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February 15, 1985
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Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Directorate of -'SeCI'C~ Intelligence Weekly International Economic & Energy DI IEEW 85-007 IS February 1985 Copy 6 8 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Secret International Economic & Energy Weekly 15 February 1985 iii Synopsis 1 erspective-The Oil Market Outlook: Another Difficult Year for OPEC~~ 3 Briefs Energy International Finance Global and Regional Developments National Developments 13 OECD: Dealing With an Oil Price Drop 17 USSR: Problems Exporting Oil and Gas 21 Nicaragua: Economic Vulnerabilities 31 %IVlexico: Dim Prospects for Foreign Investment Comments and queries regarding this publication are welcome. They may be directed to Directorate of'Intelligence Secret /S February 1985 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 25X1 25X1:1 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Secret International Economic & Energy Weekly Synopsis 1 Perspective-The Oil Market Outlook: Another Di.,~icult Year for OPEC 25X1 spring. The oil market outlook in 1985 indicates that downward pressure on oil prices will continue, and another price reduction is likely, possibly as early as this 13 OECD: Dealing With an Oil Price Drop Most OECD governments would pass on to consumers the benefits of further declines in oil prices-boosting GNP growth and lowering inflation. Although some governments would consider taxing away an oil price decline to ease budget deficits, they probably would wait to see the size and permanence of a price cut before acting. 17 USSR: Problems Exporting Oil and Gas The Soviets have substantially reduced oil and gas exports to some West and East European customers. The USSR should be able to meet its gas export commitments, but the the same may not be true for oil. 21 Nicaragua: Economic Vulnerabilities Bleak export prospects promise a worsening of Nicaragua's serious economic and financial problems. To step up military spending, the Sandinistas are reducing subsidies to local consumers and producers and further stalling international creditors. Mexico: Dim Prospects for Foreign Investment 25X1 Tough regulations and poor prospects for economic performance are discour- aging foreign investment in Mexico. As long as the government is unwilling to create a favorable investment climate, Mexico will not attract enough new overseas funds to offset the slump in domestic investment or limited access to international credits. iii Secret DI IEEW 85-007 IS February 1985 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Secret Perspective International Economic & Energy Weekly 15 February 1985 The Oil Market Outlook: Another Di,,~"icult Year for OPEC 25X1 best hold relatively flat this year. The oil market outlook in 1985 indicates that downward pressure on oil prices will continue and another price reduction is likely, possibly as early as this spring. Non-Communist oil consumption is expected to increase only marginal- ly this year. At the same time, non-OPEC oil production will again increase- albeit at a decreasing rate. As a result, demand for OPEC oil probably will at The recent OPEC agreement on prices is generally viewed as too little too late. The move reduced the average OPEC oil price by less than 50 cents per barrel, not enough to dampen increases in non-OPEC oil capacity or to spur demand. Lower revenues will encourage some OPEC members to cheat on their production quotas at the earliest possible moment. Put simply, the perception that the organization has lost control of the oil market remains widespread. We believe OPEC members realize that a moderate reduction in oil prices is unlikely to increase demand in the short-to-medium term and that cohesive- ness is necessary. Nevertheless, the motivation for some members to overpro- duce is substantial: ? Most important, Saudi ability to absorb further reductions in oil output is limited In our judgment, Riyadh currently is unwilling to take the lead on any substantial reduction in oil prices. Rather, we believe the Saudis are hopeful that the recent price agreement and institution of a mechanism to monitor production and prices will allow further cuts to be avoided. February-a move that avoids undercutting current Nigerian prices. OPEC's efforts to gain the cooperation of non-OPEC producers, such as Mexico, Egypt, Malaysia, and Brunei, have proved largely unsuccessful. Indeed, Cairo and Mexico City apparently believe that OPEC members must accept the role of residual supplier. Although North Sea producers have maintained production at capacity, London deferred setting its "official" oil price for two months because of concern that a reduction would lead to a general round of price cuts-and a further fall in the value of the pound. As a result of recent increases in spot prices, however, London is proposing to reinstate its last official oil price of $28.65 per barrel for January and 1 Secret DI JEEW 85-007 IS February /985 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 The market outlook for 1985 and the next few years indicates that OPEC faces formidable challenges, even if the organization manages to avoid another cut this year. OPEC has not formulated an effective strategy to: ? Equitably prorate its market share among members in a market where reduced stock usage exaggerates seasonal shifts in demand and pressures on Saudi Arabia, OPEC's swing supplier. ? Deal with the uncertainty on production levels and revenue streams that has resulted from the movement away from term contracts. ? Control prices on the growing volume of product exports. ? Accommodate Nigeria's need-and pressure from other members-for a higher output level while also meeting likely Iraqi demands for a quota increase, perhaps later this year. 25X1 25X1 Secret IS February 1985 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Secret Energy Western Europe's Despite a drop of $6 per barrel in world oil pl`ices since March 1983, the dol- Crude Oil Costs Rising lar's appreciation against West European currencies has more than offset lower prices, because crude oil costs are denominated in dollars. The continued strength of the US dollar has contributed to a further delay in the long- anticipated recovery in oil demand in Western Europe. Data indicate Europe- an oil consumption rose only by 1 percent in the first three quarters of 1984, as compared with a 5-percent increase in the United States. Increased cost, however, is one of several factors that continue to slow the recovery of oil de- mand in Western Europe. Japan with its healthy economic recovery has seen oil demand increase by 6 percent in the first three quarters of 1984 despite the strength of the US dollar Local Currency Crude Oil Cost Per Barrel February 1983 30 January 1985 Percent Change February 1983/ 30 January 1985 US dollars (Saudi benchmark) 34 28 -17.6 Japan (yen) 8,032.2 7,125.2 -11.3 France (!rant) 234 270.8 15.7 West Germany (Dtl~ 82.5. 88.7 7.5 Italy (lira) 47,532 54,586 14.8 United Kingdom (L) 22.2 24.8 11.7 Netherlands (guilder) 91.0 100.3 10.2 Spain (peseta) 4,411.8 4,905.6 11.2 Greece (drachma) 2,840.6 3,620.4 27.5 West European (average) 14.1 K-Norwegian Natural The United Kingdom rejected a proposal to buy 10-12 billion cubic meters of Gas Deal Rejected gas per year from Norway's Sleipner field. UK Energy Secretary Walker said that new estimates of domestic gas resources show the United Kingdom can supply its needs without Sleipner. London rejected the $30 billion contract because of concern about the balance-of-payments effect and the loss of tax revenues resulting from importing gas rather than producing domestically. 3 Secret IS February 1985 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Oslo has decided to shelve development of Sleipner for the present and try to negotiate with other West European countries for sales of gas from the larger Troll field. Oslo is going ahead with planned discussions this year on development of Troll gas, but the collapse of the Sleipner project will cool some of its enthusiasm. Moreover, the high cost of Troll gas will make it difficult to sell. Failure to develop and market Troll gas would increase the likelihood of significantly greater European reliance on Soviet gas. Bidding for South Seoul is expected to solicit tenders for nuclear power plants 11 and 12 in the Korean Nuclear Plants second half of 1985, but the bidding-originally scheduled for 1982-could be scuttled by opposition from energy planners who favor coal. Coal proponents are being bolstered by an unreleased government study that gives coal a cost edge over nuclear fuel and reported "coal lobby" backing. US Embassy officials report US, Canadian, and West European firms have begun strenuous prebid lobbying for the contracts in which technology transfer and domestic content as well as cost will weigh heavily in Seoul's decision. The two 900- megawatt units are scheduled for completion in 1996. Bids on units 13 and 14 will be delayed until 1988 because of concerns about South Korea's $43 billion foreign debt, according to press reports. Mexico Pledges More New austerity measures announced last week appear designed to gain IMF Belt-Tightening approval for Mexico's 1985 economic program. The government disclosed it will cut 1985 public spending by $465 million, sell or close 236 state companies, and freeze hiring. In addition, Mexico City plans to rely more on tariffs and reduce use of licensing. The IMF, which has been negotiating with the administration since November, is currently in Mexico City reviewing the revised 1985 economic plan. In January the IMF rejected Mexico's package for this year and asked for tougher steps on the budget and inflation. Although Secret - 4 IS February 1985 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Secret /Portugal Seeks ` /Jumbo Loan Turkish Loan D~culties likely to fight closures of large state-owned factories. we believe these latest concessions will be sufficient for the IMF, we do not ex- pect Mexico to fully implement them. Almost all of the 1985 budget will probably be spent before the July elections, and the government will attempt to keep its pledge to maintain real wages and employment. Moreover, unions are cient commitments. Lisbon is asking international bankers to participate in a $500 million credit facility to help finance Portugal's current account deficit, which is expected to reach $1 billion for 1985. An arrangement worked out between Lisbon and the lead managers of the loan sets up a mixed facility: one-half of the total credit will beta traditional syndicated loan for eight years at five-eighths percentage point over LIBOR; the other half will be a revolving credit at three-eighths percentage point over LIBOR. The deal probably requires participation in the short-term facility if banks want to subscribe to the conventional syndicated loan. Press reports indicate the Portuguese chose this route to attract financing for the cheaper revolving standby facility. The heavy oversubscription of last month's credit for the state-owned electricity company and the dramatic improvement in Portugal's current account deficit during the last two years suggest that Lisbon probably will not encounter difficulties obtaining suffi- Turkey's reputation in the international financial community. Turkey's attempt to arrange a new and innovative $500 million credit continues to face difficulty. The credit requires the lead banks to underwrite the successive issuance of short-term notes on the Euromarket over aseven- year period. As of early February the syndication manager had lined up only some $450 million. Problems began surfacing late last year when several banks decided against participating. These bankers pressured the Turkish Central Bank to abandon the so-called hybrid scheme in favor of a traditional bank syndication because Turkey's, credit rating is far below that of others, such as Sweden, that have successfully used this type of facility. Turkey's Central Bank Governor, however, has predicted optimistically that the credit will be completed by the end of February. Failure to finalize the deal could damage Global and Regional Developments Deb or LDCs Improve Foreign excHange reserves of the top 20 LDC debtors rose 20 percent from eserve Positions yearend 1983 levels, reaching almost $69 billion by the end of third quarter 1984. The most impressive gains were registered by Brazil and Mexico-the two largest LDC debtors. Argentine reserves grew to almost $2 billion but were still below the 1982 level. Substantial declines were registered by the 5 Secret l5 February /985 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Secret I S February .1985 Top 20 Debtor LDCs: Foreign Exchange Reserves e Billion US $ Reserve-to-Import Ratio (months) 1981 1982 1983 1984b Total 68.26 52.63 57.16 68.64 Brazil 6.60 3.93 4.35 9.23 7 Mexico 4.07 0.83 3.91 7.01 9.5 Argentina 3.27 2.51 1.17 1.90 5.5 South Korea 2.68 2.81 2.35 2.56 1 Venezuela 8.16 6.58 7.64 8.69 12 Indonesia 5.01 3.14 3.72 4.75 4 Egypt 0.72 0.70 0.77 0.77 1 Philippines 2.20 1.72 0.79 0.26 India 4.70 4.31 4.94 5.87 4.5 Chile 3.21 1.8 k 2.04 2.23 8 Malaysia 4.10 3.77 3.78 4.05 3.5 Algeria 3.70 2.42 1.88 1.75 2 Nigeria 3.90 1.61 0.99 0.99 1.5 Peru 1.20 1.35 1.36 1.51 7.5 Thailand 1.73 1.54 1.61 1.61 2 Colombia 4.80 3.86 1.90 0.77 2 Morocco 0.23 0.22 0.11 0.10 Pakistan 0.72 0.97 1.97 1.05 2 Taiwan 7.24 8.53 11.86 13.52 a 8 Sudan 0.02 0.02 0.02 0.02 e Total reserves minus gold; end of period. n Third quarter. Less than one-half month. a May 1984. over four months of imports-a one-half month gain since 1983. Philippines, Colombia, and Pakistan. The net increase was due largely to improved sales in recovering developed-country markets. Most of the debtors have held imports close to 1983 levels. For the group, reserve holdings equal Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Secret Tighter COCOM Controls No Agreement ~ /Expected at .:// Cocoa Meeting Saudi-Turkish / Military Cooperation COCOM members. COCOM countries at their recent high-level meeting adopted several mea- sures to tighten strategic export controls. For the first time, they agreed to some restrictions on sales of COCOM-controlled products to Cuba, although member countries still will have wide discretion on enforcement. The delegates agreed to work more closely with other countries to prevent diversion of COCOM items through their territories. They failed to resolve licensing questions involving China and formed an ad hoc subcommittee to study the problem. Exports to China now account for over 80 percent of COCOM cases-up from only 1 percent five years ago. The meeting was less acrimoni- ous than the last one, reflecting the growing consensus that more effective multilateral control is necessary. Many COCOM countries probably already impose restraints on sales to Cuba, although not in coordination with other The cocoa producing and consuming countries meeting in Geneva next week are not likely to agree on a replacement for the International Cocoa Agreement (ICCA) that expires in September. Consumers are proposing a midpoint of $1 a pound within an as yet unagreed-upon target range, and producers want a $1.10 to 1.55 range. A less contentious issue will be export restrictions to supplement the existing buffer-stock mechanism. Although most producers favor export quotas, they might agree to some form of the EC's proposal to withdraw cocoa from the market when prices fall to near the ICCA minimum. Cocoa prices are several cents below the current $1.10 per pound ICCA minimum, and many producers believe an effective new pact will be necessary to prevent further price declines. Even though consumption has outpaced production in the last two seasons, most observers expect the production surpluses this year will put more downward pressure on prices. Riyadh is negotiating with Ankara for training of Saudi officers at Turkish military schools, the maintenance of Saudi aircraft at Turkish airbases, the sale of a wide range of spare parts for the Saudi Army, and the possible purchase of Turkish-built missile attack boats. Saudi Arabia is seeking to expand ties to Turkey as part of its efforts to strengthen the informal coalition of moderate Islamic nations, to offset the potential of a powerful postwar Iraq, and to counter Soviet and radical influence in the region. The negotiations also . reflect Saudi efforts to secure new sources of spare parts and to become less dependent on US contractors and Pakistanis for aircraft maintenance. In return, Riyadh is holding out the prospect of substantial financial aid and 7 Secret IS February 1985 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 \ Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 ,~panish Exports urge Saudi Arabia, to bolster its arms industry. - other economic benefits; the US Embassy believes Turkey may already have as much as $4 billion in commercial contracts. with the Saudis. For its part, Ankara has been trying to expand arms sales in the Middle East, particularly National Developments Developed Countries policy and encourage investment growth. A sharp increase in Spanish exports last year dramatically improved the current account balance and allowed Madrid to meet its GDP growth target. Madrid estimates real exports rose ~20 percent in 1984, versus 7 percent in 1983. Export earnings rose about $4 billion, helping swing the current account from a deficit of $2.5 billion in 1983 to a surplus of $2 billion-the government target was a $500 million deficit. Export performance was also almost entirely responsible for raising real GDP growth to 2.5 percent, continuing the recovery begun in 1983. We believe the export boom stemmed mainly from a gain in competitiveness after the 1982 devaluation, slumping domestic demand, and a pickup of growth in major trading partners. Spanish officials expect a slight erosion of price competitiveness coupled with strengthening domestic demand to slow real export growth to 4 to 5 percent this year. Another large current ac- count surplus is anticipated, giving. Madrid, enough leeway to ease monetary Japanese Workweek At a January international trade union symposium in Japan, representatives roposals nations. from various industrialized nations .expressed concern that Japan's long working hours constitute a "hidden export.subsidy." Domei, a major Japanese .labor confederation, sponsored the meeting .as part of its efforts to reduce the workweek from 48 to 40 hours and to make other;changes in the country's La- bor Standards Law. A Ministry of Labor advisory. council report last year recommended only a 45-hour workweek. The union hopes international pressure will .force a favorable response from the government. Domei's proposed changes, however, fail to tackle the more difficult issue of wage increases, which could boost import demand and thus ease trade friction. Japanese, wage gains have not come close to those in other industrialized Secret IS February 1985 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Secret ~rike Threat New Jamaican conomic Reverses t Cor~icts Over the anese Economy ~ ... announced plans to cut imports-primarily of automobiles, luxury goods, and textiles-and to impose.petroleum rationing. In addition, Mengistu declared that all Ethiopians will be called on to serve tours at relief shelters and 9 Secret IS February 1985 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Less Developed Countries Bolivian General La Paz has devalued the peso by 80 percent and raised food, fuel, and increases continue to fuel the country's hyperinflation. transportation prices by an average of 400 percent. To blunt the effects of these measures, workers have received a 330-percent pay hike. The country's largest labor confederation has denounced the adjustments and is considering calling an indefinite general strike. Labor leaders almost certainly will call for the general strike in hopes of forcing President Siles to scale back austerity measures. A strike would heighten military concern and provide radicals in the labor movement with new opportunities for provoking violence. The economic gains are likely to prove ephemeral, as financial concessions and repeated wage not make him yield to opposition calls for an early general election. 25X1 25X1 The worldwide alumina glut and Jamaica's high production costs are prompt- ing Alcoa to suspend its bauxite and alumina operations in Jamaica for at least one year, according to the US Embassy. The closure comes on the heels of Prime Minister Seaga's announcement that tourism-the second-largest for- eign exchange earner-has fallen sharply since the steep hike in petroleum prices last month triggered three days of public protests. The shutdown will cost Jamaica about $60 million in export revenues this year. This loss and a possible $80-100 million drop in tourist receipts in 1985 will compound the 25X1 country's financial difficulties and may cause the collapse of its $165 million IMF package. Alcoa's closure will cost 900 jobs, and unemployment already is approaching 30 percent. Increasing economic hardships are likely to cause Seaga's party to lose local elections to be called by June, but they probably will Lebanon's rapidly deteriorating economy is becoming a new focus of antigov- ernment actions that will add to the country's climate of violence. Meanwhile, "Islamic Jihad"-probably the radical Shia Hizballah-has c aimed it bombed several Beirut banks two weeks ago to protest against those profiting from the fall of the Lebanese pound. The rapid fall of the pound in the last two months has caused prices to rise 30 to 40 per- cent-as much as the increase for all of 1984. Militias continue to siphon off customs duties, the government's major source of revenue. The government has aggravated the situation by appointing governors of the central bank who have no financial experience. Ethiopian Austerity Ethiopia this week announced the imposition of a national drought-relief tax, Measure's ~ equaling one month's pay for all workers. Chairman Mengistu on Saturday 25X1 25X1 25X1 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 the military, his primary power base. resettlement camps. Government policies largely had protected the urban population from the famine's effects, but the new austerity measures and developing food shortages in the cities now will affect it adversely. Mengistu is unlikely to extend these measures, particularly the tax and fuel rationing, to /Papua New Guinea The four-year-old, $1 billion Ok Tedi gold and, copper project in western / Closes Gold Mine Papua New Guinea will close 28 February by government order. The government was providing 20 percent of the project's cost in order to gain the transport facilities and hydroelectric system associated with the copper-mining phase. For several months, the mining consortium of US, Australian, and West German firms had been denying charges that, because of falling copper prices, it planned to abandon the project after stripping it of better-than-expected gold ores. Workers who have threatened to destroy the mine if it is closed have been pacified. by the consortium's promises to renegotiate, but the government has yet to show sigris of relenting. Port Moresby-generally friendly to foreign capital-undoubtedly intends the shutdown as a strong warning that investors .will be expected to live up to original contract provisions. Personnel Changes at China's S&T Commission Secret IS February 1985 China's State Science and Technology Commission. (SSTC) Minister, Song Jian-who will lead the Chinese delegation to the United States for the April meetings on US-China S&T cooperation-has appointed four new vice ministers, according to Embassy reporting. All are younger, well-educated men, with diverse backgrounds in industry as well as academic research. The new appointments should strengthen SSTC ties to important segments of the research and development community, and facilitate reforms designed to make research more responsive to industry needs. Beijing has been working on reform of the S&T system for several years. Song Jian's appointments indicate Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Secret Vietnam's 1985 E~mic Targets Record Rice rop in Laos scientific research is expected at the end of February. that the minister, who took over the SSTC only last September, is moving aggressively to surround himself with reform-minded personnel. A major policy statement outlining changes in the management and funding of few pragmatists in the party hierarchy. According to the Vietnamese press, Hanoi's ambitious 1985 economic plan calls for increases of 6.5 percent in GNP, 10 percent in foodgrain production, 11 percent in export earnings, and substantial boosts in the production of electricity, coal, fertilizer, and cement. Hanoi also plans to relocate 180,000 workers-nearly double last year's figure-to the new economic zones. The goals for electric power, fertilizer, and labor redistribution may be attainable. Unless the weather is unusually favorable, however, Vietnam is almost certain to fall far short of the key targets in foodgrain production and exports. The foodgrain target of 19 million metric tons is especially surprising because 1984 output fell nearly 1 million tons short of the planned 18 million tons. According to diplomatic reporting, another such miss may threaten the position of the State Planning Commission Chairman, Vo Van Kiet, one of the Favorable weather and expanded acreage led to a 1.3-million-metric-ton harvest last year, according to a recent estimate by the FAO representative in Vientiane, roughly matching domestic needs. This figure exceeds the 1983 crop by 200,000 tons. Earlier projections by the FAO of a poor harvest had spurred an appeal for international food aid at midyear, resulting in contribu- tions of roughly 20,000 tons of rice. The United States provided 5,000 tons. Despite the record crop, distribution problems may still cause localized shortages over the next few months, according to the US Embassy in Secret 15 February 1985 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Secret OECD: Dealing With an Oil Price Drop Most OECD governments would pass on to con- sumers the benefits of further declines in oil prices-boosting GNP growth and lowering infla- tion-but they would not take advantage of lower inflation to stimulate their economies. Japan and Italy, however, probably would offset at least part of a substantial price drop with new taxes to trim their budget deficits and hold down oil consump- tion. Economic Impact We have estimated the impact of a $2 and a $5 drop in the price of oil on OECD economies using our Linked Policy Impact Model (LPIM).` A $5 drop in the price of oil maintained throughout 1985 and 1986 would boost OECD GNP growth by an additional 0.7 percentage point this year and 0.5 percentage point in 1986. This effect would occur in three different ways: ? The net effect of the drop in the OECD oil import bill and the decline in sales to oil-exporting countries would boost OECD GNP growth by about 0.3 percentage point in 1985. ? OECD inflation rates would be 1 percentage point lower in 1985 than they otherwise would be; the lower price level would add slightly more than 0.2 percentage point to OECD GNP growth in 1985. ? Slower inflation would help cut interest rates by about 0.5 percentage point, on average, boosting investment, and thus increasing OECD GNP growth by slightly less than 0.2 percentage point in 1985. ' A $2 scenario assumes an economic impact too small to require a policy response, although we believe that a $5 decline-a possibility frequently mentioned by oil market analysts-is the threshold at Under this scenario, increased US import demand would benefit the other OECD countries, particu- larly Canada. Despite a decline in exports to its important OPEC market, Japan would register the largest current account improvement of any indus- trial economy. Among the Big Four West Europe- an countries, a $5 drop in oil prices probably would spur the recovery enough to keep unemployment from worsening in 1985-86. A $2 oil price drop obviously produces smaller benefits. In this case, GNP growth in the OECD would accelerate 0.3 percentage point in 1985 and 0.2 percentage point in 1986. The increase in growth, however, would barely affect unemploy- ment. Inflation would ease 0.4 percentage point in 1985 and 0.2 percentage point in 1986 from the rates that would exist without any oil price decline. The Policy Response Because the increased strength of the dollar largely has offset the decline in the price of oil since early 1983 for OECD economies other than the United States, most governments would now welcome the opportunity to pass on to consumers any decline in the price of oil. Although some governments would consider taxing away an oil price decline to ease budget deficits, they probably would wait to see the size and permanence of a price cut before acting. Although depreciation of the dollar would magnify a drop in oil prices, the gains would be reversed if the dollar strengthened again. Because of continu- ing problems with inflation and budget deficits, we believe that few, if any, OECD governments would Secret DI /EEW 85-007 IS February 1985 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 OECD: Impact of a $5 Drop in Oil Prices a Change from baseline OECD United Kingdom GNP growth rate (percentage point) 0.7 0.5 GNP growth rate (percentage point) 0.2 0.3 Inflation (percentage point) -1.0 -0.5 Inflation (percentage point) -0.5 -0.5 Unemployment rate (percentage point) -0.2 -0.3 Unemployment rate (percentage point) -0.1 -0.2 Current account (billion US $) 15.8 2.2 Current account (billion US $) -0.7 -1.1 United States Itsly GNP growth rate (percentage point) 0.8 0.7 GNP growth rate (percentage point) 1.0 0.5 Inflation (percentage point) -1.1 -0.5 Inflation (percentage point) -0.8 -0.9 Unemployment rate (percentage point) -0.2 -0:5 Unemployment rate (percentage point) -0.2 -0.2 Current account (billion US $) 5.4 -2.2 Current account (billion US $) 2.0 1.0 Japan Canada GNP growth rate (percentage point) 0.7 0.3 GNP growth rate (percentage point) 0.7 0.8 Inflation (percentage point) -0.7 xECt. Inflation (percentage point) -0.7 -0.4 Unemployment rate (percentage point) -0.1 -0.2 Unemployment rate (percentage point) -0.1 -0.4 Current account (billion US $) 7.9 8.2 Current account (billion US $) 0.5 0.8 West Germany Smaller OECD countries GNP growth rate (percentage point) 0.6 0.5 GNP growth rate (percentage point) 0.7 0.6 Inflation (percentage point) -1.0 -0.5 Inflation (percentage point) -1.2 -0.5 Unemployment rate (percentage point) -0.3 0.5 Unemployment rate (percentage point) -0.2 -0.4 Current account (billion US $) 0.1 -1.3 Current account (billion US S) -0.4 -3.3 France GNP growth rate (percentage point) 0.9 0.4 Inflation (percentage point) -0.9 -0.2 Unemployment rate (percentage point) =0.3 -0.6 Current account (billion US $) 1.0 0.2 e In the baseline, we assume an oil price of $29 per barrel in both 1985 and 1986 and that nominal government spending and money supply targets would not change. For the scenario, we assume that the.$5 price drop occurs at the beginning of 1985 and that the price of oil remains unchanged through 1986. Exchange rates stay constant. respond to lower oil prices by adopting more expan- sionary policies, despite their desire to reduce un- employment. The Japanese Government is one of the few that would consider action to keep retail oil prices from falling. According to the US Embassy, Tokyo thinks the current softness in oil prices will last only Secret IS February 1985 a few years, and producers will regain control of the oil market by the late 1980s. Consequently, if the market continues to weaken this year, Tokyo probably would raise oil taxes to maintain current Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Secret retail prices and to avoid an increase in oil depen- dence. Moreover, this would help Prime Minister Nakasone reduce the government budget deficit- coalition partners-the Christian Democrats, in particular-are calling for stimulative measures. still an important goal for the government. Although our results indicate that the United King- dom would benefit from declines in oil prices, the near-term effects of reduced government oil reve- nues as well as additional downward pressure on the pound would be unwelcome. Ultimately, Lon- don probably would have to let the pound decline, no matter how politically unpopular it would be to see sterling continue to slide. In this case, the British probably would again ask the other major governments for temporary help in supporting the pound-a positive response is unlikely. On the brighter side, higher unemployment in the coal and petroleum industries would eventually be more than offset by job gains in the rest of the economy, particularly in the nonoil export sector where the cheaper pound would make goods and services more attractive. The Canadian Government would pass on any decline in world oil prices to consumers. Ottawa also might phase out domestic oil price controls faster than planned. Nonetheless, an oil price de- cline would make reducing the sizable deficit more difficult because lower oil prices would reduce tax revenues from Canada's petroleum sector. More- over, alarge fall in oil prices probably would hamper Ottawa's plans to cut federal payments to the provinces. The oil-producing provinces, in par- ticular, would press for maintaining the payments to offset their own losses in energy revenues. Both West Germany and France are likely to allow domestic oil prices to decline as the market price of oil goes down. Better performance on growth and inflation would do more to revive French Socialist Party prospects in next year's National Assembly elections than a smaller budget deficit paid for by Britain's alternative strategy of defending the pound by hiking interest rates would be costlier for the Thatcher government, economically and politi- cally. London already has raised the commercial base lending rate by 4.5 percentage points to 14 percent-almost 10 points above the inflation rate. Another hike in interest rates would further cut growth and employment prospects for the economy. Moreover, when the economic damage from the current hikes becomes apparent, we believe Thatcher will have to lower interest rates and hope that the pound will only ease downward. In any case, a further drop in the oil price would make it more difficult to implement the proposed income tax cuts for the fiscal year beginning on 1 April. an increase in oil taxes. Almost all other OECD governments would let domestic oil prices go down in line with a world oil price decline. Lower revenues from natural gas, would make reduction of the budget deficit almost impossible for the Netherlands. Those with major deficit problems-Greece, Portugal, and Iceland- probably would consider raising oil taxes. In Italy, the government of Prime Minister Craxi almost certainly would try to impose new taxes on petroleum products to offset partially the drop in oil prices. With a budget deficit equal to more than 13 percent of GNP, Rome would be helped by a new source of revenue that would not reduce after- tax income. Infighting among the coalition mem- bers, however, would make passage difficult. Na- tionwide elections are scheduled for May, and the Secret 15 February 1985 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Secret USSR: Problems Exporting Oil and Gas The Soviets have substantially reduced oil and gas exports to some West and East European custom- ers, largely because an unusually harsh winter in the USSR has caused spot shortages of domestic energy. Later this year, the USSR should again be able to meet its gas export commitments. The same may not be true for oil, however. The currently depressed level of oil output and sharply reduced stocks will make it difficult for the USSR to meet its domestic and East European oil commitments while sustaining hard currency exports. Although reactions have been muted, this supply crunch could be causing concerns among some customers about the USSR's reliability as an energy supplier during the winter. Recent Energy Export Difficulties Underlying Causes The cutbacks have been caused or aggravated by several factors: ? This year's winter weather has been unusually severe. ? Soviet oil production has fallen in recent months. ? There is little room for increased domestic con- sumption once oil and gas commitments to East- ern Europe and hard currency customers are Normally, harsh winter weather at Soviet ports and oil and gas fields makes it difficult for Moscow to meet its energy export commitments without some interruptions in supply. Poor planning, transporta- tion problems, inadequate storage capacity, and substantial seasonal increases in domestic demand are mostly to blame. The USSR attempts to fully In recent weeks, the Soviets notified several West commit its oil and gas supplies, so imbalances European customers that the USSR will not export between supply and demand or impediments to any crude oil or oil products to them during the distribution-such as those caused by this winter's month of February. According to West European harsh weather-almost always cause shortages for press services and industry spokesmen, the Soviets some end users, domestic or foreign. In the case of told some customers that the stoppage was caused oil, the shortages appear to be getting worse each (press sources indicate a scarcity of Soviet oil sold on the spot market since Buyers' Concerns early January. In addition to the suspension in oil exports, the USSR this winter has reduced substantially natural gas deliveries to several West and East European customers. Soviet gas deliveries to Austria, for example, were reduced by 40 percent last month. So far, the impact of the recent export cutoffs on affected countries has been marginal. Alternative supplies of both oil and gas are still plentiful, even though the market has firmed somewhat recently. Cutbacks of similar proportions affected customers How Soviet cancellations in energy deliveries dur- in at least two other countries. Moreover, the ing periods of harsh weather and peak domestic cutbacks appear to have lasted far longer than demand are affecting the USSR's reputation as a normal during periods of peak demand in the USSR. Secret DI IEEW 85-007 15 February 1985 25X1 25X1 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 reliable energy supplier is unclear. Some West European business concerns have complained in recent months about dependence on the USSR for energy supplies. Reactions in West European capi- Dependence on Soviet Oil, 1983 tals to the recent delays have been limited. Because of the soft oil market, West European dependence on Soviet oil is not a crucial issue. Nevertheless, Moscow is the largest single supplier of fuel oil to Western Europe, and some OECD countries buy a large portion of their oil needs from the USSR. Finland and Iceland, for example, receive 95 percent and 70 percent of their oil needs, respectively, from the USSR. Six other West Euro- pean nations buy at least 15 percent of their total oil imports from the USSR. In contrast to Western Europe, the Communist countries are probably more concerned about the Soviet cutoff. All of Moscow's East European allies, except for Romania, depend on the USSR for at least three-fourths of their oil supplies. Most of these countries also reexport some Soviet oil to earn hard currency. In Asia, the USSR is almost the sole source of oil for the economies of Vietnam, Mongolia; Cambodia, and Afghanistan. In Latin America, Cuba depends on Moscow for all of its oil imports, and Nicaragua depends on the Soviets for over half of its oil. Moscow has promised its East European allies that it will not reduce oil exports to them through 1990 as long as they meet their export and other obliga- tions to Moscow on time. We have some doubt, however, that the USSR will live up to this com- mitment. Imports of Soviet Oil (thousands b/d) Share of Total Oil Imports (percent) Share of Total Oil Consumption (percent) OECDe Austria 30 18 15 Belgium 114 16 28 Finland . 253 95 122 Greece 53 16 23 Iceland 7 70 70 Netherlands 271 18 47 Sweden 72 . 15 18 Switzerland 46 18 19 Other Nicaragua b 7 55 55 Afghanistan ~ 9 95 95 Communist e CEMA Bulgaria 269 88 94 Czechoslovakia 342 94 101 East Germany 342 77 95 Hungary 159 75 80 Poland 300 86 91 Romania 4 1 1 Cuba 190 100 90 Mongolia 19 100 100 Vietnam ~ 33 85-90 85-90 Other Yugoslavia 112 54 39 North Korea 15 30 30 Laos 1 20-25 20-25 Cambodia ~ 3 95-100 95-100 Implications for Hard Currency Earnings The suspensions of oil and gas deliveries will reduce first-quarter hard currency earnings, but the out- look for the year as a whole is less certain. In recent years, Soviet shortfalls during the first quarter have been offset by greater deliveries later in the year. In the past three years, the USSR managed to export record amounts to OECD countries by the end of Secret i5 February 1985 e Other countries belonging to these organizations buy less than 15 percent of their oil imports from the USSR. b These data are for 1984. Information on energy use in these countries is scarce. These are rough estimates. Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 25X1 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Secret the year. Most of the increases in 1982 were at the expense of deliveries to Eastern Europe. In 1983 and 1984, however, the. reexports of OPEC oil accounted for much of the rebound. The USSR receives oil from OPEC nations mostly in return for arms deliveries. Soviet imports of OPEC oil have increased from about 80,000 b/d in 1981 to about 220,000 b/d in 1983: By third quarter 1984, these imports had increased again, to roughly 250,000 to 270,000 b/d. Earnings from sales of oil and gas provide the USSR with almost 60 percent of its total hard currency receipts from merchandise exports (in- cluding arms sales). Oil sales make up about 50 percent-earning about $15.6 billion in 1983 and probably more than $15 billion again last year. This year, however, the USSR will have to over- come some unfavorable trends if it is to maintain the value of its oil exports to the West without disrupting deliveries to its socialist partners: ? Exports are off to a very slow start during the first quarter. ? Oil prices may continue to slide somewhat in 1985. ? Soviet oil production could well decline again this year in the wake of the roughly 65,000-b/d drop in 1984. Soviet reexports of OPEC oil will help sustain earnings from oil sales, but they do not represent a net improvement to the USSR's overall hard cur- rency position. Resale of this oil represents an extra step required of the Soviets to translate its arms deliveries into hard currency. Gas sales earned the USSR about $3.3 billion in 1983, and probably close to the same amount last year. Contract deliveries to Western Europe are scheduled to increase slightly in 1985. The Soviets should have no trouble meeting these commit- ments, given their considerable success in increas- ing gas output in recent years. These sales should earn them about $3.3-3.5 billion this year. Secret 15 February 1985 25X1 1 25X1 25X1 25X1 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Secret Nicaragua: Economic Vulnerabilities Bleak export prospects promise a worsening of Nicaragua's serious economic and financial prob- lems. Managua is virtually broke, has already spent the revenues from this year's presold agricultural exports, and is likely to fail to make numerous promised deliveries. To .maintain government im- ports and step up military spending, the Sandinistas are reducing subsidies to local consumers and producers and further stalling international credi- tors. As a result, we expect the economic situation to deteriorate as consumer good shortages worsen and more producers face bankruptcy. The Sandinistas fear they may be faced with economic sanctions and already have begun to diversify trade and to try to secure more financial support. Although US sanctions probably would result in foreign exchange losses of about $25 million-which Managua could withstand-the in- direct costs probably would be substantial. Even if there are no sanctions, increased Communist sup- port would be needed to bolster the troubled econo- At the same time, government mismanagement and harassment of the private sector has gutted busi- ness confidence, led to steep business losses, and derailed productive investment. According to the US Embassy and press reports, punitive exchange and price policies are driving businessmen to black markets and smuggling to avoid bankruptcy. Huge budget deficits and growing shortages have sent consumer price inflation soaring toward triple- digit levels. The public deficit jumped from 21 percent of GDP in 1983 to 25 percent in 1984. At the same time, inflation more than doubled to 60 percent in 1984. Unemployment, currently estimat- ed at 30 percent, is rising. Public services have deteriorated, and, according to the US Embassy, government-provided water, elec- tricity, and telephones function only sporadically. Various sources report severe shortages of such basics as milk, rice, beans, toilet paper, soap, and light bulbs. Exports are in serious trouble. Earnings from coffee and cotton-Nicaragua's largest exports-are like- ly to be as much as 50 percent below the Sandinis- ta's target this year. Insurgents have hit govern- ment plantations hard, and coffee beans and cotton on private plots are rotting, because of inadequate government prices and critical labor shortages. Private growers report that chronic fertilizer and pesticide shortages and equipment problems are also hampering agricultural out ut. Recent measures to ration foreign exchange and cut the budget deficit will put further economic and financial pressure on consumers and businessmen: ? On 4 February Managua more than doubled prices on many consumer goods in an attempt to get staples back into official channels. The 50- percent wage hike given at the same time-the first adjustment in two years-will only partially restore purchasing power. ? On 8 February Managua announced a new series of exchange rates, effectively devaluing the Cor- doba by half. Revised rates will further undercut Secret D/ /EEW 85-007 15 February 1985 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Nicaragua: Econol>dic Ialdicators Real GDP Growth Percent 10 Central Government Budget Deficit as a Share of GDP Percent o -5 -10 -15 - 20 -25 Share of Bank Credit Prodded Private Sector Percent 80 60 40 20 0 Index of Exports Volume 120 100 80 60 40 20 0 1975-77 78 79 80 81 82 83 84 Secret IS February 1985 Consumer Price Inflation Percent External Public Debt (yearend, medium- and long-term) Million US $ 5000 4000 3000 2000 1000 0 150 120 90 60 30 0 1975-77 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Secret private-sector access to imported consumer and producer goods. Under the system, exchange rates will range from 20 cordobas to the dollar for essential imports to 50 cordobas to the dollar for most nongovernment purchases. ? To finance increased defense spending, Managua has also announced a freeze on government em- ployment and education spending, and a reduc- tion in consumer subsidies, government invest- ment, and social programs. Stalling Creditors Managua is promising some debt payments in order to keep Western credit lines open, but arrear- ages continue to mount. Unless overdue IMF obli- gations are settled, Nicaragua will probably be declared ineligible to make further drawings. Com- mercial bankers have recently agreed to give Nica- ragua more time to work out arrangements for token payments on interest now two years past due. Nicaraguan Exports to United States Million US S Commodity 1975-77 1984 a (annual average) We estimate Nicaragua would need a 10-percent increase in Communist financial support to com- pensate for export losses from unilateral trade sanctions. The Soviets, however, already have dem- onstrated their willingness to assist the Sandinistas further by offering increased oil financing. Nicara- gua also probably would be able partially to evade US sanctions through third party front operations ~ International Economic Leverage by relying on Cuban experience. Managua recognizes its economic vulnerabilities and has made an effort to diversify its markets and search for additional financial support. Its concerns probably have been heightened by the insurgents' calls for US trade sanctions on Managua. Sanc- tions by the United States alone, however-we doubt broad support from other Western nations- probably would lead to foreign exch nge losses equal to less than 1 percent of GDP. ~ade with the United States has already fallen sharply from pre- revolution levels. Nicaragua's US sugar quota has been lifted; the United States has never imported much Nicaraguan cotton; and coffee sales have been shifted to Western Europe and CEMA coun- tries. Secret 15 February 1985 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 The impact of unilateral US sanctions on imports probably would be harder for Managua to over- come. The $112 million in critical intermediate goods, spare parts, and machinery imported from the United States in 1984 would be difficult to replace in the medium term. A unilateral cutoff world, at least temporarily, add to consumer short- ages and idle US-made equipment. Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Nicaragua: The Foreign Financial Gap - ?Mi[[ion us S (except where notetlJ 1975-77 1982 1983 1984 Trade balance -86 -418 -485 -685 Exports, f.o.b. 518 406 428 365 Imports, f.o.b. 604 824 913 1,050 Military 0 100 135 250 Other 0 724 778 800 Net Services -62 -273 -283 -280 Interest obligations 43 217 200 200 Other -19 -56 -83 -80 Net tiansfer 13 86 150 200 Military grants 0 34 64 100 Other 0 52 86 100 Current account balance -135 -605 -618 -765 Debt principal due 35 150 155 160 Financial gap 170 755 773 925 Medium- and long-term capital inflows 163 645 826 850 Commercial bank loans 74 NEGL NEGL NEGL External debt (yearend, medium- and long-term) 703 2,800. 3,500 - 4,300 Commercial bank debt 368 964 1,030 1;120 Net international reserves a 31 -431 -450 -470 Debt service ratio n Obligations due (percent) 15.1 90.4 82.9 986 Obligations paid (percent) 15.1 45.1 35.0 27.4 a Foreign exchange reserves minus short-term liabilities. b Debt interest and principal as percent of merchandise exports. Secret i5 February 1985 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Secret Beyond the Simple Economics The indirect costs of sanctions-further strains on an already shallow managerial pool-probably would be substantial. Sandinista managers would have to assess the impact of export and import cutbacks, locate alternative markets, set new sales terms and shipping arrangements, coordinate deliv- ery dates, and line up new financing and import priorities. Moreover, sanctions would intensify the Sandinistas' siege mentality and probably would cause the regime to shift resources to defense to counter a perceived US invasion threat. Even if there are no sanctions, the Sandinistas will need increased Communist support to shore up the economy. It is uncertain, however, whether Soviet support would ever be sufficient to assure the steady growth of the Nicaraguan economy. 25 Secret IS February 1985 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Q Next 3 Page(s) In Document Denied Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Secret Mexico: Dim Prospects for Foreign Investment Tough regulations and poor prospects for economic performance are discouraging foreign investment in Mexico. Although the de la Madrid administration claims to be seeking foreign capital and technology to spur growth, Mexico City recently imposed new regulations on industries~with heavy foreign partici- pation in order to ensure that less effiicient local producers would not be driven out of business. As long as the government is unwilling to create a favorable investment climate, Mexico will not at- tract enough new. overseas funds to offset the slump in domestic investment or limited access to interna- tional credits. Changing Atmosphere Traditionally, Mexico has viewed foreign invest- ment as a "necessary evil." Government control reached new highs in the early 1970s with legisla- tion that limited foreign ownership to 49 percent, established a formal review commission to screen all applications, restricted patent protection, and sought to reduce dependence on foreign technology. Other regulations in the late 1970s imposed local content requirements in an effort to increase tech- nology transfer, local employment, and net foreign exchange earnings. Investors were still attracted by Mexico's large and growing domestic market, relatively cheap labor, lack of exchange controls, ease in finding capable Mexican partners, and proximity to US and Latin American markets. During 1976-82 the stock of direct foreign investment more than doubled to $10.8 billion, accounting for an estimated 4 percent of total investment. Nonetheless, foreign businesses played an increasingly important role; by 1981 almost 60 percent of total overseas sales of manu- factured goods were produced by Mexican affili- ates of foreign firms. Impact of the Financial Crisis Foreign investment has plunged as a result of Mexico's rapidly deterigrating economic situation. Only some $700 million in foreign investments entered Mexico in 1982 compared with $2.4 billion in 1981. During the first six months of last year, only $29 million was invested by foreigners, pri- marily in assembly operations where the domestic value added is extremely low. The surprise bank nationalization in 1982 raised concerns among both foreign and domestic investors that the government planned to greatly expand its control over the economy. At the same time, the imposition of exchange controls and sharp devaluations greatly added to the operating problems and stimulated capital flight. In 1983 the government-imposed austerity program caused a deep cut in consumer demand that slashed industry operations to only about 50 to 60 percent of capacity. Foreign investors with large equity stakes sought to boost exports to compensate for the drop in domes- tic sales and the increase in financial restrictions. The sharp peso devaluations had made Mexican products competitive abroad. Moreover, many for- eign subsidiaries were forced by exchange controls to depend on their parent companies financially manu acture goods exports jumped almost 30 percent in 1983, giving Mexico a $600 million trade surplus in manufactures. De la Madrid Sends Negative Signals In early 1983 following President de la Madrid's inauguration, the administration articulated the Secret D! lEEW 85-007 15 February 1985 25X1 25X1 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Mexico: Foreign Investment Factors, 1977-83 Foreign direct investment Foreign Direct Investment in Mexican Manufacturing Sector, By Industry, 1980 u Finance and insurance Petroleum Trade Manufactured Exports of Mexican Companies With Foreign Participation, By Industry, 1980 equipment 19 Nonelectrical machinery 6 Secret IS February 1985 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Secret need for new foreign investment, but, as the eco- nomic crisis became less acute, traditional political sensitivities to foreign investment again surfaced. De la Madrid appeared increasingly skeptical of foreign investor motives and sensitive to pressures from highly protected local producers. He began siding with advocates of more regulation, such as Foreign Minister Sepulveda and Minister of Plan- ning and Budget Salinas de Gortari, against propo- nents of liberalized foreign investment, such as Under Secretary for Foreign Investment and Tech- nology Transfer Adolfo Hegewisch and Finance Minister Silva Herzog. Controls were tightened on the auto and pharmaceutical industries-two sec- tors with extensive foreign participation-and are being considered for electronics and food process- ing. Moreover, several close observers have noted that de la Madrid's drift away from a favorable foreign investment view has made bureaucrats re- luctant. to be associated with any politically sensi- tive investment project. De la Madrid promised in February 1984 that Mexico would interpret the 1973 Investment Code more flexibly and allow up to 100-percent foreign ownership in such priority sectors as computers, communications, and oilfield and petrochemical equipment. Majority foreign equity participation, however, continued to be discouraged. Foot- dragging on foreign investment applications contin- ued, and, even when firms offered export promo- tion, new technology, or expanded employment, few exceptions were granted. Last month the govern- ment refused IBM's request for 100-percent control of its planned operation-which would have gener- ated about $20 million in net foreign exchange earnings annually-after nearly a year of negotia- tions. The rejection was backed by a broad coali- tion of local producers, the political left and at least two economic cabinet ministers. Prospects for New Foreign Investment interpreting the new decrees and guidelines. Those already there probably will concentrate on reinvest- ing earnings as they retool for export promotion, work to use excess capacity, or in some cases merge with local companies to take advantage of govern- ment incentives designed to boost local industries. For example, several US automakers, which al- ready have multibillion-dollar investments in Mexi- co, are expanding their exports of parts and some vehicles to the United States. The $500 million Ford plant in the state of Sonora has received the most publicity. We expect the largest of the already established firms to use their bargaining power as large em- ployers to cut mutually beneficial deals with the government. By selectively bending implementing regulations, Mexico hopes to gain foreign ex- change, improve competitiveness, and generate new Many potential new investors, however, have told the US Embassy and financial press that they remain skittish about investing in Mexico because they fear that the rules will change when the economy improves. Many firms also are intimidat- ed by controlled prices, recent loss of peso competi- tiveness, poor access to peso credit, export and local content requirements, protection of technology, and the government's general attitude toward the pri- vate sector, according to the US Embassy. Pros- pects for continued slow economic recovery will dampen any return of interest in Mexico's domestic market. Few expect a resurgence in consumer demand that will reduce excess capacity. Moreover, business sources also claim that growing state domination of the economy has begun to outweigh many of the economic advantages associated with investment in Mexico in the past. Nevertheless, firms that expect to be able to make special arrangements with the government-particularly those in high-priority areas-probably will advance investment proposals. Without presidential support for a better invest- ment climate, new foreign investment in Mexico is unlikely to rise significantly over the next several years. Many companies say they will not invest until Mexico demonstrates greater flexibility in Secret IS February 1985 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Tightening Control New industry guidelines, issued in late 1983, cov- ered the largely foreign-owned automobile assem- bly operations. The regulations severely restricted the types and models of vehicles that foreign investors could produce, banned eight-cylinder en- gines, tightened local content requirements, and forced investors to boost the positive trade balance between exported final products and imported components. It also made DINA, a parastatal producer of heavy trucks and buses, the sole mant4facturer of medium-duty trucks. As a result of the regulations, many manufacturers had to extensively retool production and forfeit their most profitable lines. In February 1984 new restrictions were announced for retail pharmaceutical production, 80 percent of which is produced by foreign-owned.firms. The decree requires uniform generic packaging and labeling, a move multinational labs claim will erode their patent protection, according to the US Embassy. Moreover, the decree increases restric- tions on local sourcing, product registration, and pricing. The Embassy also reports that these meas- ures have already cut into the profitability and As long as the government is unwilling to create an investment climate that is favorable for foreign enterprises, the economy will remain dependent on oil market trends and foreign bankers' largess. Mexico cannot expect to offset limited access to international borrowing or continued capital flight with large inflows of foreign investment funds. As a result, capital needed to retool and to start up new export industries will be limited. Moreover, Mexico will have poor access to new technology, experi- enced entrepreneurship, and marketing techniques necessary to increase competitiveness with other export-oriented countries. The apparent unwillingness of the de la Madrid administration to adopt a more liberal and consis- tent foreign investment policy is likely to continue Secret l5 February 1985 production of specialized medicines. Almost SO multinational labs, both American and European, are challenging the constitutionality of this decree. Some have threatened to leave Mexico if a com- promise with the government is not reached. The government also has proposed an electronics- sector plan that, if implemented, would increase local content to 80 percent within five years and .force local assembly of circuit boards and other components. Foreign-owned firms dominate all but the microcomputer end of this market. Several of these firms have indicated that local assembly of intricate components probably would cause a sig- nificant decrease in the efficiency of production. A sectoral reorganization similar to those above is also rumored to be under study for the food- processing industry. Thefood industry has sub- stantial foreign participation and has long been the target of government and leftist criticism for alleg- edly diluting the traditional Mexican diet with high-cost, low-nutrition `junk foods. " aggravating investment and trade relations with the United States. Recent US attempts to cajole the Mexicans into softening restrictions on foreign pharmaceutical companies by threatening to hold up approval of the agreement on export subsidies have produced few results. Meanwhile, other US businesses, fearing Mexico's retaliation, are press- ing Washington to ease up and allow them to make their own arrangements with the de la Madrid administration. 25X1 25X1 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4 Secret Secret Sanitized Copy Approved for Release 2011/03/01 :CIA-RDP97-007718000707400001-4