global and Regional Developments
National Developments
s: Still a Damper on LDC Earnings
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ueries re arding this publication are welcome. They may be
Directorate of Intelligence,
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4 January 1985
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International
Economic & Energy
Weekly
Synopsis
1 Perspective-LDC Economic Challenges in 1985
Despite important positive trends, economic dislocation caused by debt
problems, drought, and mismangement will keep LDCs under severe economic
pressures for a number of years.) 25X1
Argentina: The Financial Struggle Ahead
We anticipate that Buenos Aires will be unable to comply with its IMF
program this year. Domestic political pressures will test the government's
commitment to an austerity program needed to convince creditors to continue
disbursements under the agreement. 25X1
15 LDC Debtors: Struggling With Inflation
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Spiraling inflation-currently ranging from 60 to 1,600 percent-threatens to
stall the recoveries of a number of debt-troubled developing countries.F~ 25X1
19 World Metal Prices: Still a Damper on LDC Earnings
World metal prices, while likely to show more strength this year than in 1984,
probably will continue to constrain export growth in several key LDC debtors.
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23 Developing Countries: Policies Toward Foreign Direct Investment 25X1
Most debt-troubled LDCs-fearing foreign economic control and seeking to
protect domestic industries-have done little over the past several years to 25X1
boost foreign direct investment as a source of economic growth.
iii Secret
DI IEEW 85-001
4 January 1985
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International
Economic & Energy
Weekly
4 January 1985
Perspective LDC Economic Challenges in 1985
Last year was in many ways a transitional one for Third World economies.
Two important positive trends emerged. Exports-buoyed in large part by the
growing appetite of the US economy for imported goods and services-
increased by some 6 percent, and, for the non-OPEC LDCs, surpassed the
1981 peak. Concurrently, the critical atmosphere of the debt negotiations
waned, with Mexico, Venezuela, and Ecuador obtaining multiyear restructur-
ings, Brazil apparently on its way to one, and Argentina, after several bouts of
brinksmanship, reaching an IMF accord.
The LDC economies, however, are far from out of the woods:
? Imports and living standards remain depressed, with LDC imports down an
estimated 20 percent from 1981, and real per capita output off 2 percent; in
Latin America, real per capita output has fallen 12 percent in three years.
? The drought in Africa has intensified problems in a number of already poor
countries-notably Ethiopia, Chad, Niger, Mali, Sudan, Kenya, and Mo-
zambique. In those countries, some 14-20 million people face starvation; the
situation will not improve until 1986 at the earliest.
Due to the economic dislocation caused by debt problems, drought, and
economic mismanagement, most observers expect it will be the end of the
decade before most LDCs regain even 1980 living standards.
Attempts to deal with the problems imposed by external economic constraints
have themselves generated problems. Inflation in the Third World has hit
unprecedented levels, with several countries experiencing triple-digit inflation
and one-Bolivia-facing four-digit price increases. Devaluations, import
stringencies, and, in some countries, explosive monetary expansions have all
contributed to the surge in prices. Political strains also have been made worse
by the economic problems. To date, these strains have been manageable, and
economic problems alone are unlikely to create major political crises in 1985.
Nevertheless, some governments-notably the Philippines, Peru, and Bolivia-
will be under especially severe political-economic pressure this year.
We believe that, while continued OECD economic growth will be of great
benefit to the LDCs, they themselves must undertake a number of structural,
longer run adjustments to turn their difficult situation around:
? Ways must be found to replace the possible permanent loss of $20-30 billion
annually in commercial bank lending that the LDCs used to fuel growth in
the 1970s. Foreign direct investment is often mentioned as a possibility, but
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the outlook there is mixed. Some LDCs are taking steps to make foreign in-
vestment more desirable for Western companies, but others, including some
key debtors, are going in the opposite direction. In many countries, poor
general economic conditions will make foreign investment unattractive for a
number of years, and it is almost impossible to expect a rise in foreign
investment-which recently totaled only $10 billion-large enough to offset
the drop in commercial bank funds.
? Adjustments also are needed to spur growth from domestic resources. The
reluctance to take necessary structural adjustments is well known, but,
beyond that, increases in LDC domestic saving and investment to finance
structural adjustments and offset declines in foreign capital sources seem
unlikely. If anything, domestic LDC savings rates are lower than they were
in the late 1970s.
? In the famine-affected African countries, fundamental changes in food
policies are needed, but we are not optimistic that this will occur. We believe
a major cause of the Ethiopian famine is the policies of the Mengistu regime,
and even in the other countries the priorities of the governments work against
meaningful agricultural reform and development.
The lack of structural adjustment puts the LDC economies at risk to adverse
shifts in the world economy. A particularly likely risk this year could be an
OECD growth slowdown. The rise in LDC exports of more than $30 billion in
1984 was heavily driven by robust OECD economic growth of 4.8 percent.
This year, observers expect OECD growth to slow to 3 percent. If LDC export
growth declines proportionately, LDC foreign sales will rise by under $20
billion, creating the need for greater foreign borrowing or import reductions
than was necessary last year. The former may not be available; the latter
would be politically difficult.
Among debtor countries, the so-called second-tier debtors may be the most
vulnerable. These countries, such as Egypt, the Philippines, Indonesia, and
Peru, have large debt burdens, possess relatively fewer economic resources to
cope with needed structural changes, and in some cases have just begun their
adjustment processes. Moreover, because their debts are individually small,
bankers may be less willing to deal with them as they did with big debtors.
Consequently, despite the seeming improvement in the debt situation, the
probability remains that one or more of these smaller debtors may experience a
debt crisis this year similar to that experienced by the larger countries in the
past three years.
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4 January 1985
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Energy
OPEC Meeting Results OPEC has unanimously agreed to establish a high-level committee to monitor
members' compliance with production and pricing policies
but Algeria and
,
Nigeria have balked at the organization's pact to realign the differential 25X1
between its light and heavy crude oil prices. The new monitoring committee's
lack of power to enforce production guidelines will leave the door open for con-
tinued cheating and reinforces market skepticism that OPEC can control oil
prices. The small adjustments of crude prices around OPEC's benchmark price
of $29 per barrel do not accurately reflect market conditions and will keep
pressure on some producers of light crude to discount prices further. OPEC
will need a rebound in oil demand and a strong commitment to production 25X1
quotas if it hopes to avoid a price decline in the coming months.
Tankers Refuse
Enter
Iranian War Zone
Khark.
Several tankers have refused to call at Iran's Khark Island oil terminal
because of the increased Iraqi air attacks. In the past week, officers and crew
of at least one ship asked to disembark rather than go to Khark, and the Nor-
wegian ship owners association barred Norwegian-flag tankers from the Iraqi-
declared war zone. Since the resumption of Iraqi attacks on 3 December, the
maximum war-risk premium for tankers going to Khark has tripled, and cargo
insurance has quadrupled. The combined effect has raised the cost of insuring
Iranian crude from $1.30 to almost $3.00 per barrel. Sustained Iraqi attacks
probably will force Iran to lower its price to maintain exports at current levels.
For the right price, most shipowners will still be willing to risk loading at
Saudi Riyadh is proceeding rapidly with preparations for a pipeline parallel to the ex-
East-West isting East-West Petroline to the Red Sea, according to a State Department
Oil Pipeline Expansion source. The Saudi pipeline will provide greater security for some Saudi oil
exports and oil supplies to refineries on the Saudi west coast and could make
additional export capacity available for Iraqi crude to Yanbu al Bahr. Money
for the $900 million, 56-inch-pipeline project was approved by the Saudi oil
company in November. Construction could begin as early as May, with
completion possible by late 1986, according to the US Consulate in Dhahran.
The new pipeline will at least double capacity to 3.7 million barrels per day for
export at Yanbu al Bahr or use in west coast Saudi refineries. Another State
Department source indicates that the Saudis, meanwhile, are continuing to
delay approval for the proposed Phase II of the Iraqi-Saudi project, which calls
for an Iraqi pipeline paralleling Petroline
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4 January 1985
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frialaysia Cuts
Oil Production
Moroccan Financial
Negotiations
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4 January 1985
high-quality, high-priced crude.
Malaysia last week announced plans to cut 1985 oil production to 410,000
barrels per day-a 7-percent drop from the 1984 level-to support OPEC's
efforts to stabilize oil prices. Although the production cut is relatively small, it
represents the first time Malaysia has taken such action. Malaysia attended
the yearend OPEC meeting for the first time as an observer. Kuala Lumpur's
willingness to cut production may also reflect an easing of its recent foreign
payments problems. The 1984 current account deficit of $2 billion represents
more than a one-third improvement from the 1983 deficit. Moreover, the US
Embassy believes Malaysia may also be having trouble locating buyers for its
Morocco's negotiations to reschedule its commercial bank debt for 1984 are
again on hold, according to the US Embassy in Rabat. As a result, talks with
the World Bank, the IMF, and official creditors scheduled for early this year
to discuss additional debt relief probably will be delayed. Morocco needs a
multiyear debt-rescheduling agreement soon to ease the estimated $2.5 billion
debt service burden in 1985-two and a half times the level in 1984. The com-
mercial banks have backed off from their demand for a Central Bank
guarantee of debt payments, but are insisting on an IMF-backed austerity
program. Morocco's budget for 1985 includes some cuts in education and other
social programs, but the adjustments are too limited and poorly focused to
meet Fund-recommended budget deficit targets. Moroccans are increasingly
concerned over likely additional declines in living standards and may again
take their frustrations to the streets as they did in January 1984.
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EC-Spanish
,Accession Talks
Make Progress
Global and Regional Developments
until well after the scheduled 1 January 1986 accession date.
Spain moved one step closer to joining the European Community late last
month, when negotiators reached agreement. on postaccession restructuring of
the Spanish steel industry and dismantling of Spain's high tariffs on industrial
products. The steel agreement allows Spain to continue subsidies to its
domestic industry for three years following accession but will require EC 25X1
Council approval beyond that period. Spanish steel shipments to current EC
members will be limited during the three-year transition to 827,500 metric
tons for the first year, with limits for subsequent years to be negotiated later.
Tariffs on industrial products will be gradually reduced to the level of the EC's
common tariff over seven years. Auto exports to Spain from EC countries will
be subject to a three-year quota rising from 32,000 units to 40,000 units. These
agreements remove a major obstacle, but more difficult hurdles remain, 25X1
including agriculture and fishing rights, which may threaten to delay entry
West German A West German Foreign Ministry official told US diplomats that his
Push for North-South government would like the 1985 Bonn economic summit to build momentum
Round toward a high-level North-South conference similiar to the 1981 Cancun
su11ll1111. nc siresseu, 11owever, ii1a1 file GAIL for such a Gonierence snouiu come
from Mexico and Austria, which proposed Cancun. The official believes the
Cancun meeting helped give the North-South dialogue a more positive tone by
taking it out of UN forums. He said the Foreign Ministry hopes to flesh out a
proposal for the summit preparatory meeting scheduled for February. Japan,
France, and Italy are likely to be receptive to the idea of a high-level North--
South meeting. At previous economic summits, they have urged the United
States to give political impetus to the North-South dialogue, even though they
did not intend to make substantive economic concessions to the developing
countries.
Increase in
Japanese Defense
Sp nding
National Developments
Developed Countries
1-percent defense spending ceiling.
The Japanese Cabinet last week approved a 6.9-percent increase
in defense spending for FY 1985. Prime Minister Nakasone struck a
compromise between the initial Defense Agency's target of 8.6 percent and the
Finance Ministry's target of 5.1 percent. Defense spending next year will total
$12.55 billion, just under the 1-percent-share-of-GNP limit. The US-Japanese
summit this week undoubtedly influenced Nakasone's decision to push for an
increase over the 6.55-percent rise of last year. The opposition parties will
attack Nakasone when the Diet resumes in January, both for the defense
increase at a time of overall budget austerity and for the near breach of the
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 Italian
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C rent Account
eteriorates
A sharp deterioration in the Italian current account in the second quarter
resulted in a cumulative January-June 1984 deficit of $1.3 billion on a
seasonally adjusted basis, compared with a $800 million surplus over the same
period in 1983. Italy's worsened position primarily reflects a steep runup in the
trade deficit as economic recovery caused imports, particularly energy prod-
ucts, to outpace export gains in both volume and value. Limited recovery in
key EC markets and weak demand in LDC markets were largely responsible
for limiting export gains to 15 percent. Sales to the United States, however,
were a bright spot, up 62 percent, as exporters took advantage of the weak lira
to increase their market share. With the trade imbalance in the July-October
period showing a continued, albeit slower, rise, and a moderate improvement
on the invisibles account likely, the current account deficit for the year will
probably total about $1.3 billion, compared with a surplus of about $800
French Unions French unions have decided not to sign the agreement they had initialed with
Balk at Labor Accord the employers' association in mid-December, after seven months of negotia-
tions. Aimed at easing labor market rigidities, the accord would have reduced
the period necessary to authorize layoffs, increased the ability of firms to use
temporary workers, and postponed the tax and social insurance burdens firms
face when they cross certain staffing thresholds. The Communist-dominated
CGT had refused to initial the agreement from the outset and succeeded in
provoking vehement rank-and-file objections, which caused the other unions to
reverse themselves. Having failed in this collective bargaining, the government
will find it difficult to reduce employment barriers by administrative action.
At a minimum, however, it probably will speed up the layoff process and
reduce threshold charges that make it expensive for small firms to expand.
Austria Aiming
To Imitate
Si .icon Valley
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4 January 1985
interchange between research universities and business.
The Austrian Government is helping to set up technology parks and venture
capital funds to promote small, high-tech businesses. Vienna's approach is to
create complexes with easy access to universities and other research centers
where new businesses can share clerical help and lab space. The technology
parks will have staffs on hand to provide business advice and to help
entrepreneurs make contacts. The first new venture capital fund will start this
month with mostly private funding. The first park will be in business in Vienna
in about a year, with future centers slated for Salzburg, Linz, and Graz.
Although the parks will be government funded, Vienna hopes that they will
eventually be self-sufficient. Key features of Austria's economy, however,
work against innovation: the large government role; the preponderance of
heavy, traditional industry; risk-averse businessmen and bankers; and lack of
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Less Developed Countries
Nigeria Struggles Debt service payments will consume 36 percent of Nigeria's estimated $11
With Oil and Debt billion oil earnings for 1984, according to the US Embassy in Lagos. 25X1
Production this month has risen to 1.7 million barrels per day, about 400,000
barrels per day more than the OPEC quota. Nevertheless, revenues have not 25X1
and the inclusion of lower priced, heavier crudes in contract sales.
Lagos will react to any price reductions by the 25X1
Mexican Inflation
oblems in 1985
Mexican Gas Explosion
United Kingdom and Norway by trying to maintain at least a 50-cent-per-
barrel advantage over North Sea oil. 25X1
Nigeria is desperately short of cash and probably is trying to sell as much oil as
possible during the final quarter of 1984 in anticipation of continued
downward pressure on prices. The burden of larger debt payments due in 1985
and declining oil earnings would force the government to cut back even further
on imports, thus increasing inflation, unemployment, and shortages of goods.
The regime already is under pressure from almost daily rumors of an
impending coup or Head of State Buhari's resignation, and the 1985 budget is
likely to be unpopular. I 25X1
Mexico is unlikely to meet its inflation target this year as the government
focuses on promoting economic growth rather than on slowing price increases.
We believe inflation for 1985 will be near 50 percent, substantially above the
government's target of 35 percent. While slow money supply growth before 25X1
August had helped harness rising prices, the money supply grew rapidly in the
last few months as the, government sought to finance the public-sector deficit
and foreign reserves mounted. In keeping with its pledge to end the fall in real
wages, Mexico City also announced a 30-percent hike in the minimum wage.
Another is expected at midyear. Meanwhile, reduced food subsidies and higher
gasoline and utility prices will add to inflationary pressures.F__~ 25X1
unlikely to move any facilities, because of the enormous expense. The
estimated cost is $10 billion to move the plants from Mexico City alone.
The 19 November explosion that ripped through the PEMEX liquid petroleum
gas storage facility-Mexico City's largest-was the worst industrial disaster
in Mexican history. The blast at the PEMEX installation is known to have
killed more than 490 people, injured more than 4,200, and left some 900
missing and 10,000 homeless. The final death toll may exceed 1,500. The
accident was possibly the result of a lack of standard safety features, such as
gas detectors. either not in place or inoperative. The Mexican Attorney General
has officially blamed the incident on a massive gas leak at the PEMEX
facility, and ordered the state-owned company to compensate the victims.
About $2.3 million in claims have already been filed. Mexico City has
responded to public pressure to relocate dangerous facilities by taking steps to
increase safety measures at PEMEX and naming a commission to study
potential urban disasters. The debt-strapped Mexican Government, however, is
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L' yan Agricultural Qadhafi has dismissed several- key figures in the Ministry of Agriculture and
ector Shakeup other related sectors of the government over the past two months because of
sharp setbacks in agricultural production,
these dismissa s also may be aimed at
1981. The drop in domestic production, coupled with lower oil revenues since
October, has added to shortages of foodstuffs and increased disgruntlement.
curtailing private enterprise activities by bureaucrats. Overall agricultural
production probably dropped by 10 percent last year because of inept
government management and financial stringency. Spare parts are often in
short supply or delayed by customs and distribution problems. As a result of
the soft oil market, no new agricultural projects have been completed since
T/nisia and Libya Press sources report that Tunisia and Libya signed new agreements during
roaden Economic Ties meetings in Tunis last weekend that call for the elimination of customs duties
increase Libyan leverage when the security talks resume.
on national products, coordination of youth programs and education, and
security cooperation. Details on the extent of security cooperation are
unknown. These accords probably resulted from increasing Libyan pressure
designed to disrupt Tunisia's growing relationship with Algeria. Tripoli
probably also believes increased economic cooperation will position Libya to
exploit political uncertainties in Tunisia when President Bourguiba dies and
,Oman Borrows Abroad Oman has arranged a $400 million loan through Arab banks. According to the
US Embassy, the funds are needed to help finance Oman's 1984 budget
deficit. This is the second consecutive year that Oman has sought external
financing to cover budget shortfalls resulting from the lower-than-anticipated
oil revenues. Despite the loan, Muscat may have to dip into the $2.4 billion
State General Reserve Fund to cover 1984 expenditures. This special fund was
created to sustain the country when oil supplies are exhausted.
Record Pakistani
Cotton Crop
Preliminary estimates indicate that Pakistan will have a record cotton harvest
this year following a disastrous, pest-ridden crop last year. With harvesting
half over, about 460,000 metric tons of cotton had been delivered to the
ginning factories-almost equal to last year's total. Government officials F
estimate that total production will reach 800,000 to 1 million
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4 January 1985
payments position.
tons. A bumper cotton crop will provide welcome relief to an economy that last
year grew at the slowest rate since President Zia came to power in 1977. An
anticipated rebound in raw cotton and textile exports-about 30 percent of
Pakistan's total exports-also will give a boost to a deteriorating foreign
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L
CEMA Decision A Soviet economist has told US Embassy officials that CEMA will continue to
on Pricing set annual trade prices among member countries during the 1986-90 Plan
Focus on Soviet
Family Problems
Chinese Textile
TradFWith Japan
ay Be Limited
The decision was made at the recent CEMA Foreign Trade Commission L ~n
meeting in Moscow. Reports from the CEMA summit last June had indicated
the moving average formula would be replaced by a system that would take
more account of current world prices. The Soviets benefit from the five-year
average because declining world oil prices affect CEMA prices more slowly.
The current formula will help Eastern Europe if world energy prices rise.
Besides being consistent with CEMA's aversion to change, maintaining the
five-year average satisfies the preferences of the East Germans, Soviets, and
other orthodox planners for a predictable pricing mechanism. The apparent
losers are the reform-minded Hungarians, who advocate the use of current 7X1
A recent Pravda article by a prominent demographer targets improvements in
the quality of family life as a prerequisite for changing "unfavorable
demographic patterns." The article is the latest example of a public relations
campaign begun in the mid-1970s to strengthen family life after the 1970 25X1
census showed a slowdown in the growth of the population, an increasing
number of single people, and small families in Slavic areas. Policy since 1981
has been aimed at reversing the falling Slavic birthrate and reducing the high
rate of divorce, caused by increasing male alcoholism, early marriage, lack of
housing, and unequal sharing of household responsibilities. The regime has
also taken a few steps to strengthen family life, including the creation of
family counseling centers, an increase in family allowances, paid maternity
leave for working mothers, sex education programs in schools, and interest-free
housing loans to young families. These efforts may help but are being
implemented on a scale too limited to have much impact. Moreover, some
elements of Soviet policy continue to undermine efforts to promote family life.
The high rate of female labor force participation and inadequate wage scales
that virtually compel women to work contribute to a decrease in the birthrate,
particularly if child care is difficult to arrange. F--~ 25X1
The Japanese cotton fabric industry plans to ask Tokyo to negotiate a bilateral
agreement to limit imports of Chinese cotton fabrics. Such an agreement
would be based on the GATT Multifiber Arrangement (MFA), which Beijing
joined early last year. According to Japanese trade statistics, China accounts 25X1
for about 85 percent of Japan's imports of unbleached cotton fabrics. Japan
has been trying to reduce imports of these fabrics in favor of cotton yarns for
use in domestic weaving mills. China's drive to increase exports has Japanese
industrial leaders concerned that low-cost competition will reduce their share
of domestic markets. China already has bilateral agreements governing textile
trade with most OECD countries, but Japan only negotiates annual import 25X1
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Argentina:
The Financial
Struggle Ahead
Argentina was able to gain sufficient new lending
commitments from its 300 creditor banks in time to
allow the IMF to approve a request for a $1.4
billion standby loan on 28 December. The banks
are still about $400 million short of the $4.2 billion
requested despite considerable efforts by Argentine
officials, the steering committee banks, and the
IMF to sell the package. We believe, however, that
the full amount will be raised in the next few
weeks, enabling Argentina to clear its interest
arrearages and repay a $750 million bridge loan.
Even so, we foresee financial uncertainties ahead
for the government of President Alfonsin. We
anticipate that Buenos Aires will be unable to
comply with its IMF program this year, especially
with promises to keep a lid on wage increases and
reduce the public-sector deficit. With an economic
recession now brewing and inflation only ebbing
slightly, domestic political pressures will test the
government's commitment to an austerity program
needed to convince creditors to continue disburse-
ments under the agreement.
Completing the Financial Rescue Package
We believe the financial rescue package probably
will be completed over the next several weeks.
Although creditors are grumbling, they probably
recognize that some new lending is required to
protect their existing exposures and prevent the
Argentines from threatening to organize a debtors'
cartel. Even if some of these bankers refuse to
participate, the larger banks may increase their
shares of the new loans to complete the negotia-
tions, according to the press.
If the financing package is approved by February,
which we believe likely, Buenos Aires will have
enough funds to take care of about $2.2 billion in
public- and private-sector interest arrearages and
to repay a $750 million bridge loan. This money
also will allow Argentina to cover a current account
deficit of a little over $2 billion-the current
Argentine and IMF projection for 1985. Moreover,
the banks have agreed to reschedule over $13
billion in past-due loans at interest rates only
slightly above those charged for Mexico's resched-
uled debt.
The Struggle To Maintain IMF Compliance
restraint and fiscal discipline than last year.
Even when the financing package is complete,
Argentina still faces the considerable task of main-
taining compliance with its ambitious IMF pro-
gram. The memorandum of understanding that
went into force on 1 October has as its major goal a
sharp reduction of inflation, largely through a cut
in the budget deficit. For example, inflation, which
in November was running 675 percent over the 25X1
same month in 1983 is targeted to drop to 150
percent in the last quarter of 1985. This will 25X1
require Buenos Aires to exercise greater wage
Applying Wage Restraint. Buenos Aires' willing-
ness to control public-sector wage increases will
play a key role in efforts to hold spending in check.
The IMF agreement allows for scheduled monthly
wage hikes and occasional supplementary increases
to make up for inflationary losses. During the IMF
negotiations, the Argentines had given verbal as-
surances that wages would be increased by no more
than 12 percent per month during the October-
December period,
Within days after signing the accord, however, the
government announced a 14-percent monthly in-
crease for the last quarter. Concerned that such
hikes would threaten compliance with the new
program, the Fund recalled Argentine negotiators 25X1
to Washington, according to the press.
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Although the issue was temporarily defused, we
believe Buenos Aires will face growing demands
from civil servants this year for larger wage hikes.
The. US Embassy reports that real wages for civil
servants fell in October and November in the face
of inflation rates of 19.3 and 15.0 percent, respec-
tively. In response to increasing pressure from the
General Confederation of Labor, Economy Minis-
ter Grinspun has announced that in 1985 govern-
ment workers will receive higher wage increases
than last year. Moreover, he has promised a 6- to 8-
percent special salary supplement in January,
which, if kept, bodes ill for meeting IMF targets.
Exercising Budget Discipline. Buenos Aires also
faces the need to implement budget austerity,
mainly by reducing expenditures. To shrink the
deficit in the face of declining tax revenues in 1984,
according to US Embassy reporting, the govern-
ment deliberately underfunded spending programs,
most notably in the military and nuclear sectors.
The government may have used this approach to
force these agencies to economize and draw on
available cash reserves, but we judge this process
has run its course because government agencies
have fallen as much as 180 days behind in their
payments to suppliers.
We judge budget disbursements in 1985 probably
will have to show some growth just to pay past-due
bills, forcing programed spending to be pared to
stay within IMF budget targets. The government
has promised a draft budget later this month,
according to the US Embassy, and we have only
fragmentary indications of where Alfonsin will
trim. An Embassy source reports that the health
and social budgets have already been determined,
which suggests that no controversial cuts were
made here.. Figures leaked. by the military, howev-
er, indicate that its spending will be cut sharply
again-one military spokesman asserts that a 50-
percent cut will be made.
exports promise some gain in the tax take. Without
a strong increase in revenues, we judge that the
government will miss'the budget deficit targets for
1985, even if it is successful in holding down wage
increases.
Beyond this, continued monetary tightening will
probably be required to take the steam out of
inflation. Since September, government restrictions
on intercorporate loans have helped drive interest
rates well above inflation. These tighter credit
policies have caused firms to repatriate dollars and
sell them for pesos to obtain working capital.
Businessmen reportedly have become convinced
that tight monetary conditions will continue as the
government tries to adhere to the IMF program
and that the economy is in 'a recession that will last
at least through this spring. We believe that if the
government adheres to the IMF monetary targets
the downturn could last even longer.
Foreign Sector Policies. The Central Bank has
devalued the peso on a daily basis, with occasional
large adjustments to offset surges in domestic
prices. By the end of 1984, the peso had been
devalued by more than called for in the IMF
agreement, which stated that peso devaluations
should be sufficient to make up for inflation differ-
entials with Argentina's trading partners. On the
basis of trends in Argentine wholesale prices, we
judge the real value of the peso is now about 10
percent lower than at the start of 1984, and we
expect the government to keep up regular devalua-
tions to comply with the accord.
Buenos Aires has also agreed to lessen gradually
the stringent import controls established last Janu-
ary. The IMF is scheduled to review progress in
achieving this goal during the first quarter of 1985.
Although business and labor will resist the removal
of import barriers, Buenos Aires can help placate
these groups by maintaining current devaluation
policies.
Despite government promises to increase the effi-
ciency. of the notoriously leaky tax system, the fall
in revenues last year does not indicate progress.
Moreover, with recession apparently under way,
only the recently increased levies on agricultural
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We believe the government probably will continue
to achieve some success in the first few months of
1985 in staying close to its IMF targets. A slack
economy and the onset of the major harvest period
with abundant food supplies should keep inflation-
ary pressures down. Moreover, the beginning of the
summer vacation period probably will lead to a
temporary decline in political pressure to recce
purchasing power through wage increases.
Nonetheless, we expect the government in the
coming weeks to become increasingly concerned
over the weak state of the economy. Businesses will
continue to reduce their inventories because of the
high costs of financing and weak demand as real
wages shrink. We expect the Central Bank to
continue to squeeze the credit markets-to fight
inflation and attract dollars from overseas-and to
continue devaluing the peso in line with what we
believe will be declining inflation. Although this
combination of policies will encourage exports and
improve the current account, it will heighten popu-
lar opposition to austerity
By March, when political activity usually regains
momentum, we judge the government will come
under considerable pressure to grant bigger wage
increases and stimulate the economy. The Peronists
and the labor unions probably will be quick to
assert that IMF-dictated policies are causing in-
creased unemployment and losses in real wages,
which they had predicted. The financially pinched
military may also begin to ask for budget relief to
reverse deteriorating force readiness. Moreover, the
business community is likely to become alarmed
over high interest rates and slack demand and
begin to lobby for some budget stimulus, probably
through stepped-up public investment.
We believe Alfonsin remains vulnerable to such
political pressures. Alfonsin might be able to head
off trouble later by admitting now that to bring
inflation under control some of his policies will
depress the economy in the short run. To do so, he
may also have to decree a policy of no real wage
increases for 1985. If Alfonsin takes these steps, we
believe he would also increase Argentina's chances
of maintaining close enough compliance with IMF
targets to obtain waivers from the Fund during the
first review in the spring. If, instead, he decides to
buy off interest groups, Argentina runs the strong
risk of falling so badly out of compliance that
future credit tranches will be suspended. With a
projected $2 billion current account deficit this
year, another suspension of credit would reignite
financial problems.
Implications
A halt in credit disbursements would again lead to
delays in interest payments for creditors and a
major renegotiation of the credit package with
unpredictable consequences. Another round of
tough negotiations with Buenos Aires may cause
bankers to resist providing additional credit to
support the financial rescue program. Even if this
does not occur, resurgent debt problems would
reopen the debate in Argentina about whether
international credit obligations deserve to be hon-
ored. Under these conditions, any adverse turn of
events such as rises in interest rates or decline in
growth in the industrial countries would help re-
build support for the debt moratorium option with-
in the ruling Radical party. Although
the fear of an Argentine
debt moratorium has receded considerably, we
25X1
25X1
believe that Argentina could still find support for
joint action in nations such as Bolivia, Peru, Chile,
and Colombia. 25X1
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LDC Debtors:
Struggling
With Inflation
Spiraling inflation-currently ranging from 60 to
1,600 percent-threatens to stall the recoveries of a
number of debt-troubled developing countries. We
believe that attempts to cushion the decline in
living standards in the face of cutbacks in the
growth of foreign lending have played a crucial role
in the near-runaway inflation in these countries.
Large budget deficits-a growing share of GDP-
have had to be financed by faster money supply
growth fueling price increases. Domestic opposition
to needed austerity measures has hampered the
battle against inflation, promoted capital flight,
distorted investment, and imperiled IMF agree-
ments. Prospects for economic growth have
dimmed, despite progress in resolving debt prob-
lems. In particular, severe chronic inflation serious-
ly troubles governments in Argentina and Bolivia
and may contribute to political unrest in Peru and
the Philippines. Reversal of the recent downward
trend in inflation also could threaten economic
recovery and financial adjustment in Mexico.F
Consumer price inflation has become an acute
problem in a growin number of developing coun-
tries. for the nonoil LDCs
as a group, GDP-weighted annual inflation rates
increased from 25 percent in 1979, to 32 percent in
the 1980-82 period, to 44 percent last year. A
number of key debtor LDCs have been particularly
hard hit. Bolivia leads the list with 1,600-percent
inflation for 12 months through October, followed
by Argentina with 700 percent. Triple-digit infla-
tion also persists in Brazil and Peru.
Bolivia (through October 1984) 1,590
Argentina (through October 1984) 704 25X1
Brazil (through October 1984) 211
Peru (through August 1984) 104
Mexico (through November 1984) 59
Philippines (through October 1984) 64
a Percent change over preceding 12 months.
Underlying Factors
In our view, the inflation spiral now afflicting many
LDCs had its roots in the recession of the early
1980s, when many LDCs ran up huge government
deficits in an effort to protect living standards. 25X1
Public-sector expansion often continued into the
recession, even as government tax collections fell.
In Argentina, for example, government deficits
during 1981-83 as a share of GDP were triple those
of the preceding four-year period. Substantial defi-
cit increases also burdened the economies of Boliv-
ia, Brazil, Mexico, and the Philippines.) 25X1
In many debt-troubled LDCs, neither foreign nor
domestic lending could be mobilized in amounts
sufficient to cover the ballooning deficits:
? The growth of foreign lending to many develop-
ing countries slowed dramatically as lender banks
began to question the ability of LDCs to service 25X1
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Key Debtor Countries: Percent Troubled LDC Debtors: Consumer Price
Government Deficit as a Share of GDP and Money Supply Growths
9.3
3.3
100
their accumulating debt. Bolivia
new commercial lending to nonoil LDCs fell from
$41 billion in 1982 to $27 billion in 1983. 5_0_0
? Domestic lending could not meet the widening
gap between borrowing from abroad and the
growing deficits. Economic recession constrained
domestic savings, while higher foreign interest
rates and overvalued official exchange rates often
led to large-scale capital flight. We estimate, for
example, that capital flight from Latin American
LDCs may have exceeded $100 billion during
1979-83.
When borrowing could no longer support their
government deficits, some debt-troubled LDCs re-
sorted to inflationary financing through substantial
increases in the domestic money supply. Particular-
ly sharp accelerations in monetary expansion have
occurred in Argentina, Bolivia, Peru, and the Phil-
ippines; in each country, money stock growth has
nearly tripled since late 1982.
Current Developments
There are few signs that inflation in key debtor
countries is likely to abate quickly:
? While Argentina's planned budget deficit would
have accounted for 10 percent of GDP in 1984,
the reluctance of the government to cut social
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programs will almost certainly push the 1984 and
1985 public-sector deficits above government
forecasts. Likewise, pursuit of monetary disci-
pline is complicated by inflationary expectations
in the heavily indexed Argentine economy. Wage
adjustments in excess of targeted inflation have
already raised concerns in the IMF, which re-
cently called for reductions in government spend-
ing, the money supply, and inflation. Inflation
slowed somewhat in October and November, but
recent monetary tightening may offer only a short
respite to inflationary pressures.
the
monetary expansion necessary to finance recent
economic measures taken in Bolivia could push
inflation to an annual rate of over 2,000 percent
by yearend. Because of a recent dramatic decline
in real wages (36 percent between December and
August of last year), the government is under
heavy pressure from labor unions to index wage
increases to 100 percent of increases in the
consumer price index.
? Mexico's money supply has increased 92 percent
in the past year, and its public-sector deficit
remains high. With this and the government's
commitment to stem the decline in real wages, we
expect Mexico City to be unable to meet its 1985
deficit target of 5.1 percent of GDP, or its
inflation target of 35 percent.
? Brazil's attempts to tighten fiscal and monetary
policies under its IMF accord have had little
evident effect on inflation. Brazil's highly indexed
economy and inflationary expectations are keep-
ing inflation above 200 percent for the second
successive year. The Embassy reports that fight-
ing inflation has become the current military
government's top economic priority, but some
Brazilian analysts predict that the growth strate-
gy of the civilian government scheduled to take
office next year could boost inflation to 250 to
300 percent.
? With a growing budget deficit in Peru, the
Embassy reports that the government is unlikely
to meet its 1985 inflation target of 81.percent.
After several years of declining living standards,
the Belaunde administration is reluctant to im-
pose new austerity measures. This is especially
true in light of upcoming presidential elections
and recent labor unrest generated by Communist-
dominated labor unions.
? In the Philippines, real GNP fell by 5.5 percent in
1984,
The ensuing economic hardship is likely to
strengthen the Communist-backed insurgency in
rural areas. The 1985 IMF inflation target of 20
to 25 percent is less than half the current level.
The achievement of this goal depends heavily
upon the impact of President Marco's health on
Philippine political stability.
Implications
High inflation presents serious political and social
challenges in several key LDCs. Inflationary psy-
chology can undermine government efforts to re-
sume the economic growth that will ultimately
resolve debt problems by diverting investment from
productive uses to speculative ventures and encour-
aging capital flight. IMF austerity programs could
substantially alleviate these problems, but govern-
ments are wary of public reaction to the strong
measures needed to control inflation. Negotiations
on fund-supported economic programs are often
contentious, and even the negotiated targets have
been difficult to meet in the face of domestic
pressures. A collapse of these fund programs could
delay or halt IMF lending and imperil bank re-
scheduling agreements to which they are linked.
The inflationary spirals in Argentina and Bolivia
present the greatest risk of prolonged economic
chaos and increased political unrest. With money
supply growth driving already severe price inflation
to even higher levels, monetary discipline in these
nations has been almost totally lost. In both coun-
tries, economic demands of powerful labor organi-
zations significantly impede government attempts
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to devise viable austerity programs. Moreover, la-
bor unions and other important economic players
appear to have diminishing confidence that their
governments have workable plans for reducing
inflation. Other countries that face political and
social fallouts from inflation include Peru and the
Philippines, where economic deterioration and po-
litical unrest reinforce each other, and Mexico,
where social strains could intensify if living stand-
ards continue to fall.
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4 January 1985
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OCGI Cl
Still a Damper
on LDC Earnings
World metal prices, while likely to show more
strength this year than in 1984, probably will
continue to constrain export growth in several key
LDC debtors. Jamaica's situation probably will be
even worse than last year because of adverse
aluminum market trends. Copper producers such as
Chile, Zambia, and Zaire should do better, but
even in these countries we do not expect marked
improvements. Slower OECD economic growth,
the absence of inflationary pressures, and further
conservation and a continued shift to metal substi-
tutes should prevent anything other than modest
increases in prices of any metals this year.
A Disappointing Recovery for Metals
More than two years of economic recovery have
done little to revive metal prices. After a modest
2-percent gain in 1983, metal prices' in 1984
dropped 13 percent.
The factors behind the slide last year include:
? The strong US dollar, which rose by 13 to 20
percent against major European currencies last
year, depressed the price of metals that are
largely denominated in dollars.. .
? While much improved, demand has not rebound-
ed as strongly as in previous recoveries. Capital
investment has been held back by high real
interest rates, and low-capacity utilization-espe-
cially in Western Europe-also retarded capital
spending.
? Entering 1984, most metal markets were glutted.
With stocks high, improved demand put little
upward pressure on prices. Moreover, high interest
rates were a disincentive for inventory rebuilding.
Producer responses to the low metal prices have
varied widely. Producers in the OECD countries,
particularly in the United States, have generally
been sensitive to weak prices. As a result of higher
production costs, capacities have been trimmed and
production has fallen. For example, with US copper 25X1
production costs more than 20 percent above world
averages, few US producers could operate at a
profit.
In contrast, many cash-strapped LDCs maintained
production despite low prices. In Chile, for exam-
ple, where copper production costs are among the
lowest in the world, profits were made even at the
1984 price level. Moreover, even in LDCs where
production costs are high-and where low metal
prices in 1984 should have dictated significant
cutbacks-output was maintained because of reve-
nue needs. This was especially true in Zaire and
Zambia, which rely on copper earnings for 40 and
90 percent of their foreign exchange revenues,
I l 25X1
Prospects for 1985
Metal markets enter 1985 in somewhat better
condition. In general, inventories are leaner, pro-
duction is more in line with demand, and metal
usage should continue to increase. The perception
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Selected LDCs: Dependence on
Mineral Exports, 1983
Country Commodity Estimated Mineral
Export Earnings as a
Share of Total
Export Earnings
(percent)
Chile Copper, iron ore 50
Jamaica Alumina, bauxite 65
Peru Copper, iron, lead, 50
silver, zinc
Zaire Cobalt, copper, 60 a
diamonds
of the "glutted market" is beginning to erode.
Much will depend on the dollar. If the long-
expected decline in the dollar begins, there could be
substantial price gains in 1985. Even if the dollar
remains at current high levels, we expect some
recovery in at least two of the major markets:
? For the first time in five years, copper usage last
year significantly exceeded production. Stocks
were reduced from nearly 12 weeks of current
consumption to about eight. Substantial cutbacks
in productive capacities were also made during
the year, particularly in the United States and
the Philippines. Prices, however, should remain
well below the peak levels of 1980 as the restart
of idle capacities boosts supply. Additional sup-
plies of copper are expected this year from Iran,
Brazil, and Mexico, offsetting expected produc-
tion cutbacks in the United States.
? Lead prices remained depressed in 1984, averag-
ing just 20 cents a pound-about the same as in
1983 and 60 percent below their peak in 1979.
Despite strikes in Australia and the United
States, production remained unchanged, while
lead usage increased by roughly 2 percent. Stocks
fell 15 percent, equivalent to 6 weeks of current
Secret
4 January 1985
Consumption
days
65
75
70
56
59
Consumption
days
56
55
81
83
57
Stocks
2,078
3,115
2,936
2,024
2,310
Consumption
days
63
101
99
62
68
Stocks
32,584
42,691
65,500
79,100
60,000
Consumption
days
68
96
156
186
144
a Estimated yearend totals.
consumption. Lead prices should show moderate
increases in 1985. Inventories are relatively low,
and demand seems likely to improve further with
above average automobile demand.
? The weakness in aluminum prices last year result-
ed from premature reactivation of idle capacities
in 1983, prompted by rapid price increases and a
10-percent pickup in demand. Since mid-1984,
however, major producers in North America and
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World Metal Prices: Still a Damper
on LDC Earnings, 1972-84
Copper Lead
US cents per pound US cents per pound
Tin
US $ per pound
Zinc
US cents per pound
lu 1 111 IIII 111 1 1 111 i 1 I I I 1 I I I I t I I 1 I 1 I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I I II 11I I I i II
0 1972 75 80 0 1972 75 80
Aluminuma
US cents per pound
Metals
Index: 1975=100
Europe have been cutting back production. Fur-
ther cutbacks are necessary for prices to rise
significantly in 1985, as evidenced by the
300,000-ton buildup in stocks last year.
? Unlike most metals, zinc prices last year in-
creased 20 percent over 1983 levels. The price
rise was caused by a continuation of the buildup
in industrial demand begun in 1983-particularly
from the automotive sector-and heavy Chinese
buying. Zinc prices will probably be little
changed in 1985. Continued improvement in
housing and automobiles will help prop up de-
mand but this will be offset by growing output
and a buildup in stocks.
? After nearly three years of International Tin
Council (ITC)-imposed export quotas on produc-
ing members, tin consumption exceeded produc-
tion for the first time since 1976, and stocks fell
almost 25 percent. Nevertheless, the tin market
remains greatly oversupplied, with commercial
stocks totaling about 60,000 tons. Tin prices are
expected to remain weak in 1985 because of slack
demand, huge inventories, and increased produc-
tion by non-ITC members, Brazil and China. The
ITC will continue to prop up prices through
export controls and buffer stocks purchases. 25X1
Implications
The impact of improved metal prices on LDCs will
vary widely. Chile should reap additional benefits
in 1985 from recent expansion of its copper indus-
try. The same is true for Zambia, which last year
purchased new equipment that will increase pro-
ductivity and lead to gains in output this year.
Jamaica, on the other hand, will probably be worse
off in 1985. Modest price gains in aluminum will be
more than offset by fewer exports due to the closure
of US Gulf Coast aluminum plants-Jamaica's
0 1979 80 50 1972 75 80
major market for its bauxite.
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The modest price gains expected in 1985, although
a considerable improvement over last year's poor
performance, surely dashes the hopes of many
metal-exporting LDCs, who had been expecting
large increases in their minerals export earnings. If,
as many economists predict, 1985 turns out to be
the last year of recovery in the current business
cycle, it could signal worse times ahead for metal
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Developing Countries:
Policies Toward
Foreign Direct
Investment
Most debt-troubled LDCs-fearing foreign eco-
nomic control and seeking to protect domestic
industries-have done little over the past several
years to boost foreign direct investment as a source
of economic growth. Despite a decline in commer-
cial bank lending and official aid, a number of
countries have taken measures that actually dis-
courage foreign investors. Although some countries
are taking steps to encourage foreign investment,
we believe that most developing countries over the
near term will avoid substantial policy shifts that
promote foreign direct investment. Given the pros-
pects for lagging economic growth, continuing for-
eign exchange problems, and political unrest, even
substantial incentives would probably-do little to
improve the investment climate in many of these
countries.
could encourage these firms to move their region-
al headquarters to Singapore and Hong Kong,
which continue to grant such incentives.
? The elimination of tax holidays by Indonesia has
led to an immediate decline in new investment
applications, according to the US Embassy. A
new law requiring unions in foreign-owned firms
has led one company official to say he will
recommend to corporate headquarters that plans
for future investment be halted.
On the other hand, several developing countries
have recently taken steps to attract more foreign
investment often through special incentives to
channel new capital and technology into targeted
areas:
While few developing countries are actively work-
ing to attract new foreign direct investment, some
countries, including key debtors, actually have tak-
en actions discouraging to foreign investors:
? Mexico recently tightened controls over the man-
ufacturing and marketing activities of foreign-
owned automotive, electronic, and pharmaceuti-
cal firms, although a few exemptions continue to
be granted for investment in export-oriented
firms and to acquire new technology. For exam-
ple, Ford late last year secured an agreement for
a $500 million assembly plant, receiving both
financial incentives and an exemption from local
ownership controls.
? Under an IMF-supported restructuring of the tax
system, designed to increase revenues, the Philip-
pine Board of Investment recently rescinded all
tax and duty incentives given to regional head-
quarters of foreign companies-a move that
? South Korea revised its Foreign Capital Induce-
ment Law in July to open up the computer and
robotics industries to foreign participation, ease
restrictions on remittances, and streamline the
approval process for investments in which the
foreign partner holds a minority share.
? Chile is attempting to reverse the 60-percent drop
in foreign direct investment in 1983 by improving
its already liberal investment policy, according to
the US Embassy. For example, earlier this year a
new mining code was enacted that places con-
straints on expropriation and gives foreign owners
the same rights as natives to buy and sell mineral
concessions.
? Although the five Andean Pact countries are
formally bound by a treaty that establishes uni-
fied foreign investment regulations, Ecuador, Co-
lombia, and Peru have recently relaxed these
regulations to attract additional foreign capital.
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Quito has eased profit repatriation and ownership
rules; Bogota has offered tax breaks for export-
oriented firms and liberalized controls on profit
remittances; and Lima has doubled remittance
allowances.
? A few others, including Jordan, Zaire, and Ke-
nya, have approved or are considering measures
to encourage new foreign ventures.
Over the near term, increases in foreign direct
investment in most developing countries will con-
tinue to be limited by tight state controls and ao
depressed economic conditions. We believe most
Total financial
now a
developing countries will continue to be reluctant to 20 Foreign direct
encourage foreign direct investment on a substan- investment
control or a desire to protect a domestic industry
will continue to dominate the views of many of
these countries. Moreover, the economic outlook of
the country, exchange rate and trade policies, and
political stability play an important role in the
success or failure of investment incentives. In a
a Total financial now is the sum of official development assistance, export
credits, bank loans, foreign direct investment, and other flows.
country like Chile, for example, facing low econom- about $20 billion from 1981 levels. Thus, it would
is growth, foreign exchange problems, and political take an unlikely tripling of foreign investment to
unrest, even substantial incentives would probably merely offset the decline in these other sources of
do little to improve the overall investment climate. capital.
Despite some hopes expressed for foreign direct
investment to take up the slack from recent cut-
backs in bank lending and other capital flows, there
is little prospect for the role of foreign investment
in LDC recovery. Since 1970,
foreign direct investment in developing coun-
tries has held steady at an average $12 billion per
year. Other financial flows, however, are down by
Secret
4 January 1985
LDCs: Role of Foreign Investment,
1970-82
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