INTERNATIONAL ECONOMIC & ENERGY WEEKLY

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP97-00771R000807800001-9
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 42
• Document Creation Date: December 22, 2016
• Document Release Date: October 20, 2010
• Sequence Number: 1
• Publication Date: December 6, 1985
• Content Type: REPORT

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d'e~- '101~ Z9
International
Economic & Energy
Weekly
Directorate of Seer-et
Intelligence
aet
DI IEEW 83-048
6 December 1985
copy 687
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iii Snopsis
International
Economic & Energy Weekly]
Perspctive-Status of Gorbachev's Economic Program
Mexico: Dim Prospects for Economic Reform
i i ,/Iran: Developing Alternative Oi xport Facilities
urope: Winter Energy Worries
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enezuela: Modest Reforms in Foreign Direct Investment Policy
Energy
International Finance
Global and Regional Developments
National Developments
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Comments and queries re arding this publication are welcome. They may be
directed to Directorate of Intelligence, 25X1
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DI IEEW 85-048
6 December 1985
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International
Economic & Energy Weekly)
Synopsis
Perspective-Status of Gorbachev's Economic Progran(::~ 25X1
Moscow's new economic plan reaffirms previous indications that the revitaliza-
tion of the economy through science and technology is General Secretary
Gorbachev's highest domestic priority. 25X1
The recently released draft plan for 1986-90 and guidelines to the year 2000
call for the economy to grow at rates not achieved for more than a decade and
even faster during the 1990s. The stress on unrealistic gains in productivity is
likely to result in production shortfalls, increased bottlenecks, and unfulfilled
expectations.
7 Mexico: Dim Prospects for Economic Reform
Mexico is rapidly losing its reputation as the model debtor because of
government failures to take appropriate adjustment measures and the subse-
quent economic problems that currently beset the country. Until a comprehen-
sive policy package can be put in place, we believe Mexico will continue to in-
cur budget overruns, current account deficits and financing gaps that will
reduce the President's policy options
11 Iran: Developing Alternative Oil Export Facilities
Recent Iraqi success-although limited-at disrupting Iranian oil flows from
Khark Island has forced the oil industry managers in Tehran to reexamine
alternative oil export plans to bypass Khark.
15 Eastern Europe: Winter Energy Worries
After suffering some of the worst energy shortages in the postwar era last
winter, East Europeans are preparing anxiously for the coming season.
Bulgaria, Romania, and Yugoslavia probably will incur energy shortages this
winter even if the weather is average.
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19 Venezuela: Modest Reforms in Foreign Direct Investment Policy
Confronted by the prospect of long-term stagnation in oil revenues, Venezuela
revised its development strategy. A key feature is a renewed role for foreign di-
rect investment (FDI) to broaden the industrial base and reduce import needs.
The reforms announced by the government last June are unlikely to stimulate
significant foreign investment.
23 Kenya: Economy at the Crossroads
Kenya faces problems-a ponderous government bureaucracy, runaway popu-
lation growth, deteriorating foreign payments position, and a vulnerable export
market-which, if unresolved, could undermine its position as one of the few
open and successful economies on the continent. In our view, Kenya can no
longer afford merely to continue making relatively minor adjustments to the
policies that have served it well in the past.
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Perspective
International
Economic & Energy Weekly
Status of Gorbachev's Economic Program
The recently published 12th Five-Year Plan and guidelines to the year 2000
reaffirm previous indications that the revitalization of the economy through
science and technology is General Secretary Gorbachev's highest domestic
priority. He seems to realize that, despite the recent upturn in economic
growth, substantial improvement in the economy's capability to create and use
new technologies is still required for Moscow to recapture the higher growth
rates of the first half of the 1970s and match the productivity of Western in-
dustrial powers.
cations.
To address these issues Gorbachev has set ambitious goals. Overall economic
growth during 1986-2000 is to accelerate to almost 5 percent annually-
double the rate achieved during 1979-84. Special emphasis will be placed on
the same industries that have led industrial modernization efforts in the
West-machine tools, robots, microelectronics, computers, and telecommuni-
To achieve these goals, Gorbachev has outlined a two-stage strategy. In the
short term, he seeks to boost economic performance through "human factor"
adjustments-new personnel, some organizational changes, a vigorous temper-
ance campaign, and a renewed emphasis on discipline and improved worker
effort. In the longer term, Gorbachev hopes that growth will be further
accelerated as his nascent program to modernize plant and equipment and
stimulate technological progress comes to fruition. Central to this program is
the redirection of resources from new construction to retooling existing
facilities. To provide the equipment necessary for retooling, investment in
civilian machine building will grow in 1986-90 by 80 percent over that of
1981-85. By 1990 Moscow plans that 50 percent of all equipment in industry
be "new."
apparatus, the Foreign Ministry, and the Council of Ministers.
The short-run prospects for at least moderate success for Gorbachev's program
are promising. Economic growth in 1985 may be a full percentage point higher
than in 1984. Much credit is due to better weather and a good agricultural
showing, but Gorbachev's initiatives are no doubt having a positive impact. He
has consolidated power faster than any of his predecessors and already has
achieved a working majority in the Politburo, a rapid pace of cadre renewal,
and the placement of key lieutenants to head Gosplan, the Foreign Trade
1 Secret
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The long-term prospects for sustained improvements, however, are uncertain.
The sweeping personnel changes, management reforms, and greater discipline
may boost labor productivity for a year or so, but by themselves cannot sustain
growth indefinitely. Furthermore:
? Reallocation of investment to machine building may squeeze other vital
sectors threatening production bottlenecks.
? Investment in some consumer sectors may get short shrift, risking consumer
discontent that will counter efforts to raise productivity.
? Exogenous constraints-labor shortages and increasing raw material costs-
will remain severe.
? Hard currency constraints and Soviet problems assimilating and diffusing
foreign technology will limit the potential contribution of imports to
achieving goals.
Most important, Gorbachev is, so far, leaving the principal features of the
economic system intact. This system was designed to operate most effectively
under conditions of abundant resources, but it is ill prepared to generate
innovation and stimulate efficiency in today's resource-constrained environ-
ment
If Gorbachev's plan to increase growth and accelerate S&T falters, he may
consider bolder reforms, such as steps toward market socialism. His political
momentum augurs well for his future ability to take bolder steps, and the
ambitious nature of his goals increases the chances he will have to do so to
avoid being seen as just another leader unable to make good on his promises.
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Soviets Outline Next
Five-Year Plan
The recently released draft plan for 1986-90 and
guidelines to the year 2000 call for the economy to
grow at average annual rates not achieved for more
than a decade, and even faster during the 1990s.
This growth is to come almost entirely from gains
in productivity, but past campaigns to raise produc-
tivity have fared badly. Moscow's agenda offers
hope for improvement, but not on the scale neces-
sary to compensate for the increasing scarcities of
basic resources
As the 12th Five-Year Plan period begins the
Soviets remain stuck in a decade-old economic
slowdown. Although performance has improved in
the last couple of years, the Soviet economy still
cannot simultaneously maintain rapid growth in
defense spending, satisfy consumer demand for
more goods and services, generate enough invest-
ment for modernization and expansion, and under-
write client economies
The new leadership apparently understands these
limitations and realizes that overall economic
growth must be increased substantially over its 2.5-
percent annual average of the last five years to
adequately address the conflicting demands. Gor-
bachev's earlier speeches had implied growth in
GNP of at least 4 percent per year, and the
General Secretary had remanded the draft plan
three times for revision. The published draft calls
for average annual growth of almost 5 percent
during 1986-2000-3.5-percent annual growth for
the rest of the decade, followed by rates in excess of
5 percent during the 1990s. Output in the vital
industrial sector is to follow much the same pat-
tern, rising from the 3-percent average annual pace
of the current five-year period, to more than 4
percent during the period 1986-90 and more than 5
percent during the 1990s. These targets will be
discussed and possibly revised prior to final approv-
technologists.
The plan goals are in keeping with Gorbachev's aim
of immediately boosting economic growth through
better management and increased discipline.
Growth will be further accelerated as the impact of
the "scientific and technological revolution" he
envisions for the economy increasingly asserts it-
self. The plan makes clear that retooling industry
with new and improved equipment is Moscow's
number-one priority. The unusually detailed de-
scriptions of machinery development and produc-
tion plans suggest substantial inputs from Soviet
Modernizing Industry-
The Linchpin of the Plan
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The plan calls for a cutback in new construction
and a 50-percent increase in expenditures for re-
tooling existing enterprises. Currently, 30 to 40
percent of all Soviet equipment has been in opera-
tion for more than 20 years, but, by 1990, the plan
declares, one-third of all fixed capital-including 25X1
one-half of all machinery-must be new. To meet
this ambitious goal, machinery production-the
main carrier of new technology-is to grow at 7 to
8 percent annually, rates not achieved since the
early 1970s. Within machine building the high-
technology sectors producing computer equipment,
precision instruments, electrical equipment, and
electronics are to receive special emphasis and grow
at even faster rates.
Domestic machine builders will be hard pressed to
meet these production goals:
? For industrial modernization to succeed, not only
more, but also higher quality machinery must be
produced. The machinery must be made to order
al, scheduled for late 1986.
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USSR: Selected Indicators of Economic Performance, 1971-2000
86-9(1 91 -2000
Plan Plan
1971-75 76-80 81-85? 86-90 91-2000
Plan Plan
1971-75 76-80 81-85" 86-90
Plan
to meet the unique needs of plants being re-
tooled-a most difficult task for an industry used
to manufacturing large lots of a small variety of
equipment for use in plants being constructed
under highly standardized designs.
? The bureaucratic and geographic separation of
research from the production line will continue to
slow the development and introduction of new
equipment. Pravda reports that 70 percent of all
inventions get no further than the prototype stage
and only 2 percent are ever introduced into five or
more enterprises.
? Shortages of critical components will impede the
development of high-technology machinery.
The plan makes clear that Moscow expects its
domestic machine builders to receive substantial
help from Eastern Europe. The plan guidelines
reflect the regime's determination to increase eco-
nomic integration within CEMA by emphasizing
direct production links between enterprises and the
implementation of joint large-scale projects. The
recent appointment of Boris Aristov and Nikolay
Talyzin-both with extensive experience in East
European affairs-as Foreign Trade Minister and
Chairman of the State Planning Committee, re-
spectively, could facilitate this effort.
Energy-A Major Stumblingblock
to Plan Fulfillment
Moscow will clearly have trouble achieving its goal
of 3.2- to 3.8-percent average annual growth in
energy production. Although the targets for gas
and electricity production appear attainable, those
for oil and coal are probably beyond reach:
? Coal output, after five years of stagnation, is to
increase by 10 percent by 1990-with the entire
increment made possible by productivity gains.
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USSR: Average Annual Energy Production Growth, 1976-90
Average annual percent
Shaded portion represents a range
Primary Energy
1976-80 81-85a 86-90
Plan
1976-80 81-85, 86-90
Plan
Coal production at most major underground
mines is in decline, however, and output and use
of the lower grade coal found in surface mines
continues to be costly and beset with technical
problems.
? Oil production is supposed to rise sharply, revers-
ing a two-year decline. In view of the decreasing
well flows in West Siberia and the aging of the
USSR's best fields, however, we expect the de-
cline to continue.
Shortfalls in oil and coal production will likely limit
increases in total energy output to about 2 percent
annually, thus threatening new economic bottle-
necks.
Big Promises to the Consumer
Agricultural output is to rise by 3.2 percent annual-
ly-nearly 1 percentage point more than the 1981-
85 average-with all growth coming from in-
creased productivity. By 1990, the size of the grain
1976-80 81-85d 86-90 -1 1976-80 81-85a 86-90
Plan Plan
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harvest is to increase by about 30 percent over the
level of recent years. Even with the scheduled
increases in deliveries of critical inputs, such as
fertilizer and machinery, these targets are probably
out of reach unless weather conditions return to the
average for 1976-80-the most favorable of the
past 65 years. In consumer goods other than food,
the 2.6-percent growth achieved during the period
1981-85 is to be doubled. This goal is unlikely to be
achieved without substantial increases in invest-
ment, but a high-level Soviet planning official
indicated earlier to our Embassy that there will be
little, if any, increase in investment for the
consumer.
Resource Allocation in Question
Overall investment in 1986-90 is to rise at about
the same rate as GNP, but the draft guidelines give
no indication of how capital resources will be
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allocated among sectors. The plan for 1986, just
published last week, calls surprisingly for a big hike
in investment-to almost 8 percent-implying that
to stay within the 12th Five-Year Plan guidelines,
investment growth would have to fall to about 2.5
to 3 percent per annum during 1987-90. The big
push in investment in 1986 indicates Gorbachev's
intention to get his industrial modernization pro-
gram off to a running start. Priority will go to
machine building-the sector most critical to mod-
ernization-but energy will get a sharp boost as
well. If investment growth stays within the 1986-90
guidelines-and machine building and energy
maintain their increased shares planned for 1986-
other critical sectors such as transportation are
likely to be squeezed.
Prospects
The productivity increases called for in the 1986-90
plan are far greater than any achieved in recent
years. While some improvement is possible from
increased discipline and better management, sub-
stantial gains require a quick payback from Gorba-
chev's industrial modernization campaign. But the
lead times involved in producing new, productivity-
enhancing equipment are long, and Soviet machine
builders-given their track record-may not be up
to the task. In any event, few benefits would be
realized over the next five years. On balance, the
plan's stress on unrealistic gains in productivity is
likely to result in production shortfalls, increased
bottlenecks, and unfulfilled expectations.
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Mexico: Dim Prospects for
Economic Reform
Mexico is rapidly losing its reputation as the model
debtor because of government failures to take
appropriate adjustment measures and the subse-
quent economic problems that currently beset the
country. In our opinion, the key question for Mexi-
co's economic future is whether President de la
Madrid is able and willing to return to implement-
ing strong macroeconomic adjustment policies and
complement those with difficult, long-term eco-
nomic structural reforms. The 1986 budget-
although viewed as overly ambitious and unrealis-
tic-represents short-term movement in the right
direction. We believe, however, that implementing
this budget likely will exhaust much of the Presi-
dent's political clout, damaging prospects for more
substantial reforms. Until a comprehensive policy
package can be put in place, we believe Mexico will
continue to incur budget overruns, current account
deficits, and financing gaps that will reduce the
President's policy options
During 1983 and 1984, Mexico's economic adjust-
ment policies and their implementation under de la
Madrid were cited by the international financial
community as the model for other debtor countries.
As Mexico's financial troubles eased, the deep
recession created by these stringent policies caused
the government to reassess its economic situation in
mid-1984 with an eye toward political gain. We
believe the shift in policy direction that occurred
reflected both the ruling party's (PRI) belief that
Mexicans would not accept continued strict auster-
ity and the view that it was necessary to make a
strong showing in the important July 1985 local
and gubernatorial elections. According to Embassy
reports, key government officials decided a greater
level of economic growth was necessary, even at the
cost of higher inflation and overvaluation of the
peso. High government spending, along with an
accommodating monetary policy, spurred domestic
demand and boosted real GDP in the first six
months of 1985 at a 6-percent annual rate. Mainly
as a result of these excesses, Mexico is now experi-
encing serious financial and economic problems
that were complicated by the recent earthquake:
? Nearly $14 billion in budget overruns this year
are being financed largely through domestic
borrowing.
? The money supply has risen by 65 percent so
far this year, according to Embassy reporting,
fueling an annualized inflation rate of at least
60 percent. Recent efforts to force interest rates
down have nearly halted private purchases of
government bonds and threaten to fuel money
supply growth.
capital
flight is continuing at about $1 billion per month.
This outflow has put renewed downward pressure
on the peso as the free market rate has fallen
from 360 per US dollar in mid-August to over
500 per dollar by late November
? Mexico's current account has moved into deficit
and the financing gap has widened. We believe in
1986 Mexico will need perhaps as much as twice
the $4.1 billion in foreign funding already re-
quested from international creditor institutions.
The government's commitment to a new set of
austerity measures, announced shortly after the
elections was sidetracked by September's earth-
quakes. Perhaps more important, de la Madrid's
handling of the disaster caused latent doubts to
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surface among supporters inside and outside the
government over his leadership ability,
Policy Challenges in 1986
In our view, de la Madrid will face a complex
economic challenge in 1986-trying to avoid a
repeat of 1983's deep recession and resisting politi-
cal pressure to continue expansion. On the basis of
his annual budget message delivered to the Mexi-
can Congress on 15 November, it appears de la
Madrid is aware of the difficulty. Allowing for
little or no economic growth, next year's program
seeks to slash the budget deficit as a percentage of
GDP in half to 5 percent and cut inflation from
over 60 percent to 45 percent. The President also
promised significant structural adjustments and
reaffirmed the country's intention to honor its debt
obligations.
We believe de la Madrid will come under increas-
ing pressure to abandon austerity in the months
ahead. Labor probably will try to recoup some of
the 30-percent decline in real wages suffered over
the last three years. Businessmen are likely to
demand compensation if their profits are threat-
ened by increased foreign competition. Moreover,
political infighting within the President's economic
cabinet threatens to undermine the confidence de la
Madrid must build if he is to gain popular support,
stem capital flight, and temper inflationary expec-
Longer term structural changes needed to restore
market forces, encourage domestic savings and
investment, and reverse capital flight include:
? Reducing the government's role in the economy,
especially by the liquidation or sale of inefficient
public enterprises and return of Mexico's banks
to private-sector control.
? Redirecting public-sector investment to empha-
size labor-intensive activities such as assembly
industries, infrastructure construction, and
agriculture.
? Liberalizing trade to promote competition
through elimination of burdensome import li-
censes and bureaucratic redtape.
? Encouraging export promotion in the private
sector to diversify sources of foreign exchange
and reduce vulnerability to volatile oil prices.
? Changing foreign investment laws to acquire
much-needed capital, create jobs, and modernize
Mexican industry.
Dismal Prospects for Comprehensive
Economic Restructuring
We believe prospects for implementation of longer
term structural reforms are not good, because they
all run counter to traditional Mexican political and
economic philosophy and would have a painful
impact on important interest groups. Government
involvement in the economy is deep seated with
many Mexicans regarding a strong government role
and Mexicanization as a cornerstone of the PRI.
Private-sector autonomy has been sacrificed to co-
opt groups such as labor and the left. The govern-
ment, in turn, compensates affected influential
businessmen by granting them favorable treatment,
such as protecting their markets and appointing
them to top positions in state-owned enterprises.
At the same time, we believe strong Mexican
nationalism and a longheld policy of import substi-
tution hinders Mexican policymakers from signifi-
cantly opening the economy to foreign investment
and imports. Despite the decision to allow IBM
100-percent ownership of its Mexican subsidiary-
an exception to the standing 49-percent limit-we
agree with international financial observers that
the move was a one-time action designed to deflect
foreign criticism. Import liberalization is viewed
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with even greater trepidation by inefficient domes-
tic producers who fear that foreign competition
would threaten their entrenched monopolistic posi-
tions. Replacement of some licenses with a more
efficient tariff system has helped boost imports by
30 percent this year. Since Mexico City would
undoubtedly be pressured to compensate manufac-
turers for profits lost to foreign suppliers-at least
in the short run-in our opinion, de la Madrid is
not likely to make progress on this front.
Because the adjustment measures required for
long-term economic health would generate power-
ful controversy, we believe de la Madrid will
muddle through with stop-and-go policies until his
administration ends in 1988. Procrastination will
leave the economy in worse shape than when he
took office and make the inevitable adjustment
more painful. From a political perspective, we
believe this backsliding would aggravate existing
policy conflicts within the government, strengthen-
ing the hand of those who favor anti-US and
protectionist policies.
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Iran: Developing Alternative
Oil Export Facilities
Khark Island handles nearly 90 percent of all Iran's
crude exports. Recent Iraqi success-although lim-
ited-at disrupting Iranian oil flows from Khark
Island has forced the oil industry managers in
Tehran to reexamine alternative oil export plans to
bypass Khark. a
number of alternative export facilities-many still
within Iraqi air range-have been discussed within
Iran's National Oil Company (NIOC). All involve
laying of pipe and the construction of another
loading terminal. NIOC has already started con-
struction of one at Ganaveh, and, we believe,
construction of at least one more bypass project will
begin soon, reducing Iran's dependency on Khark.
Additional Iranian export facilities will also en-
hance the security of Western oil supplies and
reduce the risk of escalation of the war within the
Persian Gulf
Ganaveh Project
A short-term project is under way connecting the
oil pipeline manifold at Ganaveh, which links Iran's
onshore oilfields to Khark Island, with a loading
facility to be located about 24 kilometers offshore.
two 42-inch
We expect the initial loading facilities will probably
consist of three floating hoses at the end of each of
the two pipelines from which supertankers can load
up to 1.5 million b/d. Once single-point buoy
moorings (SBM)H
are installed, we believe loading
rates could exceed 2 million b/d. We estimate the
cost of this project will be about $70 million with
exports beginning in early 1986
The IGAT2 Option
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proposal under consideration involves laying pipe
approximately 80 kilometers from the major Gach-
saran oilfield across the mountains to the partially
completed 56-inch IGAT2 gas pipeline-originally 25X1
designed to transport gas from Iran's southern
gasfields to the USSR. Plans to use the IGAT2
pipeline for gas transmission would have to be
abandoned-a likely prospect given the continuing
chill in Iranian relations with Moscow. The gasline 25X1
would need to be converted to handle oil by adding
a pump station along the line. Additionally, some
modifications within the oilfield pipeline system
would have to be made so that crude from Iran's
other major oilfields could flow through this line to
meet its projected capacity. The existing line ends
at the Kangan gas processing plant in southern
Iran, requiring NIOC to build a 30-kilometer
connecting pipeline from the processing plant to an
oil-loading terminal on the coast, probably at Ta-
heri. We estimate that Tehran also would need to
construct a tank farm to handle 6-10 million
barrels of storage and install several SBMs to load
the crude.
Our engineering analysis suggests this alternative
could add approximately 2 million b/d to Iran's oil
export capacity at a cost between $300-400 million
pipelines are being laid, an
they will terminate in water at least 25 meters
deep-enough to handle very large crude carriers.
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and would probably take eight to 10 months to
complete. The timeframe could be cut by up to
half-but only at a proportional increase in cost-
by using additional crews and an intense work
schedule. Crude flows through the IGAT2 line
would be extremely difficult to disrupt because the
pipeline would traverse inland mountain valleys
and the proposed export facilities at Taheri would
be much smaller and about twice as far from Iraq
as Khark Island.
Completion of IGAT2 as an oil project would also
provide Tehran an option to continue the pipeline
network from Kangan or Taheri to a point outside of
the Strait of Hormuz, probably Jask, should an even
more secure outlet be desired. The need for a crude
oil pipeline-even two-to an export terminal out-
side the Strait has been seriously considered by both
NIOC and the Iranian parliament before, but so far
the high cost and long leadtimes of a new pipeline
system have been considered prohibitive. Using the
prospective IGAT2 connection, we estimate the
overall project from Gachsaran to Jask would still
involve the construction of several pump stations,
more than 600 kilometers of pipeline, and a new oil
storage and export terminal. Such a project could
cost well over $2 billion and take two years or more
to complete once an agreement is reached.
Tehran is also consid-
ering use of another future gas project-the Pars
project-as an alternate oil route. This project was
initially designed-but never built-to bring gas
north from the offshore Pars and onshore Kangan
gasfields along the coast to the major onshore
oilfields for injection to maintain oil reservoir pres-
sures. The plan consists of laying two 42-inch high-
pressure pipelines that would terminate at a loading
terminal at Taheri, Asaluyeh, or Lavan Island.
When the war is over, these lines could be convert-
ed back for use as a high-pressure gas transmission
line. The option would provide a capacity of 2
million b/d, take up to two years to complete, and
could cost in excess of $2 billion.
We expect that the IGAT2 oil pipeline project will
be approved and would be started as soon as bids
are reviewed and a contract agreement reached.
The Pars gas pipeline conversion scheme will not be
implemented, in our opinion, although the original
concept for the Pars gas pipeline project may be
approved. the produc-
tive capacity of Iran's main oilfields is deteriorating
because of low reservoir pressures and must soon
have gas injection to sustain current production
levels
If Tehran proceeds with these projects, its export
capacity will quickly exceed its oilfield productive
capability-currently estimated at just over 3 mil-
lion b/d. With repairs at Khark Island continuing,
export capacity there could soon be nearly 4 million
b/d and completion of the offshore facilities at
Gavaneh would bring export capacity up to about 6
million b/d. By the end of 1986, Tehran could have
an export capability of up to 8 million b/d if it
proceeds promptly with the IGAT2 option and Iraq
does not knock out the current export facilities.
Completion of these projects would give Tehran the
ability to increase its oil exports well beyond cur-
rent levels.
With little prospect for any substantial increase in
the demand for OPEC oil, higher oil exports by Iran
certainly would add to downward pressures on world
oil prices. We would expect Tehran to try to main-
tain revenue flows so it can continue to finance its
war, adjusting export levels and prices to accomplish
its goal. Creation of additional Iranian oil export
capacity will reduce the vulnerability of Tehran's oil
exports to Iraqi attacks and the risk that Tehran
might retaliate for attacks on Khark by striking
Arab oil facilities across the Gulf. The West may
also benefit from lower prices for crude as Iran
competes with the other OPEC countries with sur-
plus productive capacity to maintain revenues in a
soft oil market, although we do not expect Tehran to
be a leader in any oil-market price cuts.
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Iranian Oil Export Alternatives
Saudi Arabia
Neutral tone
ilawr at
Hammar
SAUDI ARABIA
Dezfil
SAM
}
ARABIA
Kermanshah
Mina
AIAWAIT
2~lr
25ak s
CASPIAN
SEA
Jazireh ye
Kherk\
.Shiraz
it
SOVIET- UNION
Oilfield
Oil pipeline
? Gasfield
Gas pipeline
a
aer
Refinery
Tanker terminal
Abada
Bahregan
coring export termi,
Jazirehye /NO-Q
Qeshm {(o~
NOTE: Proposed pipeline alignments
are approximate
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Eastern Europe:
Winter Energy Worries
After suffering some of the worst energy shortages
in the postwar era last winter, East Europeans are
preparing anxiously for the coming season. Every
country in the region is attempting to increase fuel
production and imports, accelerate the repair and
construction of energy facilities, and implement
stringent-if belated-conservation measures.
Nonetheless, Bulgaria, Romania, and Yugoslavia
probably will incur energy shortages this winter
even if the weather is average. These shortfalls will
again cripple industrial production and stunt eco-
nomic growth. The populace-especially in Roma-
nia-almost certainly will have to cope with anoth-
er cold, dark winter that can only lead to further
disaffection toward their Communist leaders.F_
? In Yugoslavia, heavy snows disrupted coal and
fuel oil deliveries to thermoelectric plants causing
brief power outages in some areas. The govern-
ment was forced to boost imports of oil by 31
percent and to increase imports of electricity.
Deliveries of gas to industry were restricted, and
some towns experienced heating problems.
Drought-now in its third year-aggravated ener-
gy shortages in these three countries, which depend
more than the rest of the region on hydroelectric
power. Yugoslavia is the most vulnerable because it
relies on hydroelectric power for one-third of its
electricity compared to 14 to 18 percent in Roma-
nia, and 8 to 12 percent in Bulgaria.
Last Winter's Big Chill
Temperatures in Eastern Europe last January and
February averaged 9 degrees Fahrenheit below
normal. The cold weather increased demand for
energy and disrupted supplies, hindering transpor-
tation and industrial production. The impact of the
energy shortages varied considerably, with coun-
tries in the southern tier faring worst:
? In Bulgaria, widespread shortages of electricity
and heating created a near emergency. Electricity
was provided on a three-hours-on, three-hours-off
schedule. The few open gas stations faced long
lines of motorists. Factories were shut down, train
schedules were reduced, television broadcasts
were scaled back, and school classes were can-
celed to conserve energy.
? In Romania, authorities implemented strict mea-
sures to ration energy. Additional workers were
mustered for round-the-clock mining operations
to increase coal production. A 50-percent reduc-
tion in public lighting was mandated, with house-
holds limited to the use of one 15-watt light bulb.
Across the country many homes were without
heat, gas, or water for days.
Although countries in the north fared better, ener-
gy shortages there also were worse than usual:
? In East Germany, authorities called in military
personnel and police to help mine and transport
coal and operate power stations when the freezing
of water-laden lignite beds caused local fuel
shortages and power outages. East Berlin was
forced to import coal from West Germany to
keep steel mills from shutting down.
? In Czechoslovakia, deliveries of gas to large-scale
industrial consumers were cut 10 percent. Coal
deliveries were down because the Elbe River
froze and rail transportation fell below planned
levels.
? In Hungary, a natural gas shortage forced re-
strictions on industrial users for more than 40
days, resulting in considerable loss in production.
Although imports of oil and natural gas were
increased for industry, most consumption needs
were met by oil reserves, according to the Hun-
garian press. Households, however, were largely
unaffected except for restrictions on TV broad-
casting, sporadic electricity shortages, and some
rationing of coal.
Secret
DI IEEW 85-048
6 December 1985
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Constraints on Energy Imports
A shortage of hard currency and tight Soviet oil
supplies contribute to Eastern Europe's energy
worries. The hard currency problems, which
plagued most of Eastern Europe in the early
1980s, have forced the region to restrict Western
imports, slowing the replacement of antiquated
plant and machinery with more modern, energy-
efficient equipment. The poor condition of power
installations results in frequent breakdowns and
limits the ability of these countries to step up
energy output when demand surges. Moreover,
most countries cannot afford to buy substantial
amounts of additional oil in the West.
Although Soviet energy deliveries to several coun-
tries were interrupted temporarily last winter be-
cause of technical and logistic problems, Moscow
for the most part met the contracted volume of
deliveries. Limits on Soviet oil deliveries in recent
years, however, have forced Eastern Europe to rely
more heavily on domestic resources. Thus, last
winter's disruptions in production hit even harder.
Moreover, because of its displeasure with Sofia's
economic and political policies, Moscow has decid-
ed to cut oil supplies to Bulgaria and made it clear
that other East European countries cannot expect
increased deliveries in the coming year
moved to a two-hours-on, two-hours-off schedule
for most of the country. A Bulgarian official
admitted to US diplomats in late October that 10
percent of electrical capacity was shut off at any
given time. Romania's energy difficulties were
highlighted in October when the government an-
nounced that military commanders were to be
assigned to all power plants to oversee the strict
observance of maintenance and production sched-
ules. Employees are to work under stringent mili-
tary rules.
Continuing problems in Yugoslavia were evidenced
in October with the imposition of restrictions on
electricity usage throughout much of the country.
The restrictions, while generally mild, have created
anxieties over the coming winter. Some republics
have already begun to cut electricity to industry.
To avoid a repetition of last winter's shortages, the
East Europeans are attempting-with limited suc-
cess-to expand energy production and replenish
stocks. They are also speeding repair work, con-
structing new energy facilities, and imposing vari-
ous conservation measures. Hungary, Bulgaria, Po-
land, and Yugoslavia also have raised prices for
domestic energy in order to dampen demand.
? In Poland, supplies of coal, natural gas, and
electricity to large industrial users were restricted
to make extra energy available to heating plants,
power plants, and households. Transportation
breakdowns because of heavy snow and freezing
temperatures hampered coal deliveries. Sporadic
shortages hit many areas around the country.
Planned outages in Romania and Bulgaria are
largely attempts to spread energy reductions
throughout the entire year and avoid more serious
disruptions during the winter
We believe that the northern tier of the region will
make it through this winter without major energy
disruptions, barring another bout with record cold.
For Czechoslovakia, Hungary, Poland, and East
Germany, their ability to meet most of their energy
needs under adverse conditions, combined with
extra precautions and better overall preparedness,
suggests that an average winter will pose no major
While the energy situation eased in the spring,
Bulgaria and Romania have continued to be
plagued by shortages. In late July, Bulgarian au-
thorities reinstituted the three-hours-on, three-
hours-off electricity schedules, and in August
threat
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Yugoslavia's prospects this winter hinge in large
part on the continuing severity of the drought. At
this point the situation potentially is more serious
than last year, but better than in 1983 when
reduced hydroelectric reserves-as much as 40
percent below normal-led to periodic electricity
blackouts throughout the country
Bulgarians probably will suffer the same electricity
cutbacks this winter that they have faced most of
this year despite measures to increase supplies and
remedy the breakdowns in the power industry.
While Sofia's planners could increase imports even
more to offset production shortfalls and reduced
Soviet oil supplies, they have been reluctant to
increase hard currency debts and probably will
continue to squeeze the population.
We expect that Romania will face the gravest
energy difficulties this winter. The imposition of a
military work regime on demoralized workers may
succeed in lifting energy production somewhat, but
coal production will fall far short of the unrealistic
targets set by Bucharest. Because of acute hard
currency problems, Romanian leaders will continue
to export a significant portion of the country's oil-
even in the face of domestic energy shortages.
Romanian households will be forced to bear the
burden of energy shortfalls.
Energy shortages this winter in Bulgaria, Romania,
and possibly Yugoslavia will again be reflected in
losses in production, which will lower economic
growth and set back export and investment plans.
Romania, trying hard to maintain some confidence
of Western bankers in its crumbling economy, will
have even more difficulty in sustaining hard cur-
rency exports.
Nonetheless, major domestic unrest due to energy
shortages seems unlikely. Romanians are accus-
tomed to hardships, and leaders in other East
European countries were careful to favor house-
holds last winter at the expense of industry and
subsequent production declines. We believe that
Yugoslavia will monitor carefully popular reaction
to conservation measures. In the event of wide-
spread public unrest, Belgrade probably would
boost energy supplies to the population, either by
shorting industry or increasing imports.
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Venezuela: Modest Reforms in Foreign
Direct Investment Policy
Confronted by the prospect of long-term stagnation
in oil revenues, Venezuela has revised its develop-
ment strategy. A key feature is a renewed role for
foreign direct investment (FDI), to broaden the
industrial base and reduce import needs. President
Lusinchi's top economic advisers see FDI as an
important potential source of technology, manage-
rial know-how, and capital. The administration's
attempts to liberalize regulations governing FDI,
however, have been constrained by domestic politi-
cal considerations and restrictions imposed by the
Andean Pact. The reforms announced by the gov-
ernment last June are, in the view of the US
Embassy, unlikely to stimulate significant foreign
investment. We believe that, for the medium term,
the absence of important new commitments by
foreign investors will probably combine with de-
pressed private domestic investment to further ex-
tend an economic recession that is now in its
seventh year. Over the longer term, the failure to
attract FDI raises questions about the prospects for
economic development because of the state's repu-
tation for inefficiency and corruption.
Venezuela: Real Nonpetroleum
GDP Growth, 1970-85
FDI: A Decade of Neglect
Venezuela withdrew the welcome mat for foreign
investors in 1974, as euphoria over a prospective oil
bonanza led nationalists to conclude that FDI was
no longer essential. They asserted that the nation's
capital requirements could be drawn from-or
borrowed against-the inflow of petrodollars and
that the technology that normally accompanies
foreign investment could be licensed. Acceptance of
this view led Venezuela to join the Andean Pact' in
1973 and, the following year, to enact legislation
implementing the Pact's Decision 24, which regu-
lates FDI.
' The Andean Pact is an association for regional economic integra-
tion and cooperation comprising Venezuela, Colombia, Ecuador,
Venezuelan regulations implementing Decision 24
require that firms with majority foreign ownership:
? Convert to majority Venezuelan ownership within
15 years of entry.
? Limit annual profit remittances to 20 percent of
registered foreign capital.
? Limit increases in registered foreign capital to 7
percent per year.
? Limit borrowing in domestic financial markets to
an amount equal to 40 percent of capital.
? Negotiate royalty and license fees to be paid
abroad with the office of foreign investment
(SIEX).
? Submit to a bewildering array of SIEX rules and
regulations.
Secret
DI /EEW 85-048
6 December 1985
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Venezuela: Gross Fixed Investment,
by Sector, 1975-84
Billion 1968 Bolivars
20
4
0 1975 76 77 78 79 80 81 82 83 84
The results over the past decade have been dramat-
ic-most registered foreign investment now in Ven-
ezuela entered before 1974. Since then, FDI has
largely been financed through the reinvestment of
retained profits, while investment financed by new
money from abroad has slowed to a trickle. Invest-
ment consultants in Caracas note that potential
investors object most to the requirement to convert
to majority Venezuelan ownership. They add that
fear of losing control of proprietary information
causes some multinationals to reject even minority
participation by host country investors.
Last June, following nearly one year of intense
debate, the President decreed a revision of the
foreign investment code. According to the US
Embassy, the move to liberalize the code was
spearheaded by Development Minister Hurtado,
Finance Minister Azpurua, and Minister of the
US Direct Investment Position in
South America, 1983
Brazil
Argentina
Peru
Colombia
Venezuela
Other
I
Presidency Lauria-each a respected technocrat,
but without power bases within the ruling party.
dollar accounts abroad.
According to press accounts, the reformers con-
tended that the development strategy followed over
the past decade had contributed to stagnation by
making the economy overly dependent on the state
for entrepreneurship, risk capital, and technology.
Proponents also argued that, although the direct
impact of increased foreign investment would be
important, FDI's catalytic effect on domestic inves-
tors would likely be far more significant. Invest-
ment by foreigners would create opportunities for
domestic investors in related industries and, by
improving the general investment climate, would
also encourage the repatriation of capital from
The call for reform drew wide-ranging opposition,
however. According to the US Embassy, leftist and
nationalistic elements within the ruling party, as
well as opposition parties of the left, rejected FDI
liberalization on ideological grounds. In addition,
domestic industrialists opposed any moves that
might threaten their market shares and profits.
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Venezuela: Share of Cumulative
Foreign Direct Investment,
by Country of Origin, 1984
Total
Belgium
Japan
3.2
Switzerland
United Kingdom
United States
Others
Complicating President Lusinchi's dilemma, ac-
cording to investment consultants in Caracas, was
his fear of being perceived as caving in to foreign
interests. He had been subjected to such charges
when, shortly after taking office in 1984, he estab-
lished a preferential exchange rate for repayment
of the external private debt. Consequently, the June
decree incorporates many of the changes advanced
by the cabinet reform group, but also attempts to
placate opponents by not carrying reform beyond
the spirit of Decision 24.
The principal features of the reform are:
? Foreign investment may now be registered in the
currency of origin, thus shielding the 20-percent
cap on profit remittances against devaluations.
? Agriculture, agro-industry, tourism, and con-
struction are exempted from the principal provi-
sions of Decision 24.
? Investment in most other sectors may be ap-
proved if it emphasizes technology transfer, em-
ployment, local value added, or exports.
? The hard currency debt of foreign-owned firms
may be converted to registered investment.
? Foreign-owned firms will be allowed greater ad-
ministrative freedom from SIEX.
Venezuela: Share of Cumulative
Foreign Direct Investment,
by Sector, 1984
Total 100.0
Agriculture, fishing, mining 2.4
Commerce, restaurants,
hotels, services
74.0
4.5
3.1
4.8
Dim Prospects
We believe that the June revisions are far too
modest to generate a significant surge in foreign
direct investment, despite ambitious forays abroad
by SIEX to sell Venezuela to potential investors.
The decree fails to address the core concerns of
investors, in particular the requirement to convert
to majority Venezuelan ownership within 15 years.
A significant liberalization of Decision 24 will
probably be required before investors again per-
ceive Venezuela and the other Andean nations as
attractive markets in which to invest. Andean Pact
foreign ministers will meet in January to consider
proposals for liberalization, a move that is gaining
support within the Pact, according to reports from
US Embassies.
In our judgment, however, foreign investment flows
are likely to remain depressed over the medium
term, even if Decision 24 is liberalized. Investor
confidence in Venezuela has been severely shaken
by six years of economic stagnation, the deteriorat-
ing prospects for oil exports, a decade of policymak-
ing flip-flops, and the Latin American debt crisis.
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Other countries with more positive foreign invest-
ment climates offer potential investors better profit
prospects.
Implications
To the extent that foreign investment-and associ-
ated domestic investment funds repatriated from
abroad-falls short of its potential, balance-of-
payments management will be more difficult than
otherwise. This will, in our view, aggravate the
pressures that stagnant oil revenues are likely to
place on the government to limit current account
deficits through austerity measures.
The failure to attract significant foreign and associ-
ated domestic private investment also implies, we
believe, continued reliance upon the state for entre-
preneurship and risk capital. Such reliance could
increase the potential for social unrest by retarding
economic development. Over the past decade, the
government has squandered huge sums of oil reve-
nues on poorly conceived and ill-managed projects,
and its management of investment funds has been
riddled with corruption.
For the United States, an improved investment
climate would enable US firms to invest and
produce behind Venezuela's heightened import bar-
riers, thus offsetting, in part, US export revenues
lost to such barriers. Nonetheless, we believe that
continued restrictions on foreign direct investment
clearly foreshadow reduced commercial opportuni-
ties in Venezuela, our most important export mar-
ket in South America.
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Kenya:
Economy at the Crossroads
Kenya faces problems-a ponderous government
bureaucracy, runaway population growth, deterio-
rating foreign payments position, and a vulnerable
export market-which, if unresolved, could under-
mine its position as one of the few open and
successful economies on the continent. After Ken-
ya's remarkable economic successes in the first
decade following independence in 1963, a series of
international events, together with significant
structural problems, have combined since the 1970s
to undermine prior gains. In our view, Kenya can
no longer afford merely to continue making rela-
tively minor adjustments to the policies that have
served it well in the past. Economic performance
over the past few years has been mixed, but the
prospects for improvement over the near term
under the current government strategy are not
bright. Although real GDP is expected to grow by 4
percent in 1985, Kenya is saddled with an urban
unemployment rate exceeding 12 percent, a debt
service ratio of approximately 30 percent, and
sufficient hard currency for less than three months
Kenya to import large amounts of foodstuffs. The
only bright spots were the doubling of the world-
market price for tea and a 10-percent improvement
in the export price for coffee in 1984F ~ 25X1
Although Kenya has emerged successfully from the
drought in 1985, serious long-term problems re-
main. The relentless growth in population-the
highest in the world at 4.2 percent last year-is
outstripping the ability of farmers to increase food
production. Kenya's small proportion of arable land
has exceeded its carrying capacity, forcing growing
numbers to cultivate marginal lands and making
productivity gains more difficult to achieve. Ken-
ya's agricultural productivity has been further
eroded by disincentives to farmers resulting from
government regulation of prices. According the US
Embassy, actual receipts by Kenyan farmers are
generally between 75 and 85 percent of the free-
market price. In spite of government promises to
reduce the number of commodities that are price
controlled, progress to date has been slow.[ 25X1
of imports.
Agriculture: A Troubled Sector
Sluggish Manufacturing Performance
Kenya's crucial agricultural sector is in deep trou-
ble. Agriculture provides more than two-thirds of
Kenya's exports and contributes a 30-percent share
of GDP; about 85 percent of the country's popula-
tion depends upon agriculture for its livelihood.
Agricultural growth has slowed considerably, from
a 4.6-percent per annum growth rate during the
eight years following independence to an average of
about 2.7 percent during 1972-79. Total output
from the agricultural sector declined by 2.9 percent
in 1984 compared to 1983, largely because of the
worst drought in the country's history. Coffee, sisal,
and sugarcane showed modest increases with most
other agricultural commodities registering declines.
The IMF estimates, that, in 1984, grain output fell
by about 40 percent below normal levels, requiring
Protectionism and import substitution of the post-
independence years have not prepared Kenya's
manufacturing sector for competition in current
markets. Comprising approximately 11 percent of
GDP, with a growth rate of about 4 percent in
1984, Kenyan industrial output has slowed consid-
erably compared to the 10-percent average growth
rate of the 1970s. The collapse of the East African
Community in 1978, with the ensuing closure of
neighboring countries' borders, and attempts by the
government to open domestic markets to imports
have hurt Kenyan manufacturers, increasing unuti-
lized capacity and delaying additional investments.
Kenya's declining terms of trade have considerably
Secret
DI IEEW 85-048
6 December 1985
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Kenya: Selected Economic Indicators, 1980-85
Real GDP
Percent
Debt Service Ratio
Percent
limited the country's import capacity and hence the
supply of essential foreign inputs for industrial
production.
Inhibiting Role of the
Public Sector
The government's role in the economy is overly
intrusive and often counterproductive, in our judg-
ment. Although government spending accounts for
only about 29 percent of GDP, the government
controls the prices of basic producer and consumer
goods, bank rates, foreign exchange rates, and
minimum wages. The US Embassy reports that the
huge, inefficient, and costly Kenyan bureaucracy
fetters the marketplace with overregulation and
corruption, reducing incentives to investors and
primary producers. Kenya operates a vast network
of parastatal organizations-apart from the statu-
tory boards, there are 47 wholly owned enterprises
and more than 100 companies with majority or
minority government ownership. While some of
Trade Balance
Billion SDRs
Government Spending
Billion Kenyan shillings
these public enterprises have made profits, many
have made significant losses, with the cumulative
effect of a net fiscal drain and the diversion of
scarce resources away from more productive uses.
Substantial progress has been recorded in reducing
the overall budgetary deficit in the last few years,
but, according to the IMF additional actions will be
required in the 1985/86 budget
Foreign Payments Difficulties
Kenya's vulnerability to fluctuations in commodity
prices, combined with the recent drought, has
generated a worsening foreign payments situation.
Although Kenya benefited from unanticipated high
coffee and tea prices in 1984, the outlook for 1985
and 1986 is precarious. A combination of high
import levels, less buoyant coffee and tea earnings,
"off-budget" foreign exchange commitments for
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Secret
airline and patrol boat programs, plus a slower rate
of disbursal from aid donors will reduce foreign
exchange holdings. Kenya's central bank and trea-
sury project a 20-percent fall in coffee prices and a
34-percent drop in tea prices this year. Coffee
earnings will remain further constrained by Ken-
ya's modest International Coffee Organization ex-
port quota which stands at two-thirds of its produc-
believe the generally optimistic outlook held by the
IMF has served both to postpone needed policy
adjustments and to limit the bilateral aid that a
more pessimistic assessment of Kenya's economic
tion
As a result of reduced coffee and tea prices, the
Kenyans have boosted their projection of the cur-
rent account deficit for 1985 by 25 percent. Ac-
cording to internal central bank estimates, at the
end of October, Kenya's foreign exchange reserves
stood at $320 million-the lowest level in two
years-enough to cover less than three months of
imports. Thus far, there has been no increase in
government grants from donors. Likewise, tourism
earnings are not expected to improve unless there is
a new appreciation of the US dollar. Unless Ken-
ya's export sector improves drastically, the next
several years will be difficult.
Kenya's implementation of many IMF recommend-
ed adjustments and its integration of the private
sector into its development strategy stand in stark
contrast to the policies of most of its radical
African sister states. Having successfully negotiat-
ed several standby agreements, Kenya stands as
one of the IMF's prize pupils in Africa. Despite the
trauma of the 1984 drought, Kenya has effected
some limited IMF-sponsored adjustments that have
merely kept the lid on the budget deficit and
inflation-currently about 12 percent. Under the
Fund's auspices, Kenya has made strides in liberal-
izing the trade regime, slowing fiscal expansion,
depreciating the Kenyan shilling, and enacting
several other reforms laudable in an LDC context.
According to the US Embassy, however, some
observers feel that the IMF is pulling its punches
on more fundamental reforms for fear of damaging
its present positive relationship with Nairobi. We
health would elicit from donor countries.
The coming years will be crucial ones for Kenya's
economy. The combination of several years of
external shocks to the economy and lack of ade-
quate policy responses have led to growing econom-
ic tensions. Although increased export prices helped
to lessen the impact of the 1984 drought, Kenya, in
our view, cannot reliably depend upon the volatile
commodity market to raise domestic growth. Ken-
ya's current abundant food situation masks a sharp
deterioration in the terms of trade for its chief
resources, coffee and tea.
Unless the Moi government can use its present
window of opportunity before the next external 25X1
shock to enact the arduous reforms necessary to
encourage growth, we believe Kenya's past achieve-
ments will be undermined. In our view, prerequi-
sites to better per capita growth performance in-
clude the dismantling of policies that retard
agricultural growth, instituting aggressive budget-
ary and anticorruption measures, rationalizing par-
astatals, and reducing the rate of population
growth. Unless decisive action is taken on these and
other fronts, it is difficult to identify a vehicle that
Kenya can use to generate sustained economic
growth.
The Kenyan Government acknowledges the need to
act on the host of hard choices to effect structural
change. It wants the resources that are available
from its bilateral and multilateral donors but finds
the broad policy prescriptions that accompany the
dialogue with donors unpalatable. We believe that
the government's desire to limit the presence and 25X1
influence of private corporations, the role of tribal
patronage in Kenya's economic decision making,
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and the general government desire to be in the
driver's seat will limit President Moi's willingness
to enact the major initiatives necessary to invigo-
rate the economy.
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OPEC Ministers
Meet This Weekend
Oil Price Increases
Energy
The meeting in Geneva will probably focus on ways to avert a major break in
oil prices early next year. Little progress is likely to be made, however, because
oil companies are building up stocks for the winter heating season, which has
strengthened the oil market and reduced the pressure on OPEC to take
immediate action. OPEC crude oil production rose to about 18 million b/d last
month in response to the higher demand, but this level probably would be
about 3-4 million b/d greater than next spring's demand for OPEC crude oil.
Several non-OPEC oil producers have announced crude oil price increases in
response to rising spot prices. Egypt raised prices for its heavier crudes by 25 to
65 cents per barrel, and Mexico increased its light crude prices by 55 to 85
cents per barrel effective 1 December. In addition, two Canadian companies
have announced increases of more than $1 per barrel. Meanwhile, Venezuela
plans to raise prices for petroleum product exports. Spot prices are rising
because of low oil inventories, the start of the winter heating season, and
curtailed Soviet exports. Unless OPEC producers restore production discipline
and cut output, however, the market will have a difficult. time supporting these
increases. Price weakness could reappear by early next year in response to a
seasonal decline in demand or sooner if oil inventories begin to climb.
Reduction in Soviet The Soviets are warning longtime customers in the West that contracts for
J Oil Exports
delivery of crude oil and refined products next year will be reduced. Hard
currency oil exports for 1985, estimated to average 1.15 million barrels per
are down 25
da
ercent from last
ear
y,
p
y
.
Apparently-----deliveries to the West will bear the
brunt of any reductions, at least initially. The USSR's prospects for reversing
the decline in its hard currency earnings are slim. So far Moscow has
responded by stepping up borrowing and apparently by postponing purchases.
It may, however, want to step up gold sales next year.
Recent Iranian oil barter deals have encountered resistance that could worsen
shortages of imported goods. an increasing
number of foreign customers have rejected Iranian barter proposals because of
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DI IEEW 85-048
6 December 1985
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concern over Tehran's ability to export oil through the Gulf. Handling fees as
high as 18 percent charged by "middleman" companies, and the recent slide of
the dollar-which complicates calculations of these charges-also are cited by
customers. In addition, many firms have complained about stringent technical
clauses in the contracts and bureaucratic inefficiencies in Tehran. These
difficulties are likely to cause Iran to channel trade throuah its well
established barter links to Japanese and Turkish firms.
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according to the US Embassy in
market]
Riyadh, the negotiations for the second phase of the Iraqi-Saudi pipeline
appear stalled after reportedly difficult meetings between the two countries'
petroleum ministers in early November. Although a Saudi agreement in
principle for phase two was obtained sometime ago, Iraq probably is resisting
expensive Saudi technical requirements nominally intended to protect
Aramco's colocated facilities. We believe Saudi reluctance stems more from
concern about Iraqi access to Saudi Arabia and more Iraqi oil in a weak oil
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Meanwhile, Sanaa has asked the World Bank to help it establish a new
mechanism to review all contracts and proposals from firms interested in a role
in North Yemen's oil industry. This may stem from criticism by some officials
that international firms took advantage of North Yemen's lack of experience
in negotiating oil contracts. Sanaa's new system, however, is unlikely to affect
the oil relationship with the United States
As Foreign Minister Shevardnadze's January visit to Japan approaches,
pressure to find a suitable welcoming "gift" is rising.
MITI may offer to import I million tons of LNG
beginning in 1995 and somewhat larger quantities at an unspecified later date.
This represents a five-year postponement and a two-thirds reduction in the
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6 December 1985
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Secret
China Stalling
on Nuclear Power
Contracts
original volume. MITI probably wants to stall as long as possible. The
proposed cut in volume, however, would make the venture uneconomic,and, we
believe, the project will remain on hold. Japanese utilities already have
sufficient supplies well into the 1990s and want the Soviets to lower their price
to below that of oil, which is unlikely.
Beijing is deliberately stalling on finalizing contracts with West German and
French firms for construction of nuclear power plants in China. Moreover, the
bidding for these much-coveted deals may be reopened to include US and
Japanese suppliers. (Both the US and Japan recently signed nuclear accords
with China.) Beijing, over the last five years, has expressed dissatisfication
with the French over pricing terms and the slow projected rate of technology
transfer for the Daya Bay project in Guangdong Province. Moreover, Chinese
officials have stated that the current talks are France's "last chance." Beijing
has also pressed the West Germans, the leading contender for the Sunan
project in Jiangsu Province, for a sizable amount of countertrade financing.
Although the Germans may be willing to cooperate, Beijing has not budgeted
the project in the next five-year plan. Experiencing a significant foreign
currency shortage, China may be prepared to temporarily forgo the nuclear
option and turn to low-cost coal plants until economic conditions improve.
agreements because of its strong foreign payments position. Finance Minister
Funaro announced last week that Brazil will cease efforts to reach an IMF ac-
cord and to restructure its bank debt. Brasilia claims its fiscal reform program
for 1986 is as tough as is politically feasible and that it will reduce the public-
sector deficit substantially, although not as much as demanded by the Fund.
The government
evidently believes that most banks will continue to reschedule short-term
credits and principal repayments next year if interest payments are met. With
important national elections scheduled for late next year, greater concessions
to international creditors are likely only if the inflation rate exceeds 250
percent.
The government's decision last month to liquidate two large private banks in
Sao Paulo and a smaller bank in the south should strengthen the domestic fi-
nancial sector but may further sour relations with foreign creditors. Financial
difficulties have plagued the three banks for much of this year because of bad
loans and poor management. Most other large private banks, however,
generally are showing hefty profits, according to Brazil's financial press.
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Brazil Going It Alone Brasilia currently feels little pressure to conclude new IMF and debt
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6 December 1985
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ypt Attempts
'o Cut Supplier
Credit Arrearages
Improved Portuguese
Finances Prompt Loan
Renegotiations
Zambia Lays
Groundwork for
IMF Standby
Secret
6 December 1985
or restructuring debt must await resolution of the issue.
Breaking with past policy of bailing out large troubled banks avoids boosting
the large fiscal deficit. Many foreign bank creditors, however, are concerned
about the unwillingness of the government to guarantee full repayment of the
failed banks' overseas loans and maintain that rolling over short-term credits
official stand
the National Monetary Council has not yet taken a final
Egypt's four public-sector banks have reportedly been instructed by the
government to eliminate supplier credit arrearages by the end of the year.
Arrearages that had been running as much as seven months behind have,
according to US Embassy sources, been cut to four months. President
Mubarak reportedly ordered the Central Bank to clear up arrearages after
belatedly learning of Egypt's deteriorating credit rating. Many foreign banks
have recently reacted by building in higher charges, cutting back on the length
of credit, and reducing credit lines. Most of the banks are, however, apparently
having difficulty obtaining the needed foreign exchange from the Central
Bank. Cairo will probably settle for something less than total elimination of ar-
rearages, given competing demands for scarce official exchange reserves. The
current effort to reduce arrearages is widely rumored to presage a devaluation
and exchange rate unification shortly after the beginning of the year.
Portugal is trying to take advantage of its improved credit rating by seeking
better terms on some outstanding loans. Since 1981, the country's current
account deficit has been slashed 90 percent-to an estimated $250 million this
year-while foreign exchange reserves have tripled to a reported $1.7 billion.
Lisbon is trying to renegotiate the terms on two 1983 loans-totaling $550
million. The government would like to drop the US prime margins and to
reduce the LIBOR margin by one-half percentage point. Despite some
grumbling, the banks will probably agree. Portuguese officials hope this would
enable them to refinance other loans and to negotiate improved terms on new
credit. Portugal's impending EC entry is likely to mean a larger current
account deficit and new external borrowing needs
The success of Lusaka's weekly foreign exchange auction has removed a major
obstacle to a new IMF standby loan. The IMF ended disbursements last
January because of Lusaka's refusal to meet IMF devaluation guidelines and
its inability to reduce arrearages to the IMF. Zambia's decision in October,
however, to use a weekly auction to allocate foreign exchange has resulted in a
60-percent devaluation. Organized, regime-threatening opposition to the de-
valuation is not apparent despite widespread grumbling in the military and
labor unions about steep price increases. Agreement on a new standby
arrangement probably would require additional cuts in budget deficits and
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about $100 million in new loans to cover IMF arrearages, according to US
Embassy reporting. Zambia may be able to raise some additional funding at a
scheduled 17 December meeting in Paris of the World Bank Consultative
Group on Zambia.
Mali's Third Standby On 8 November the IMF approved Mali's third standby agreement-a
Agreement Approved $24 million loan-which Bamako will likely use to pay military and civil
service salaries and amortize its previous standby agreements, according to the
US Embassy. Negotiations, which were strained in early October over IMF
suggestions of higher domestic cereal prices, were concluded after officials won
union support for the agreement by promising a wage increase in 1986. 25X1
Nonetheless, the country's drought-ridden economy still faces structural
problems that ensure domestic tension in coming months.F___7 25X1
Global and Regional Developments
Ottawa Renews
Footwear Quotas
Ottawa's decision to extend quotas on women's and girls' footwear-they have
been in effect eight years-provoked an angry reaction from the EC,
heightening tensions between the two trading partners. Ottawa accepted the
recommendation for extension by an independent tribunal to reassure the key
provinces of Ontario and Quebec that it can safeguard their interests in the up-
coming bilateral talks with Washington. Because women's and girls' footwear
accounts for 60 percent of EC footwear exports to Canada, the Community is
requesting immediate consultations with Ottawa on compensation under the 25X1
GATT. The EC would prefer a negotiated settlement but is threatening
retaliation; Canadian turbines, paper, and petrochemicals are likely targets.
yf~apanese (Japanese suppliers will probably dominate the 25X1
/ A gressively Selling Chinese market for telephone switching equipment. China is expected to
telecommunications become the world's largest market for such equipment during the 1990s as it
Equipment to China attempts to achieve its goal of increasing the number of telephone lines in
service from the present 5.6 million to 33.6 million by the end of the century.
Price advantages on sophisticated equipment and market penetration in 10
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major cities are key to Japanese success, A
Belgian subsidiary of a US telecommunications firm plans to triple the size of
its joint venture with a Chinese producer as the only way to effectively
compete with Japanese companies. Competition for the added sales will add
greatly to Beijing's present minimal leverage over Japan in areas such as
increasing imports of Chinese agricultural products and fuels and expanding
technological cooperation.
Soviet Purchases of
US Agr technology
In mid-October the USSR agreed to purchase 714 metric tons of US
herbicide, costing $50 million, which will broaden the spectrum of weeds
controlled in Soviet grain and sugar beet fields. Negotiations are also under
way to buy a 1,400 ton-per-year herbicide plant to be completed in five to six
years. The Soviets continue to purchase large quantities of Western pesticides
for their "intensive technology" program to boost crop yields.
some intensively cultivated fields yielded as much
1985
as one and a half to two times more grain than traditionally cultivated fields in
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6 December 1985
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Lib a Purchases Libya has purchased 70 percent of the outstanding stock of the financially
Refinery in Italy troubled Tamoil oil refinery and distribution system, according to the Italian
Ministry of Industry. The relatively unsophisticated refinery has a capacity of
about 100,000 b/d. Libya's first acquisition of a foreign refinery increases
Tripoli's overall refining capacity to nearly 500,000 b/d and provides a
guaranteed market for a portion of Libyan oil. Rome is probably uneasy about
the purchase, but prefers Libyan ownership to the loss of 450 Italian jobs if the
refinery were to close. Several major companies have abandoned their refinery
operations in Italy over the past few years because of government redtape and
declining demand, and the government is anxious to avoid further job loss.
Developed Countries
Japanese To Increase NEC, the largest Japanese semiconductor maker, reportedly has decided to
Imports of US import more US-made semiconductors next year in response to MITI guid-
Semiconductors ance. NEC officials expect that other
Minimum Prices for
Japanese
V /Semiconductor
Exports
Japanese electronics firms also will increase such imports. NEC will purchase
more bipolar devices for which US firms have been strong traditional suppliers
but that NEC itself now could make in Japan. The Japanese firms and MITI
apparently believe that the increased imports will ease trade friction and lessen
efforts to restrict Japanese semiconductor exports to the crucial US market.
Japanese imports of US-made semiconductors should increase next year in any
event as both the US and Japanese semiconductor markets recover from this
year's downturn in sales. Nevertheless, the trade balance will remain strongly
in Japan's favor, since the Japanese are stronger in the larger market sectors,
such as 256k DRAMs.
MITI officials do not expect the United States to drop its semiconductor trade
actions in exchange for the Japanese proposal to set minimum prices for
semiconductor exports to the United States,
MITI officials proposed the price floors to assist
some Japanese firms that have been hurt by the rapid decline in semiconductor
prices as well as to defuse US trade complaints. We believe minimum prices
may be difficult to enforce because of unauthorized exports of semiconductors
sold in Japan below the floor price.
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Italy Unlikely To Meet Italy will probably be unable to decelerate its money supply growth enough in
the last quarter of the year for the Bank of Italy to meet its monetary targets
for 1985, despite their upward revision last month. Although both the
monetary base and M2 have been growing by over 14 percent on an annual ba-
Secret
6 December 1985
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Parliamentary
Committee Opposes
British EMS
Membership
Secret
6 December 1985
sis, the new annual targets were only raised to 11 percent for the monetary
base and 12 percent for M2, from an original 10 percent for each. The Bank of
Italy's pursuit of a tight money policy from 1980 to 1984 helped halve the in-
flation rate. If the apparent relaxation of monetary policy this year continues,
however, it will almost certainly derail the government's efforts to reduce
inflation from the current rate of 8.6 percent to 6 percent for 1986
Support for British entry into the European Monetary System (EMS) received
a setback last month when a bipartisan House of Commons committee came
out against membership. While not ruling out eventual entry, the committee
reaffirmed Prime Minister Thatcher's position that the time is "not yet ripe."
The committee's main argument is that the pound is already overvalued
against the deutsche mark, and, if the current exchange rate were frozen,
British trade competitiveness would worsen due to Britain's higher inflation
rate-two-thirds of Britain's $12.8 billion trade deficit with the EC is with
West Germany. Some committee members also expressed concern that
membership would subordinate British macroeconomic policy decisions to
those of Bonn. The report did point out that joining EMS would reduce
currency fluctuations, thus helping industry with future planning. British
membership, while probably inevitable, is not likely in the near future. F_
Israel's consumer price index declined 1.5 percent in the first half of
November, the first recorded drop in 11 years. Inflation for all of November is
still expected to be positive, but under the government's 3-percent target. The
rate for all of 1985 is likely to fall below 200 percent, compared with last
year's record rate of 445 percent. Slowing inflation stems in part from the over
20-percent decline in real wages since the government imposed new austerity
measures last July. Demand is expected to be held in check in the near term as
further cuts in government spending are being considered for the 1986-87
budget, and no new wage concessions are in the works.
Less Developed Countries
The government is worried that current economic policies and projected
growth of less than 2 percent this year will aggravate unrest and further
weaken President Pinochet politically, according to the US Embassy. Econom-
ic performance has been hurt by prolonged delays in negotiating a debt
package. Some senior advisers are urging him to stimulate the economy, and
he has responded with a wage hike and has increased protection for domestic
industry. Pinochet may also replace his economic team next year. The delays
in disbursements from the recently concluded debt package could reduce
growth even more and shrink real wages for the fourth year in a row. This,
coupled with continuing political protests and uneasiness within the armed
forces, might persuade Pinochet to change his economic team sooner and
revert to expansionary policies. Such actions, however, would risk alienating
foreign creditors and raise the danger of a foreign exchange crisis.
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ran's Austerity
Budget Reflects
Problems
Indonesia's
Current Account
Deficit Widens
On Sunday Prime Minister Musavi presented the Consultative Assembly a
budget for the fiscal year beginning next March that calls for negligible
growth in spending. A 12.5-percent increase in defense outlays would be offset
by cuts in most other domestic spending. As a result, real nondefense spending
probably will fall by at least 15 percent next year, aggravating economic
hardships. In real terms, defense expenditures probably will remain about the
same. Musavi's emphasis on developing domestic defense industries suggests
that purchases of military hardware from abroad will not increase. Musavi
said Iraqi attacks on Khark and the soft oil market have kept oil income-
more than half of government revenue-40 percent below projections for the
current fiscal year. Expected declines in oil income next year would be offset
by doubling domestic borrowing-Musavi warned this was necessary to avert
recession despite the inflationary effects. The assembly, already at odds with
Musavi over some of his radical economic policies, is likely to insist on even
further cuts in domestic spending to avoid this increased borrowing.
Iraq is seeking to increase ties to US firms to obtain US technology for
economic development.
According to the US Embassy, Iraq believes closer
economic ties will strengthen relations with the United States and help offset
political differences, such as US support for Israel
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According to US Embassy reporting, Indonesia's current account deficit for
the first half of the fiscal year beginning 1 April reached $1.5 billion, about
twice the level recorded in the same period a year earlier. The deterioration re-
sulted from a 30-percent reduction in oil and gas revenues. Jakarta expects
some improvement in the second half, resulting in a yearend deficit of $2.8 bil-
lion. In our view, however, these figures are optimistic because of the
continued weakness of oil prices. Oil prices may fall below $20 per barrel
during the next 18 months. Despite government efforts to trim imports, a
growing current account deficit would cut into Jakarta's $10.5 billion in total 25X1
foreign reserves and require a significant increase in the country's $34 billion
external debt to keep the economy growing. 25X1
Indosia's Surging Provisional data for the first six months of the current fiscal year (1 April-
B, d'get Revenues
31 March) indicate that total government revenues amounted to roughly $8.7
billion-a 15-percent increase over the same period for the previous fiscal
year-despite a dramatic decline in oil export revenues, which provide more
than half of all government income. The US Embassy reports the surge
reflects increased government efficiency in tax collection. In particular, the
value-added tax instituted last year has surpassed the income tax as the most
reliable source of nonoil government revenue. According to Finance Minister
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Prawiro, Jakarta is committed to making up for falling petroleum revenues by
cracking down on tax evaders and through further revisions in property and
stamp taxes. These efforts to mobilize national savings to pay for domestic
development programs, however, probably will have limited success in closing
the estimated $1 billion budget deficit for fiscal year 1985.
Singapore Averting The unprecedented closure of Singapore's stock exchange on 2 December will
Financial Crisis blemish the country's reputation as a reliable financial center. Last Friday, 30
Taiwan Settling
The ADB Stalemate
creditors of the floundering Pan Electric-a large firm with subsidaries in five
other countries-failed to agree on a plan to restructure debts of over US $190
million. The company was then placed in receivership. Fearing investor panic,
the government suspended stock trading-a move that prompted Malaysia to
suspend trading on its exchange in Kuala Lumpur. Because US $160 of Pan
El's assets have been used to secure an estimated US $350-400 million of
private debt incurred by shareholders, its collapse endangers several large
brokerage firms. By Wednesday the government had persuaded banks to cover
brokers' cash flow problems and promised tighter control over the stock
exchange by the central bank, enabling the exchange to reopen Thursday. Pan
El's troubles-overinvestment in failing real estate, hotel, and electronics
enterprises-are common among companies in Singapore. The government
must now convince the public that Pan El's collapse is not the first of a long
string of bankruptcies in a year already marred by the first contraction of the
economy in decades
Taiwan has apparently decided to remain in the Asian Development Bank
(ADB) after China becomes a member.
Premier Yu Kuo-hua indicated that Taipei has decided to
remain in the Bank but is unhappy with the US-supported name change
"Taipei, China." The Foreign Ministry's press statement on China's applica-
tion to join the Bank was less hard line than previous statements on the ADB
and simply noted Taipei's hope that the ADB would work out a fair and
rational solution that would not harm Taiwan's interests. Taiwan's decision to
remain in the ABD would represent a victory for senior government and
military officials who had feared withdrawal would be a psychological gain for
China and could harm Taiwan's already strained relations with Washington.
Taipei may now hope that it has quieted domestic critics by not retreating
from its "principled stand" on the nomenclature issue and has built a case that
it was forced to accept "Taipei, China" under pressure from Washington.
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Soviet grain buying in the first five months of the current market year is
running about 30 percent behind last year's pace.
the USSR has bought 15 million tons of wheat and coarse grains. Less
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than half has been delivered, with the remainder to be delivered by next
March. US grain sales to the USSR are running even further behind. Wheat
sales are only 152,600 tons compared with 6.8 million tons by this time last
year; corn sales are running nearly 60 percent below last year, at 3.8 million
tons. Slack US sales reflect lower prices of competitors-$30 to $40 less per
ton for wheat-and Soviet anger at not receiving the lower prices available
under the US export subsidy program. Canada has already sold over 4 million
tons of grain. French wheat sales of 4 million tons already total two-thirds of
yearly expected EC sales. Soviet purchases of Argentine wheat-reportedly
1.5 million tons-are about on a par with the 1985 pace. Soviet grain buying is
expected to pick up in January-March, but for the 1986 market year total im-
ports will probably reach only 25-30 million tons, as much as 50 percent below
last year. Total Soviet purchases of US grain could dip as low as 9 million tons
compared with 22 million tons last year.
East German Economic East Germany's economic plan and state budget for 1986 released on 29
Plans for 1986 November suggest that East Berlin will continue most of its current economic
policies into the first year of the new five-year plan. Projected national income
growth of 4.4 percent is the same as this year's target. Production of lignite is
to rise 6 percent, further reducing East German dependence on imported,
mainly Soviet, energy. A 13-percent increase in investment reverses the
declines of recent years and could indicate increased capital goods purchases
from the West. Steel production is to reach 9.2 million tons, up from 7.6
million tons in 1984, which probably reflects completion of a new Austrian-
built mill. The state budget includes another big increase in subsidies for
consumer goods. Also noteworthy is a 7.7-percent increase in defense spending,
a slightly higher growth rate than in recent years. The targets for 1986 are at-
tainable, but the regime will have to overcome a host of problems to keep
growth as high through 1990.
Czechoslovakia has announced an investment plan for 1986-90 that will focus
on problems of technological stagnation, energy dependence, uncompetitive
exports, and pollution. The plan calls for average annual investment growth of
3.5 percent, compared with the 0.4-percent average during 1981-85. Even this
higher level would probably be insufficient to achieve the regime's ambitious
goals for modernizing the obsolescent capital stock. Prodded by Moscow's
demand for more and better goods, the program emphasizes investment in
robotics, electronics, and some chemicals, as well as those industries, such as
tractors and trucks, for which it is a major supplier to CEMA. To counter
some of the worst pollution in Eastern Europe, investment in environmental
protection will almost double that of the previous five years. Prague will
continue substituting nuclear power for fossil fuels, doubling the nuclear share
of total energy to almost one-third by 1990.
Chinese
officials stated that they have no immediate plans to import any phosphate
fertilizer or potash. Early this year, China's fertilizer importer, Sinochem,
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increased imports, thinking that China's new agricultural reforms would
increase demand for fertilizer. Local press reports indicate, however, that
fertilizer usage dropped dramatically, as profit-seeking peasants minimized
their use of farm inputs. In addition, transportation problems slowed fertilizer
distribution, contributing to large stockpiles. Chemical industry officials have
cut back domestic fertilizer production and temporarily shelved expansion
plans. Although Western firms are hoping for rush orders in early 1986, we do
not expect Chinese fertilizer purchases next year to match previous years'
imports.
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