INTERNATIONAL ECONOMIC & ENERGY WEEKLY

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP97-00771R000807810001-8
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 46
• Document Creation Date: December 22, 2016
• Document Release Date: October 14, 2010
• Sequence Number: 1
• Publication Date: December 13, 1985
• Content Type: REPORT

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Directorate of
Intelligence
93
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13 Dettather 19115
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DI IEEW 85-049
13 December 1985
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International
Economic & Energy Weekly
13 ?ecember 1985
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iii ynopsis
Perspective?West European Arms Exports
OPE Decision Will Precipatate Oil Price Decline
5 Spanish Arms Exports: A Successful Program Facing Economic Constraints
qrfited Kingdom: Revival of Arms Sales
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17
21
25
Iraw Increased Vulnerability of Economic Facilities
Angola:, Oil Boom Amid Economic Decay
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ast`en Europe?Kina: Expanding Economic Relations
Briefs
Energy
International Finance
Global and Regional Developments
National Developments
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Comments and queries regarding this publication are welcome. They may be
directed to Directorate of Intelligence,
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International
Economic & Energy Weekly
Synopsis
1 Perspective?West European Arms Exports
West European arms sales have decline over the past five years amid declining
oil revenues and growing debt problems in the Third World, and the
completion of man weapons modernization programs in the Third World and
Western Europe.
3 OPEC Decision Will Precipitate Oil Price Decline
Oil prices could fall sharply next year if OPEC aggressively follows through on
its recent decision to defend its "fair" share of the oil market.
5 Spanish Arms Exports: A Successful Program Facing Economic Constraints
Spain has become a competitive arms supplier to the Third World in the last
five years and is trying to expand its niche in the market. The government's ef-
fort will probably be unsuccessful because of the general downturn in Third
World arms purchases and stiff competition from larger suppliers, such as
France.
9 United Kingdom: Revival of Arms Sales
A series of recent agreements with several Third World countries will end a
four-year slump in British arms sales and bring renewed life to UK defense in-
dustries. The revival is due in part to a more sophisticated British sales
program combine more attractive financing and Prime Minister Thatcher's
personal support.
13 Iran: Increased Vulnerability of Economic Facilities
Deterioration of Iran's economic facilities since the revolution has made them
more vulnerable to Iraq's recently expanded war of economic attrition.
Although these attacks so far have not imposed significant additional hard-
ships on the Iranian people, a more persistent Iraqi campaign would seriously
undermine Iran's eocnomy prompting Tehran to retaliate against Iraqi and
Gulf state targets.
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17 Angola: Oil Boom Amid Economic Decay
The cost of battling the UNITA Insurgency probably has offset most of the
economic benefits of the current oil boom in Angola. As a result, little
economic relief for hard pressed consumers can be expected thorugh 1986.
21 Eastern Europe?China: Expanding Economic Relations
Eastern Europe's economic links with China are on the upswing after
languishing for decades since the Sino-Soviet split. Nonetheless, Beijing's
continued interest in acquiring advanced Western technology and growing
Soviet pressure for intra-CEMA economic integration.
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International
Economic & Energy Weekly
13 December 1985
Perspective West European Arms Exports
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West European arms sales have declined over the past five years amid
declining oil revenues and growing debt problems in the Third World and the
completion of many weapons modernization programs in the Third World and
Western Europe. West European sales of arms fell from an alltime high of
$18.6 billion in 1980 to $14.1 billion in 1984.' Our preliminary estimate for
1985 indicates that West European exports will total about $10 billion in
current dollars, continuing the downward trend.
The 17 West European nations exporting arms still account for about 25 to 30
percent of the global market, but only France and Spain have been successful
in maintaining or expanding their market shares, largely because of aggressive
sales campaigns. French exports have averaged $6 billion annually, while
Spain doubled its sales to about $1 billion in 1983 and 1984, pushing it ahead
of Great Britain's sagging sales in those years. The other major suppliers?
West Germany and Italy?have also experienced dramatic drops in their
export programs. Secondary suppliers with small but well established niches in
the market, such as Belgium and Switzerland, have experienced proportionally
smaller declines.
West European countries export about 50 percent of their arms production,
compared to about 15 percent for the superpowers, and the sales decline has
led to cuts in production and employment. We believe these cuts are boosting
the unit costs of equipment and placing an extra burden on already tight West
European defense budgets. Declining profits in the defense sector are also
reducing the funds available for investment in new plant and equipment and in
weapons research and development. Such economic pressures are a major
reason, in our view, for Western Europe's strong interest in new major defense
cooperation ventures, such as the European Fighter Aircraft and the proposed
new family of military helicopters.
West European arms exports could rebound somewhat in the next few years if
Middle Eastern states are unable to acquire desired weapons from the United
States. British arms sales received a boost in September when Saudi Arabia
chose to buy the Tornado and Hawk jet aircraft, rather than wait for the
United States to offer additional F-1 5s, for example. Decisions next year by
Jordan and Morocco whether to buy the Tornado or French Mirage-2000?
even though both prefer US aircraft?would indicate renewed strength for
West European sales in the region that already accounts for 50 to 75 percent
of sales by major West European suppliers. Over the longer term, any
' The magnitude of the decline may be exaggerated by the growing strength of the US dollar during
this period.
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sustained increase in West European arms exports will depend on improved
economic conditions in the Third World that would allow a weapons modern-
ization cycle to begin in the 1990s.
The shrinking arms export market provides a strong incentive for West
European nations to substitute indigenously produced arms for US weapons
now in their inventories. The United States has reduced its favorable arms
trade balance with Western Europe from over 9 to 1 to about 3 to 1 in recent
years by buying more European military equipment, but we believe US allies
will continue to press for more access to the US defense market, still the
largest in the non-Communist world. At a minimum, the Europeans will insist
on more offset ourchases when they buy weapons from the United States in the
future.
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OPEC Decision Will Precipitate
Oil Price Decline
Oil prices could fall next year if OPEC aggressively
follows through on its recent decision to defend its
"fair" share of the oil market. Oil demand is
expected to fall in early 1986, primarily reflecting a
seasonal decline in consumption. Demand for
OPEC crude oil will fall as low as 15 million b/d
during the summer months and average 16 million
b/d next year?the present OPEC production quo-
ta. If OPEC attempts to maintain crude production
at its current level of 18 million b/d, oil prices
would fall sharply in order to balance supply and
demand, perhaps to as low as $15 per barrel?
compared to the present official benchmark price of
$28.
OPEC's Challenge
OPEC's decision is intended to pressure non-OPEC
producers and oil companies to share the burden of
maintaining prices. For the OPEC strategy to work
production cuts would probably have to be made by
Mexico, the United Kingdom and US producers
among others. OPEC recognizes that without the
threat of a price war, the non-OPEC producers are
unlikely to reduce output voluntarily. Some oil
companies estimate that as much as 750,000 b/d of
production mainly in the United States may be-
come uneconomic at prices somewhat below $20.
OPEC's failure to announce the specific production
level it will attempt to defend indicates that it will
not act precipitously. The prospect of greater finan-
cial pressures may cause OPEC to adopt a produc-
tion floor closer to its current 16 million b/d output
ceiling. Because oil consumption is relatively unre-
sponsive to price changes in the short run, a $10
price drop would raise oil consumption by only
about 1 million b/d. In this case, annual OPEC
revenues would fall one-third or by more than $40
billion
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The Saudi Role
The level of production OPEC ultimately decides to
defend will depend in large part on Saudi actions.
Although Saudi Arabia has abandoned its role as
the OPEC swing producer, if oil prices begin to
plummet, Riyadh could choose to restrain its pro-
duction in an attempt to stabilize prices in the $20-
25 range. Riyadh probably would resume its role as
swing producer only in exchange for increased
production restraint from both OPEC and non-
OPEC producers or if oil demand prospects im- 25X1
proved sufficiently to guarantee Saudi Arabia a
growing market for its oil.
Because of the complexity of the international oil
market, it will be difficult for OPEC to control a
rapid price decline. Unless short-term demand
prospects improve more than expected, declining
export earnings will increase pressures to boost
output even further in order to maintain revenues.
The downward price pressure that would emerge
could force prices below $15 per barrel, at least
temporarily.
Implications of Lower Prices
The prospect of lower oil prices is generally good
news for energy consumers. Falling prices help
keep inflation under control and give impetus to
economic expansion. Some consuming countries
may raise taxes or implement import tariffs to
reduce budget deficits. Oil exporting debtor coun-
tries such as Mexico, Nigeria, and Venezuela,
however, would suffer major economic setbacks if
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prices fall sharply, perhaps triggering another in-
ternational financial crisis. At $15 per barrel,
Mexican oil revenues would be reduced by about $6
billion. For the longer term, lower prices could raise
oil demand, slow oil and gas supply development,
and hasten a return to a tight market situation.
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Spanish Arms Exports:
A Successful Program
Facing Economic Constraints
Spain has become a competitive arms supplier to
the Third World in the last six years and is trying
to expand its niche in the market. Spanish arms
sales to developing nations totaled more than $3
billion in 1979-84, making Spain the leader among
Western Europe's "second-tier" arms suppliers.
The Socialist government?despite its original
pledge to tighten arms export policy?is trying to
increase sales further to finance modernization of
the defense industry, maintain domestic employ-
ment, and improve Spain's trade position. The
government's effort will probably be unsuccessful
because of the general downturn in Third World
arms purchases and stiff competition from larger
suppliers, such as France. In the face of these
problems, Madrid will likely approve more sales
inimical to US interests while pressing Washington
for a better balance on bilateral arms trade.
Recent Trends
Spain: Arms Sales by Region, 1979-84
Percent
Latin America
12
Sub-Saharan
Africa
15
Madrid's concentration on the Third World market
enabled it to sell more than $3 billion worth of
military equipment and services in 1979-84, almost
quadrupling sales of the preceding six years. Al-
though Spanish sales do not approach the $2 billion
or more that France, Britain, Italy, and West
Germany each sells annually, Spain has moved
ahead of all other second-tier West European sup-
pliers, such as Switzerland, Belgium, and Sweden.
Unlike the top four, none of the second-tier suppli-
ers can produce a full range of naval, air, and
ground weapons. As a result, each focuses on a
more limited range of products. Spain has carved
out a niche in the Third World market by building
a reputation for quality production of ammunition,
small warships, and jet trainer and transport air-
craft
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Other.
1
Middle East
72
Exports to Asia and Europe.
307009 12-86
International market conditions have provided a
further boost to Spanish sales:
? Latin America became Spain's third-largest mar-
ket when Chile and Argentina were forced to turn
to alternative suppliers after US embargoes were
imposed in 1976. The brief Soviet embargo of
Iraq and sales limitations imposed by larger West
European suppliers on Iran also created openings.
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Spanish Arms Sales:
Leading Customers, 1979-84
Total
(million US $)
Equipment
Egypt
Iran
1,429 Warships, personnel carriers
389 Ammunition, antitank guns
Sudan 330
Ammunition
Saudi Arabia 219
Amphibious vehicles
Iraq 154 Ammunition,
military construction
Mexico
147 Patrol boats
Argentina
112 Patrol boats
Somalia
53 Ammunition
Chile
50
Jet trainers
Equatorial Guinea
38 Ammunition
? Conflicts in Latin America and the Persian Gulf
have provided opportunities to Spain. Madrid's
lack of sales restrictions have allowed it to sell
transport aircraft to both Nicaragua and Hondu-
ras and ammunition to Iran and Iraq.
? Arab states seeking to diversify their arms suppli-
ers have favored Spain because of its pro-Arab
stance despite recent moves toward establishing
relations with Israel. Saudi Arabia has become a
major customer at least partly for this reason.
An Economic Motivation
Domestic economic conditions are the primary
factors behind the effort to increase foreign sales:
? Orders from the Spanish military are small and
sporadic, and exports are necessary to keep pro-
duction lines open and reduce unit costs.
? Foreign sales have helped the arms industry
remain a bright spot in an otherwise dismal
national employment picture. While many Span-
ish industries have been forced to cut production
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since 1978, the arms industry continues to work
around the clock. Although unemployment since
1980 has risen from 18 to 22 percent, employ-
ment in the arms sector of 65,000 workers?less
than 1 percent of the labor force?has remained
stable in the same period.
? The defense industries export 60 percent of their
production and account for almost 3 percent of
Spanish exports.
Prior to assuming power in January 1983, the
Socialist Party was critical of arms exports to
pariah states or regions of tension in the Third
World and promised more restrictive regulations.
The strength of Spain's arms sales program and its
impact on domestic employment apparently con-
vinced the Socialists by late 1983 to revise their
position and seek to further increase exports. In
fact, arms sales since the Socialists took office have
risen almost 500 percent over the level of the
previous two years.
Keys to Success
Spain has used cooperative production agreements
with US and West European firms, meant original-
ly to serve Spanish military needs, to acquire
technologies and experience for developing weapons
geared to the needs of Third World customers.
Construcciones Aeron-
auticas, for example, designed the multirole C-101
Aviojet trainer and C-212 Aviocar transport with
US and West German assistance. Empresa Na-
cional Bazan?which coproduces Italian and Swed-
ish naval guns?teamed with a research organiza-
tion to develop the Meroka point-defense gun. The
Meroka's reliability and simple operation have
generated much market interest.
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Spain has followed a very permissive sales policy
approving arms sales to almost any government
regardless of human rights or political consider-
ations.
Spain has helped fill the
gap for governments, such as Argentina, Chile, and
Iran, embargoed by the major suppliers. Spain?
like other second-tier suppliers?is also willing to
maintain secrecy in politically sensitive sales to
such governments
The Spanish Government aggressively markets its
products through DEFEX, the official arms mar-
keting organization.
most Spanish arms producers have traded their
right to sell their products independently in ex-
change for the government's agreement to absorb
all promotional and marketing costs. DEFEX
maintains offices worldwide and does multilingual
merchandising through catalogues and trade jour-
nals. DEFEX agents reportedly are given wide
autonomy to approve sales without prior consulta-
tion with Madrid,
The Spanish Government also supports its arms
sales by providing export credits. According to US
Embassy reporting, the Ministry of Commerce
extends credit through the Development Assistance
Program at interest rates as low as 5 percent with
18-year repayment and no downpayment. The
Spanish financing apparatus is not as formidable as
that of larger West European suppliers, such as
France and Italy, and financing for any purchase is
usually limited to $50 million or less.
Outlook
The Socialist effort to increase sales is unlikely to
succeed because of economic problems and chang-
ing market conditions in the Third World. Large
public-sector budget deficits and international
debts in many of Spain's major Third World
markets are already having a negative effect.
Argentina has experienced
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difficulties paying for naval craft bought from
Spain, and funding shortages forced Cairo to re-
quest aid from a Saudi businessman to finance the
bulk of its 1983 naval purchase. The US Embassy
reports that a high-ranking Spanish official has
expressed anxiety over the credit terms that Ma-
drid continues to offer to clinch deals.
Spain is facing greater competition from other
suppliers bent on maintaining their own sales in a
declining world arms market.
Brazil, for example, is stepping up its
marketing efforts throughout the Third World,
while British and French manufacturers continue
to concentrate on the Middle Eastern market. We
believe Spain will be unable to meet the favorable
financial terms larger governments are offering on
major equipment, but Spanish sales of less expen-
sive, lower technology items such as ammunition
are unlikely to be affected as much. Purchases of
major equipment to diversify suppliers may also
dwindle under the growing requirement to stan-
dardize inventories in a time of budgetary con-
straints.
Implications for the United States
Declining earnings from arms sales will hinder
Spain's efforts to expand and modernize the arms
industry and provide fewer funds to meet startup
costs for new programs. Moreover, Spain's own
tight defense budget is unlikely to offer much help.
In our view, lagging Spanish arms sales will prompt
Madrid to pursue more arms transfers that are
inimical to US interests. Spain appears willing, for
example, to sell arms to Libya and Nicaragua.
Although Madrid has taken into account US con-
cerns in some sensitive sales,
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The downturn in Spanish sales will also put more
pressure on Madrid to seek a more favorable
balance in arms trade with the United States.
Madrid wants Washington to purchase more Span-
ish arms under the revised Mutual Defense Treaty
to allow it to justify further purchases of US
equipment. Spain claims that the US response will
be a major factor in its decision to renew the
Defense Treaty in 1987. We believe this is an
overstatement, but Madrid will probably use the
US response in part to determine the level of future
purchases of US arms.
On the positive side, the United States may benefit
indirectly from those Spanish arms sales that ex-
tend Western influence and security assistance to
countries where a direct US connection is diffi-
cult?for example, Iraq and Taiwan. Spain's
pro?Third World stance, moreover, places it in a
good position to offset the Soviet presence in some
Sub-Saharan African and Middle Eastern nations
that do not buy US arms?such as Angola.
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United Kingdom:
Revival of Arms Sales
A series of recent agreements with several Third
World countries will end a four-year slump in
British arms sales and bring renewed life to UK
defense industries. Besides the sale of Tornado
aircraft to Saudi Arabia and Oman, the British
have negotiated major deals with Jordan and India
for ships, planes, missiles, and communications
equipment. The revival is due in part to a more
sophisticated British sales program combining
more attractive financing and Prime Minister
Thatcher's personal support. These new incentives
may presage a more aggressive export campaign in
other Third World countries. The increase in arms
sales will benefit British industry and encourage
NATO purchases of British equipment by reducing
unit costs for individual systems, providing a great-
er return on R&D investment, and?in the case of
the Tornado sale?reducing startup costs for the
new European Fighter Aircraft.
The Slump and Its Impact on Industry
For most of the post?World War II era, the United
Kingdom was among the world's leading arms
exporters, ranking third behind the United States
and the Soviet Union. Since 1981, however, Bri-
tain's position in the international arms market has
declined steadily, slipping by 1984 to fourth in
Western Europe behind France, West Germany,
and Spain.
The arms export market is critical to the profitabil-
ity and survivability of British defense industries,
which typically employ some 400,000 workers.
Exports generally account for about a fourth of
production, including more than half the fighter,
attack, and trainer aircraft. Sixty percent of aero-
space manufacturing and one-third of shipbuilding
are devoted to military work.
Declining export sales since the late 1970s have led
to layoffs in several defense industries and have
9
Estimated Dollar Values
of Military Equipment Deliveries
by West European Suppliers in 1984
Billion US $
France
3.3
West Germany
2.2
Spain
1.0
United Kingdom
0.97
Italy
0.95
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forced the closing of at least one shipyard. Accord-
ing to attache reporting, Vickers, a tank manufac-
turer, plans no new hiring and will streamline its
current work force through attrition. The Royal
Ordnance factories also will cut employment once
production of gun tubes for Egyptian tanks ends.
Without the recent Tornado sale, some 30,000
workers reportedly would have been laid off when
Tornado production ended.
Foreign Buyers
Sales of British armaments are concentrated in a
few Middle Eastern and South Asian countries that
maintain close security assistance relations with the
United Kingdom. India, Saudi Arabia, Jordan, and
Oman accounted for roughly half of UK military
deliveries during 1980-84. Elsewhere, Britain sells
arms to its European allies and has developed a
limited market for aircraft in Nigeria. The British
also have established joint ventures with US firms
for production of Harrier jet fighters and Hawk
trainers that promise to bring several billion dollars
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of defense work to British industry over the next
few years. In fiscal year 1984, for example, the
United States bought nearly $500 million worth of
British military equipment.
Aerospace and electronic equipment account for
more than half of British military exports, with
Jaguar fighters and Hawk trainers heading the list.
Ground forces equipment?such as Chieftain tanks
and FH-70 field guns?have played a lesser but
still important role, representing 15 to 20 percent of
annual exports. The British also provide substantial
training and support services. In 1982, for example,
they signed a $581 million contract with the Saudi
Air Force for training and maintenance.
The Nascent Revival
The large sales of British military equipment this
year reflect a continuing reliance on their primary
export markets rather than a major expansion into
new markets:
? India has agreed to purchase the aging aircraft
carrier Hermes?which will be overhauled by
British firms?plus 11 Sea Harriers and 26 Sea
Eagle antiship missiles for $316 million.
? The deal with Saudi Arabia involves 72 Tornado
fighters and 30 advanced Hawk trainers for $5.6
billion. British industry will receive approximate-
ly $3.6 billion from the Saudis with the remain-
der going to Britain's West German and Italian
partners in the Tornado program. Support pack-
ages?including spares, technical assistance, and
service over the life of the aircraft?will generate
another $5 billion.
? In Jordan, the provision of $360 million in mili-
tary equipment for the most part supports British
equipment already in Jordan and may include a
training package similar to that regularly provid-
ed Saudi Arabia.
The revival of arms exports will help stem the
growing costs of British weapon systems to other
countries and may enable the Ministry of Defense
to preserve procurement programs in the face of
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tighter budgets. Higher production runs will lower
unit costs and allow for the recovery of R&D costs.
In the case of aircraft, for example, the equipment
purchaser pays a unit manufacturing cost plus a
proportional share of the total R&D cost of the
aircraft. The R&D costs are divided over the
projected total quantity of aircraft to be produced.
When additional aircraft are sold, each buyer may
be refunded a portion of its original R&D costs.
R&D expenditures make up about 11 percent of the
UK defense budget and represent important seed
money necessary to keep design teams to ether and
develop new weapon systems.
Prospects
The $3.6 billion Tornado sale should keep Tornado
production lines open until the new European
Fighter Aircraft (EFA) takes its place in the early
1990s. With the transition to EFA, Tornado facili-
ties will have to be retooled, but other potentially
large startup costs, including training skilled work-
ers, should be reduced. The Tornado sale also
should give a significant boost to overall economic
activity and employment. Using our econometric
model of the British economy, we estimate that, if
the sale had not gone through, 30,000 jobs in the
aerospace industry would have been lost, plus an-
other 20,000 to 30,000 laid off from jobs indirectly
dependent on Tornado production. The sale also
should raise real GDP about 0.4 percent, and the
foreign trade balance should improve by about
$300 million. If UK arms sales reach $8 billion in a
three-year period, as the press has speculated, the
economic effects would be roughly double those of
the Tornado sale.
Many of the new arms deals are attributable to a
more sophisticated sales effort and aggressive, per-
sonal lobbying by Prime Minister Thatcher?tac-
tics that may continue to help exports. For exam-
ple, British negotiations with India were successful
in large part because of London's ability to offer
flexible financing and pricing, including a 2.5-
percent discount for the Sea Harriers. Rigid financ-
ing and high unit costs in the past have made
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Major British Deliveries of
Military Equipment, 1980-84
System
Aerospace
Jet combat aircraft
Jaguar
Hawk
Transport aircraft
Helicopters
Sea King
Lynx
Commando
Missiles and launchers
Blowpipe
Rapier
Swingfire
Ground forces
Tanks
Chieftan
Vickers
APCs, AFVs, and ARVs
Artillery pieces
FH-70
105-mm field gun
Naval craft
Patrol boats
Mine-clearing vessels
Frigates
Recipients
Finland, India, Indonesia
Burkina, Madagascar, Suriname
Australia, India, Argentina, Norway, West Germany, France,
Denmark
Australia, Thailand, Qatar, Egypt, Singapore, Chile, Nigeria,
Portugal, Norway, Ecuador
Jordan, Oman, Nigeria, Kenya
Malaysia, Nepal, Kenya, the Philippines, Sri Lanka, Thailand
Nigeria, Iraq, Tanzania, Portugal, Oman, Ireland, UAE
Saudi Arabia, UAE, Ireland, Nepal
Australia, Nigeria, Trinidad and Tobago, Lebanon, Saudi Arabia,
Oman, Egypt
Greece
Bangladesh
11 Secret
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Implications for the United States
Continued British aggressiveness, particularly in
courting the Middle Eastern arms market, could
present a serious challenge to US industry. Recent
sales suggest that Middle Eastern countries are
attempting to diversify their Western arms purchases
to avoid an overdependence on the United States.
According to press and attache reporting, many Mid-
dle Eastern customers view the US decisionmaking
process in arms sales as overly political and heavily
burdened by technology-transfer issues that are less a
problem with European arms producers'
London's recent sales could provide the British with
incentives to offer the same attractive financing ar-
rangements in future sales to make their high-quality
weapons available to other countries that may prefer
a non-US supplier for their weapons.
British military equipment unattractive to finan-
cially constrained Third World countries. And,
according to attache and press reports, the Prime
Minister's personal salesmanship played a key role
in winning the Saudi aircraft contract and also
helped seal both the jet fighter deal with Oman and
the Jordanian arms package.
Secret
British industry still must overcome several weak-
nesses before it can return as a viable long-term
competitor with other Western suppliers. The re-
cent sales indicate Britain has not broadened its
narrow customer base. France and Italy, for exam-
ple, make sizable sales in Latin America, East
Asia, and Africa in addition to the lucrative Middle
Eastern market. The new British pricing discounts
and financing packages may increase their compet-
itiveness in these markets. Nonetheless, British
industry continues to design and develop equipment
primarily suited for use on the European battlefield
and has yet to follow the lead of France and Italy in
tailoring its weapon designs for Third World use
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Iran: Increased Vulnerability
of Economic Facilities
Deterioration of Iran's economic facilities since the
revolution has made them more vulnerable to Iraq's
recently expanded war of economic attrition. In the
past few weeks, Iraq has augmented hitting Khark
Island with limited attacks on industrial targets,
including pipelines feeding Iran's refineries, a steel
plant, and hydroelectric stations. Although these
attacks so far have not imposed significant addi-
tional hardships on the Iranian people, an Iraqi
campaign that damages key facilities would seri-
ously undermine Iran's economy. Should this occur
Tehran is likely to retaliate against similar Iraqi
targets and threaten to hit industrial targets in
Kuwait or other Gulf states.
Iran's Vulnerability
The tenuous condition of the industrial sector and
Tehran's financial straits make Iran more vulnera-
ble to Iraqi attacks. Lack of spare parts and raw
materials have forced many factories to shut down
or operate far below capacity. Moreover, Tehran is
hard pressed to repair war-damaged facilities be-
cause of shortages of foreign exchange and skilled
technicians.
Most critical economic facilities in Iran are virtual-
ly undefended because of limited air defense sys-
tems. Even those economic facilities that are de-
fended are susceptible to determined Iraqi attacks.
For example, Khark Island's defenses are more
extensive than those at other economic targets, yet
they have been unable to stop repeated high-
altitude bombing or even occasional low-altitude
Iraqi air raids.
Despite the vulnerabilities, recent Iraqi attacks on
economic targets besides Khark appear so far to
have had little effect on Iran's economy. Baghdad
has launched only a few raids on industrial facili-
ties near the border and shown no determination to
13
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destroy the targets. The three industries attacked?
electric power, oil refining, and steel?however,
already suffer from production problems.
Persistent Electric Power Problems
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This past summer, without Iraqi interference, Iran
suffered its worst power shortages since the revolu-
tion, according to the Iranian press. There were
regular blackouts of up to eight hours a day in
Tehran and most other major cities. Subsequent
repair to some facilities and reduced demand for 25X1
electricity in the cooler weather have eased prob-
lems somewhat. 25X1
Iran's electric power troubles have grown as the
government has pursued a strategy of providing
power to as many people as possible. Capacity
limitations have been aggravated by widespread
maintenance problems, isolated acts of sabotage,
and a shortage of skilled technicians. Moreover,
Iran's failure to integrate its power grid has led to
more frequent and severe outages than would oth-
erwise be the case,
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The regime blamed last 25X1
summer's outages on other nations, in particular
the Soviet Union, which withdrew technicians from 25X1
several plants last spring following Iraq's bombing
of cities.
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periodic power out- 25X1
ages have dampened already weak industrial out-
put. Electricity failures not only reduce production
directly but also cause voltage fluctuations that
burn out difficult-to-replace equipment. Loss of
refrigeration during power outages also has dam-
aged valuable supplies of food and medicine, ac-
cording to the Iranian press. 25X1
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Vulnerabili of Iranian Economic Targets to Iraqi Attack
Shahr-e Rey to Tabriz (87,000 bpd,
5 pumping stations)
(260)
Ahvaz oilfield to Shahr-e Rey Rabin Karim
refinery (295,000 bpd, 7 (Shakier)
pumping stations) \\\
(12)4 Kaminski11
run oilfield to Eqfahan (550,
6 pumping stations)
Selected pump station
Selected oil refinery'
Iranian tanker terminal
hs Selected power plant"
owl Steel plant
'Estimated current refinery output in thousands
of barrels per day (bpd)(260)
bCapacity in megawatts (790)?
0 200 Kilometers
0 200 Miii
706597 (A05176) 12-85
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Iran's electric power system is especially vulnerable these lines
to attacks on transmission lines, but the most
serious damage would be at principal transformer _
stations or generating plants that serve large urban
centers and industrial complexes. Since September, So far
Iraq claims to have attacked both of Iran's princi- there are no indications that refinery operations
pal hydroelectric plants, have been affected.
These two plants are located less than 200 kilome-
ters from the Iraqi border and account for 15
percent of Iran's electrical capacity.
Refineries Fall Short of
Domestic Needs
Iran has recovered considerably from the loss of its
Abadan refinery early in the war, but still must
import about 100,000 b/d of refined products?
one-seventh of domestic needs. To keep imports
down, refineries have been operated as much as 30
percent above design capacity
Refinery capacity is concen-
trated at Tehran and Esfahan that provide 75 to 80
percent of output
Another 10 to 15 percent is provided by the
refinery at Tabriz. Moreover, all refineries?except
the very small refinery on Lavan Island?receive
oil by pipelines from Iran's southern oilfields.
A prolonged shutdown of a large portion of Iran's
refining capacity would create severe economic
problems. With limited stocks, Iran would suffer
almost immediate shortages of gasoline and heating
fuel. Iran's transportation system would be disrupt-
ed, creating urban shortages of a wide variety of
items and causing logistic problems for the mili-
tary. Winter fuel shortages, a recurring source of
considerable domestic discontent, would worsen.
Tehran would be unable to import significant addi-
tional supplies to offset the shortfall because un-
loading facilities are near capacity
Prime Iraqi targets are the two pipelines feeding
refineries at Tehran, Esfahan, and Tabriz.
in the first week of Novem-
ber Iraq damaged three pumping stations along
15
Steel Industry: A Tempting Target
Iran's steel mills are crucial to its industrial devel-
opment plans and the biggest nonoil industrial
employer. Steel capacity is split almost evenly
among three mills, two near Esfahan and the third
in a suburb of Ahvaz. Also near Ahvaz are facili-
ties that produce steel pipe for the National Iranian
Oil Company. None of the mills are operating at
full capacity because of a lack of raw materials,
spare parts, and skilled technicians. The Soviet-
built facilities near Esfahan, in particular, are
experiencing difficulties because of the departure
of Soviet technicians last spring, according to the
Iranian exile press.
The proximity of the Ahvaz steel mill to Iraqi
airbases makes it an easily accessible target. In
early November the plant was bombed twice in
some of the largest air raids of the war; Iraq used
about 30 planes in each attack. Tehran admitted
that 28 workers were killed in the first attack and
several more in the second
The attacks on Ahvaz to date probably will have
only a minor impact on the Iranian economy.
Further attacks, particularly in combination with
attacks on the mills around Esfahan, however,
would harm construction and factory operations.
Repairs are already under way at Ahvaz, and
Iran's other steel mills may be able to make up
most of the loss. To the extent Iraq reduces Iran's
steel output, Tehran would be forced to reallocate
scarce foreign exchange in order to make up the
shortfall.
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Outlook
Despite Iran's vulnerability, Baghdad's irresolute
use of its air power probably will prevent it from
doing any serious harm to the Iranian economy.
For example, Iraq would have to knock out several
pump stations on both refinery pipelines to shut
down refinery operations in Tehran, Esfahan, and
Tabriz. Attacks such as those on the Ahvaz steel
plant will be ineffective as Ion as other facilities
can pick up the slack
Baghdad's expanded attacks on economic targets
probably reflect frustration over the ineffectiveness
of its attacks on Khark Island and the need for
further means of putting pressure on Iran. Recent
Iraqi statements have been playing down the im-
portance of attacking Khark Island and have
stressed the near impossibility of knocking out
Iran's oil exports. Nevertheless, the US Embassy in
Baghdad reports that Iraqi officials insist the cam-
paign against Khark will continue and that the
other bombin raids represent a widening of the air
war.
If Iraq mounts an effective campaign against Irani-
an industrial targets, Tehran would retaliate
against economic facilities in Iraq or possibly other
Gulf states. Past Iranian attacks on economic
targets in Iraq, however, have been largely ineffec-
tive because of Iraqi defenses and the poor state of
Iran's Air Force. For the time being, we believe
Tehran hopes the threat to expand the war to other
Gulf states will be sufficient to put pressure on Iraq
to stop its attacks. In the face of broader Iraqi
raids, Iran may feel compelled to carry out its
threats, probably against refineries or desalination
plants in Kuwait.
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Angola: Oil Boom Amid
Economic Decay
The cost of battling the UNITA insurgency proba-
bly has offset most of the economic benefits of the
current oil boom in Angola. Oil production, which
accounts for nearly 95 percent of Angolan exports,
has roughly doubled since 1982 and is projected by
industry experts to double again by about 1990.
The nonoil sector of the economy, however, is
suffering from the impact of the fighting. We
believe that growing hard currency payments by
Luanda for arms purchases and military services
from the USSR, Cuba, and other Communist
military suppliers stand in the way of any effort to
use the foreign exchange windfall from oil exports
to alleviate domestic hardships and spur invest-
ment. Even though arms deliveries have declined
this year, we believe that service requirements on
existing military debt are continuing to rise. As a 0.2
result, little economic relief for hard-pressed con-
sumers can be expected through 1986.
Soviet/Warsaw Pact Military
Deliveries to Angola, 1976-85
Billion US $
1.0
0.8
0.6
0.4
Economic Stagnation
We believe that the Angolan economy has achieved
little or no economic growth in the 1980s,' follow-
ing a precipitous economic contraction as a result
of the exodus of about 400,000 Portuguese settlers
after independence a decade ago. The economic
problems stem mainly from the impact of fighting
the UNITA insurgency, but recovery prospects
have been undermined by Luanda's efforts to im-
pose socialism on the society.
The deterioration of Angola's coffee and diamond
industries?prior to independence the country's two
largest sources of export earnings and employ-
ment?exemplify the economic decline:
? UNITA attacks on bridges and poor road mainte-
nance have forced the state-controlled diamond
mining company (Diamang) to operate a costly
'Angola has not published any economic statistics since indepen-
dence
17
1976-80. 1981 1982 1983 1984 1985b
U Annual average.
b Estimated value of deliveries through third quarter 1985. Data on
additional deliveries to Angola in fourth quarter 1985 are not yet available.
307344 12435
1,900-kilometer airlift to get fuel, machinery,
and supplies from Luanda to the mines. Short-
ages resulting from these transport constraints
and severe losses from smuggling have reduced
diamond production by 40 percent since 1980,
according to a press statement by the president
of Diamang. Reduced volume, plus a steep drop
in diamond prices, cut the value of diamond
exports by 85 percent to $64 million in 1984.
? In addition to problems caused by the insurgency,
the coffee industry has suffered from managerial
deficiencies. Only about one-fourth of the area
planted in coffee when colonial rule ended is in
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full production, according to a recent press state-
ment by the Vice Minister of Agriculture for
Coffee. Production totaled less than 25,000 met-
ric tons in 1984?only about 10 percent of
preindependence output?
Production of corn and cassava, the main food
staples in Angola, has dropped sharply. More than
200,000 people have been driven from the central
and southern food producing regions of the country
by the fighting, according to Red Cross data. In
addition, the government's socialist programs have
not replaced the Portuguese-run transportation and
marketing systems that provided distribution chan-
nels for output by small farmers. These problems
have forced Angola, which had exported corn and
cassava before independence, to devote up to one-
fourth of its export earnings to food imports. Severe
food shortages, nonetheless, are wides read in both
urban and rural areas.
With manufacturing output severely depressed be-
cause of the economy-wide shortages of imported
parts and raw materials, electric power outages,
transportation interruptions, and deficiencies in
technical and managerial expertise, sketchy press
reporting indicates that few factories are operating
at more than about 40 percent of capacity. Food
processing plants, which normally account for
about one-third of manufacturing output, suffer
from transport problems and foreign exchange
shortages. Shortages of imported raw materials
may force the important textile enterprise in Luan-
da, ENTEX, to close down, according to reporting
in the city's major daily and the official regime
mouthpiece, Jornal de Angola. Angola's only tire
factory is still in operation, but has been forced to
shut down for several days on repeated occasions
this year because of frequent loss of electric power,
Secret
Angola: Export Earnings, 1974-84
Billion US
3.0
0.5
0 1974 75 76 77 78 79 80 81 82 83 84
Total
Petroleum
Diamonds
Coffee
307346 12-85
Oil Boom
Oil production has been the only bright spot in the
economy. Funded and operated by Western oil
companies, the oil industry has roughly doubled its
output since 1982 to almost 250,000 b/d currently,
according to press accounts. Despite the slippage in
international oil prices, the rise in production has
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resulted in large increases in Angola's foreign
exchange earnings.
The economic benefits from the oil boom, however,
have been limited. Although rising oil exports have
more than compensated for the loss of foreign
exchange earnings caused by the decline of the
coffee and diamond industries, new employment
opportunities in oil production have fallen far short
of the number lost on coffee plantations and in
diamond mines. Employment in coffee and dia-
mond production has fallen from more than
325,000 workers before independence to about
50,000 to 60,000 currently, according to press
reports. In contrast, the oil industry employs only a
few thousand workers, and most of these are
expatriate technicians and managers.
Paying for Communist Arms
Payments to Communist countries?mainly the
USSR and Cuba?for arms and military services
significantly limit Luanda's ability to use its oil
windfall to alleviate economic shortages, in our
judgment. We believe that Angola pays hard cur-
rency for most of its military assistance, including
weapons, foreign personnel, and support.
Angola also pays hard
currency for Cuban combat forces that supplement
the Angolan Army.
payments to Com-
munist countries for arms and military services
may equal roughly $1 billion annually. Deliveries
of fighter aircraft, helicopters, and air defense and
ground force equipment to Angola totaled over $2.5
billion during 1980-85, according to our estimates.
In addition, Angola incurred hard currency obliga-
tions to pay for military training for Angolans, for
the services of technicians to help maintain and
operate imported equipment, and for the presence
of about 42,000 Cuban troops and technicians.
Angolan exports to Communist countries have av-
eraged little more than about $100 million a year
since 1980, according to our estimates. As a result,
19
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payments to Communist arms suppliers have ab-
sorbed virtually all of the foreign exchange surplus-
es earned from oil exports to Western countries.
Angola's trade surplus with the West totaled about
$1.1 billion in 1984, for example, but net foreign
exchange outflows to Communist countries proba-
bly exceeded $1.4 billion.
Government Measures
Public statements by government leaders indicate
growing concern about the dismal performance of
the economy. Economic problems, for example,
were a major theme at a national conference of the
ruling party in January 1985. Two newly created
commissions were instructed to present reports at
the Second Party Congress this month on ways to
improve the economy's performance. Despite spec-
ulation that the
Congress would call for increased reliance on pri-
vate enterprise to supplement operations by large
state enterprises, the Congress moved to increase
economic centralization
The regime is seeking Western economic help. It
signed an agreement with France in January 1985
for aid to help restore coffee production. Angola
also has called on Western firms?particularly the
oil companies?for help on a variety of economic
projects, such as road repairs, hotel construction,
and agricultural assistance. Angola signed the
Lome Convention in April 1985, opening the possi-
bility of EC credits and aid.
Prospects
Prospects for achieving an economic turnaround in
1986 are poor, in our judgment, despite the proba-
bility of significant increases in oil production.
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Angola: Current Account, 1980-85
Million US$
1980
1981
1982
1983
1984
1985
Current account balance
?250
?560
?125
?90
?150
50
Trade balance
?60
?135
95
40
100
250
Western
240
200
575
1,000
1,100
900
Communist
?300
?335
?480
?960
?1,000
?650
Service balance a
?190
?425
?220
?130
?250
?200
We believe that these data on services, which were published by
the National Bank of Angola, do not include foreign exchange
outflows for Communist military support. The addition of payments
by Angola for the services of Cuban combat forces and Communist
technicians would increase the deficit for services by $300-700
million annually, according to our estimates.
Major problems such as food shortages, disrupted
transport, electric power interruptions, and below-
capacity manufacturing will continue.
We believe that Angola's oil industry will prosper
over the next several years, but with no end in sight
to the civil war this improvement will be unlikely to
reverse the decline in the rest of the economy.
Western oil companies are expanding investment in
exploration and development of offshore oilfields,
and Luanda has set a production target of 500,000
b/d by 1987. We believe that such volume in-
creases over the next several years probably will
more than compensate for any income losses from
lower oil prices and that Angola's foreign exchange
earnings will continue to rise. Any downturn in
world oil sales probably would not significantly
affect demand for high-quality Angolan crude oil,
which is exported mainly to US East Coast mar-
kets.
Prospects for increased Western investment outside
of oil production, however, are poor because of the
military conflict and the aversion of potential
Western investors to Angola's socialist economic
system. Although recent comments by Angolan
Secret
President dos Santos indi-
cate his interest in strengthening the private sector
in Angola, little liberalization in the planned econo-
my is likely. UNITA leader Savimbi's public threat
earlier this year not to release foreign technicians
and workers captured by UNITA in Angola has
dampened the already marginal enthusiasm of
Western firms for further investment.
UNITA's recently an-
nounced intention to target Angola's petroleum
industry also undermines investment prospectsp7
diamond production?
an active UNITA target?will continue to be se-
verely curtailed for the next year or so.
The decline in arms deliveries in 1985 will not
significantly reduce arms-related foreign exchange
outflows over the next year or so, in our judgment,
because of continuing requirements to service debt
to the USSR and other Communist countries.
Paying for Cuban combat forces and other Com-
munist technicians also will continue to drain for-
eign exchange.
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Eastern Europe?China:
Expanding Economic Relations
Eastern Europe's economic links to China are on
the upswing after languishing for decades since the
Sino-Soviet split. Trade with China has increased
this year, and several agreements signed by trade
delegations have paved the way for future growth
in commercial contacts. Chinese Vice Premier Li
Peng in May led a delegation?the highest ranking
group to visit Eastern Europe in more than 20
years?to East Germany, Poland, and Hungary
that underscored each side's interest in expanded
ties. Nonetheless, Beijing's continued interest in
acquiring advanced Western technology and grow-
ing Soviet pressure for intra-CEMA economic inte-
gration are likely to prevent such trade from ac-
quiring major significance for either China or
Eastern Europe.
Renewal of Trade Ties
Soviet and East European advisers helped China
build many industrial plants in the 1950s but left
abruptly when Moscow and Beijing broke relations
in the early 1960s. Although Beijing continued
some cooperation with Eastern Europe, such as a
Sino-Polish joint shipping company, most ties were
suspended. The first signs of a thaw in relations did
not appear until the early 1970s when Romania's
desire to demonstrate its independence from Mos-
cow led Bucharest to establish closer links to
China. Romania soon became China's single-
largest trading partner in Eastern Europe, but
economic relations with the other countries re-
mained minimal. In fact, Sino?East European two-
way trade declined about one-third from 1980 to
1984, and Eastern Europe's share of China's trade
dropped from 6 percent to 3 percent over the
period.
In the past two years, both sides have sought to
revive commercial ties. In 1984, a delegation from
the Chinese State Economic Commission followed
by Chen Muhua, then the Minister of Foreign
21
Economic Relations and Trade, visited several East
European countries. Several delegations explored
mutual cooperation and ways to improve economic
efficiency.
Chinese Vice Premier Li
Peng's May visit to Eastern Europe resulted in five-
year trade pacts with Warsaw and Budapest. Since
then, the other East European states except Bulgar-
ia have concluded five-year trade pacts with China
as well as other formal economic agreements. Li
Peng is scheduled to visit Bulgaria to promote trade
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Of all the East European countries, Poland is
expanding its trade with China the fastest. Accord-
ing to the Polish press, total trade will nearly triple
this year, led by large sales of Polish mining
equipment and vehicles. Polish exports to China in
the first half of 1985 were 72 percent greater than
those for the same period of last year, according to
Polish trade statistics. On 23 November, the senior
economic planning officials for China and Poland
signed an agreement calling for closer contacts
between the state planning commissions of the two
countries. At the signing, both officials said that
bilateral trade between the two countries over the
next five years would actually be about 40 percent
greater than the amount planned in their five-year
trade protocol signed last May. Hungary's trade
with China also increased in the first half of 1985,
with exports rising 90 percent and imports 74
percent over the same period last year. Czechoslo-
vakia and Bulgaria planned 30-percent increases in
their trade with the Chinese for this year. Although
Romania continues to be China's major trading
partner, Beijing is resisting Romania's pitch for
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Chinese Trade With Eastern Europe, 1983-84 .
Million US $
Chinese Exports
Chinese Imports
Trade Balance
1983
1984
1983
1984
1983
1984
Total
668.1
587.4
840.2
1042.6
172.2
455.2
Bulgaria
23.9
27.9
14.7
20.2
9.1
7.7
Czechoslovakia
90.1
103.8
112.7
124.6
-22.6
-20.8
East Germany
59.0
85.9
186.8
131.2
-127.8
-45.3
Hungary
25.9
27.8
45.3
58.9
-19.4
-31.1
Poland
163.5
100.6
99.8
160.0
63.7
-59.5
Romania
289.7
222.8
309.1
448.9
-19.4
-226.1
Yugoslavia
16.0
18.6
71.8
98.8
-55.9
-80.2
Although Eastern Europe's trade with China is conducted primar-
ily in barter, prices are attached to traded goods and any deficits
are registered in clearing accounts. Through the 1980s, the Chinese
have run sizable deficits with East European countries and are
pressing them to close the deficits by importing more Chinese
goods.
even greater trade, in part because of improved ties
to the rest of Eastern Europe, according to the US
Embassy in Bucharest
Chinese trade with Yugoslavia and Albania also is
increasing. According to the Yugoslav press, total
trade between China and Yugoslavia for the first
10 months of 1985 was double that of the same
period last year. The two countries signed a five-
year trade protocol in October that calls for Sino-
Yugoslav trade in the 1986-90 period to increase
fourfold over the level for the previous five years.
Politburo member Hu Qili visited Yugoslavia in
November mainly to encourage greater economic
cooperation, according to the US Embassy in Bel-
grade. On 3 December, China and Albania signed
a trade protocol for 1986 and a trade pact for 1986-
90, their first long-term trade accord since they
split in 1978.
Motives for Expanded Trade
Both Eastern Europe and China see gains from
closer economic cooperation. Trade may expand
without using limited hard currency reserves be-
cause each produces goods the other can use and is
Secret
willing to barter. Also, each side gains an outlet for
goods that are not competitive in international
markets because of low quality, low demand, or
protectionist measures. While not as advanced as
Western equipment, East European-manufactured
goods-vehicles, machine tools, agriculture and
mining equipment, and electric power generating
equipment-can still make a useful contribution to
China's modernization effort. Chinese shoes, tex-
tiles, clothing, tools, and agricultural products can
help ease chronic shortages of food and consumer
goods in Eastern Europe.
Political motives also have figured in the recent
moves to expand economic relations. The Chinese
probably see trade as a lever to increase their
influence in Eastern Europe and partially offset
current Soviet efforts at closer CEMA integration.
For their part, the East Europeans apparently have
concluded that closer economic links are now ac-
ceptable given the warming of Sino-Soviet rela-
tions, particularly the signing of a Sino-Soviet five-
year trade accord earlier this year. Moreover, the
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Sino-East European Five-Year Trade Pacts
China has signed bilateral trade protocols this year
with virtually every country in Eastern Europe. Bul-
garia, the sole exception, is still negotiating with
Beijing. Coming as the countries' five-year plans are
being completed, the trade agreements are intended to
assist central planners in coordinating their long-term
foreign trade. Each agreement sets out a general
framework for negotiating annual trade protocols
plus broad targets for the volume Qf trade over the
1986-90 planning period. Moreover, the pacts provide
the Chinese and East Europeans with a rationale for
continued dialogue and improvements in overall po-
litical and economic relations:
Date
China Delivers
China Receives
Poland May Rice, maize, soybeans,
shoes, cotton, clothes,
textiles, porcelain, min-
erals, tea
Power genera-
tors, trucks, min-
ing equipment,
copper
Hungary June
Rice, fruits, shoes, tea,
cotton, clothes, vegeta-
bles, cooperation in
agriculture
Steel, aluminum,
trucks, medical
instruments
East July
Germany
Rice, oil, corn, textiles Railroad cars,
trucks, combines,
agricultural
harvesters
Romania October
Coal, coke, crude oil,
chemicals, nonferrous
metals, clothing
Railroad cars,
tractors, oil drill-
ing and mining
equipment
Czecho- October
slovakia
Cereals, meats, tea,
chemicals, minerals,
clothing
Machinery, iron,
steel, railroad
cars, technical
assistance in en-
ergy production
Yugo- October
slavia
Textiles, rice,
soybeans, oil
Sheet metal,
trucks, buses,
fertilizer
Chinese Trade With Eastern Europe
by Commodity Category, 1984a
Percent
Chinese Imports From Eastern Europe
Semi manufactured
and miscellaneous
goods
24
Chemicals
16
Machinery and
equipment
60
Chinese Exports to Eastern Europe
Food and animal Semimanufactured
by products and miscellaneous
31 goods
47
Crude materials
and fossil fuels
14
Chemicals
5
a Excluding Yugoslavia and Albania.
Albania December Cotton, tires,
rice, chemicals
Chromium,
copper
Bulgaria Negotia-
tions
continue
23
Machinery and equipment
3
307607 12-85
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East European regimes have their own interests in
cultivating Beijing. East Germany, for example,
sees this as enhancing its international prestige
while the reform-minded Hungarians want to build
relations with a similarly inclined socialist state.
Outside the Bloc, Albania and Yugoslavia probably
want to improve their relations with another non-
aligned Communist country. Albania's recent
agreement to a five-year trade pact with China
may indicate that the successors to the late Party
boss Enver Hoxha want to modify his xenophobic
and autarkic external policies.
Outlook
The recent bilateral trade and cooperation agree-
ments set the stage for growth in trade between the
two regions through the rest of the decade. None-
theless, several factors will prevent the trade flow
from acquiring major significance:
? Eastern Europe lacks sufficient production capac-
ity to meet a large share of China's total demand
for manufactured goods.
? China's main needs are products embodying
higher levels of technology and quality available
only in the industrial West.
? Eastern Europe's need to satisfy increasing Soviet
demands for more and higher quality exports will
limit the amount of goods available to support
trade with China.
? Each side's need to maximize hard currency
earnings means the Sino?East European connec-
tion will receive only secondary attention.
? The inflexibility of a barter system will restrict
trade to the extent that each has only a limited
need for the products of the other.
Secret
We believe that political developments will contin-
ue to influence the growth of East European-
Chinese trade. The East Europeans will watch
closely the evolution of Sino-Soviet relations in
deciding how to approach their commercial deal-
ings with Beijing. While the Chinese will assign a
small role to Eastern Europe in their trade as long
as they continue to expand relations with the West,
this could change if political or economic consider-
ations forced Beijing to curtail trade with the West.
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Briefs
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Energy
c
gerian Gas Contract
enegotiations
Under Way
Algiers is currently renegotiating its natural gas contracts with Belgium and
Italy, with France to follow at the end of next year. We believe the process will
drag on for at least six months. According to Embassy reporting, Distrigaz?
the Belgian state gas company?is seeking either a price cut or an agreement
to stretch out deliveries. The Italian buyer Snam is asking for a reduction in
price, now that Rome has removed its subsidy for Algerian gas purchases.
Algerian gas costs European customers as much
as $1 per million Btu more than gas from alternative suppliers. The pressure
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Dutch To Purchase
Coal From China
1
jSpanish Foreign
Debt Reduced
Dutch Capital
Market Deregulation
LDC Debtors' GDP
Growth Projected
To Slow
on Algiers to agree to a more realistic price is partially offset, according to
Embassy reporting, by Belgian fears of having exports to Algeria shut off and
Italian and French hopes of increasing their own sales to Algiers.
The Netherlands signed an agreement last week to purchase 4 million metric
tons of Chinese coal during 1986-90. The agreement is China's largest single
commodity deal with a West European country. Coal imports?historically
from the United States and Australia?cover about 10 percent of Dutch
energy demand and generate about 30 percent of the country's electricity. At
current coal prices, China is likely to earn as much as $36 million annually.
International Finance
Spain's net foreign debt totaled $27.9 billion (17 percent of GDP) in June
1985, down from $31 billion (19 percent of GDP) a year earlier. This is the
lowest debt figure since the summer of 1982. The improvement is due to the
turnaround in Spain's current account balance?from a $2.7 billion deficit in
1983 to a $2.3 billion surplus in 1984 and a projected $1.9 billion surplus this
year. With Spain set to enter the EC next month, this improved debt position
will give Madrid some breathing room in adapting to EC membership. The re-
quired dismantling of tariff barriers and an inflation rate about 4 percentage
points above the EC average will very likely lead to a deterioration in Spain's
external accounts. We nevertheless expect a sizable current account surniis in
1986 and a continuation of successful debt management.
The Hague's decision to further deregulate capital markets is aimed at keeping
pace with British and West German deregulation plans and establishing
Amsterdam as a leading European financial center. The changes, which take
effect 1 January, will allow foreign banks to take the lead in forming
syndicates for guilder bonds and to underwrite up to one-third of a bond issue;
the current limit is one-fifth. Domestic and foreign banks will also be
permitted to offer floating rate notes, certificates of deposit, and commercial
paper. Finally, trading commissions on the Amsterdam Stock Exchange will be
cut. We expect that banks will establish an Amsterdam interbank offered rate
(AIBOR), modeled on London's LIBOR, to serve as a guideline for the new in-
struments. Domestic banks are worried about increased competition from
foreign banks, which already have one-third of the Dutch financial market?
US banks in particular are rapidly expanding their presence.
Global and Regional Developments
Forecasts by economic consulting firms basically agree with our estimates that
growth in key LDC debtors will be about 3.0 to 3.5 percent this year but will
decline in 1986 to about 2.5 percent. Mexico is expected to experience the
sharpest decline in 1986, Most
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/
C Moves Toward
Financial Integration
forecasters also expect Brazil's growth to slow. More positively, the Philippine
and Argentine economies are projected to bounce back in 1986 after witness-
ing negative growth in 1985. Chile and Venezuela are also expected to have
higher growth next year. Peru is projected to continue to grow at about 2 per-
cent. Nigeria's growth will improve a bit in
1986,
251
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The EC finance ministers have adopted new directives that will allow a mutual
fund to operate throughout the Community once any EC member approves the
fund. Although the directives are not binding?each government is responsible
for implementing them?they represent a statement of policy toward freer
capital movements. The United Kingdom, West Germany, the Benelux
countries, and Denmark probably will put the directives quickly into effect,
partly because of their governments' support of open markets. France and
Ireland probably will take more time because of concern over the impact on
capital markets. Countries with foreign payments problems or underdeveloped
capital markets?Italy, Greece, Spain, and Portugal?almost certainly will
drag their feet until economic conditions are more favorable. Because of their
financial sophistication, British brokers and US financial services companies 25X1
with operations in the Community have a good chance of gaining a dominant
share of the market 25X1
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Secret
J int Sino-Japanese Leading Japanese aircraft manufacturers, MITI, and the Chinese are studying
ommuter Aircraft the feasibility of joint development of a 30 to 40 seat commuter aircraft.
Project Tentative plans call for a twin turboprop aircraft that would be designed in Ja-
pan and produced in both countries. A production run of 600 units is planned,
200 of which would be sold to third parties. In addition to design work, this
project could provide Japanese firms with an export market for newly
developed avionics and other aircraft parts. The partners will probably have to
import or produce under license a US or West European engine. Outside
China and Japan this airliner would face stiff competition?manufacturers in
nine countries are now marketing six models in the 30 to 40 seat range.
Li an Aid to
caragua
Libya's austerity budget for 1986 apparently leaves little room for direct
financial aid to Nicaragua. Since 1981 Tripoli has provided as much as $400
million to the Managua regime in grants, low cost loans, and oil barter deals.
Tripoli will help market Nicara-
gua's agricultural exports worldwide and import increasing volumes of these
products to replace direct aid. Libya has imported at least $40 million in
Nicaraguan agricultural goods so far this year and could easily double this
amount in 1986. The Libyan Arab Foreign Investment Company, LAFICO,
probably will manage the marketing effort. LAFICO's worldwide affiliations
and frequent use as a tool of Qadhafi's radical foreign policy raise prospects
that Tripoli might even try to market Nicaraguan goods in the United States.
National Developments
Developed Countries
Japanese Government Bowing to political pressure, last month the Japanese Government agreed to
Efforts To Moderate temporarily provide low-interest loans totaling $500 million?an amount 10
I Impact of Stronger Yen times greater than what is currently available?to small- and medium-sized
companies hurt by the rapidly strengthening yen. Small firms producing for
the domestic market and export-dependent companies are now eligible for
loans from government financial institutions at a 6.8-percent interest rate
instead of the present 7.2-percent rate.
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13 December 1985
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MITI admits that some companies may use the loans to sustain
exports, and to appease US concern that the loans would be a form of export
subsidy MITI says it will advise the firms to reduce their dependence on
exports.
itish Business
Calls for Slower
Wage Increases
At its annual conference this fall, the Confederation of British Industries (CBI)
began a drive for slower wage increases. The business group argues that recent
pay increases have outstripped gains in productivity, thus fueling inflation,
hampering British competitiveness, and helping keep unemployment above 13
percent. Government officials are worried that the temporary pickup in
inflation to 7 percent this July over last July may have raised union
expectations for 1986 contract negotiations. Stressing that inflation is expected
to fall to 3.5 percent by mid-1986, CBI leaders want the government to use its
influence to keep pay settlements in check. Results from our Linked Policy
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Limited British
Social Security Reform
Increasing
West German
Merger Activity
rench Current
Account Improves
Secret
13 December 1985
Impact Model indicate that, if the relative price of labor remains constant
during 1986-90, unemployment will fall to 11.3 percent by 1990, assuming
GDP growth averages 2.5 percent a year. On the other hand, if unions
continue the exceptionally high real wage gains of 1984-85 and cause the
relative price of labor to rise 4 percent each year, unemployment could hit 16
percent by 1990.
According to the British press, Social Services Secretary Fowler will publish a
White Paper on social security reform?delayed since September by strong
public outcry against major welfare cuts?early next week. London reportedly
will now propose only modest reductions in the State Earnings-Related
Pension Scheme, a heavily subsidized supplement to the flat-rate universal
pension, but will not abolish the program as originally planned. The govern-
ment will also streamline social security by combining several benefits under
one new program but has reportedly abandoned plans to cut housing benefits.
Prime Minister Thatcher is determined to win a third term and probably
regards limited reform proposals as necessary to set the stage for later, more
fundamental social security changes. The majority of voters and interest
groups?including a sizable part of the Conservative Party?opposes any
changes in the national pension system. Many moderate Tories, moreover,
would prefer to avoid confronting welfare reform until after the next election.
Rightwing Tories, however, will very likely criticize the proposed changes as
falling far sh r f Thatcher's ambitious goals and providing only minimal
savings
A wave of mergers is reshaping West German industry. The large auto and
chemical firms, flush with export earnings, are searching for acquisitions that
promise technological spinoffs, while defense suppliers, anticipating drops in
military procurement, are seeking financially strong partners. Daimler-Benz
recently paid $600 million for AEG, West Germany's second-largest electron-
ics firm, with over $500 million per year in defense contracts. Earlier this year,
Daimler-Benz acquired the aircraft manufacturer, Dornier, and the jet engine
supplier, MTU. The carmaker is now West Germany's largest private concern
and a major defense supplier. Messerschmitt-Bolkow-Blohm (MBB), the
nation's largest aerospace firm, recently took control of Krauss Maffei, the
manufacturer of the Leopard II tank. The Bavarian State government is now
urging BMW to buy control of MBB. BMW, however, has bought several
small high-tech firms, and may be leery of such a major acquisition. The
Cartel Office, which is reviewing the AEG purchase, is likely to approve any
merger that promotes efficiency without unduly heightening industrial concen-
tration in a particular sector.
The French current account registered a small seasonally adjusted surplus for
the first nine months of 1985, as compared with a year-earlier deficit of almost
$1 billion. For the full year, the surplus should approach $1 billion?a roughly
$2 billion turnaround from 1984 and a dramatic change from the $12 billion
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S eden Rejects Major
apital Flow and
Exchange
Liberalization
Swedish Unemployment
Declines
Argentina's Grain
Crops Damaged
aecret
deficit recorded in 1982. Favorable factors include lower imported raw
material prices in dollars, the increased dollar value of French exports, and the
still slow rate of economic growth, which held down import demand. Nonethe-
less, a significant attempt to speed growth would quickly wipe out the surplus
at a time when Paris is intent on reducing the substantial foreign debt
accumulated in the early 1980s.
After eight years, a divided parliamentary commission has proposed only
limited reforms of Sweden's foreign exchange and capital control regime. The
commission majority, appointed from the ruling Social Democrats and the
trade unions, argued that foreign payments constraints preclude more exten-
sive liberalization. The influential trade unions especially fear that increases in
Swedish investment overseas would cost jobs at home and require greater wage
restraint in order to maintain competitiveness. Consequently the report
recommends only minor changes, such as permitting Swedish firms to hold
foreign securities as a hedge against exchange risk and allowing small firms to
retire foreign debts before maturity. Other proposals would strengthen central
bank control of Swedish overseas investment and thus may run counter to
OECD agreements on capital flows. By contrast, the minority members,
chosen from the opposition and the business community, sought much more
extensive deregulation to impose discipline on domestic economic policy and
control inflation. The report's main recommendations are subject to a six-
month review before the government can introduce legislation to carry them
out.
An improving labor market is likely to thwart the Palme government's tough
stance in the current round of wage negotiations. Total employment has
increased by 47,000 since last October while the number of vacancies has also
risen. Unemployment has held at about 2.5 percent for the past two months,
down from 3.2 percent in September. The percentage of workers in special
government-provided jobs has also declined?to 3.8 percent of the labor force,
as compared with 4.5 percent a year ago. The government is stressing that
large wage increases could weaken export competitiveness. Nonetheless, some
white-collar unions are seeking annual pay increases as high as 30 percent to
increase their pay differential vis-a-vis less-skilled workers. The trade unions,
for their part, intend to keep the differential at a minimum. Tight labor
market conditions probably will mean higher wage settlements than the
government would like.
Less Developed Countries
Recent prolonged rains and flooding are believed to have taken a heavy toll on
Argentina's wheat crop. As a result, USDA is expected to reduce its wheat
production estimate for Argentina from 12.3 million metric tons to perhaps as
low as 10.5. Similarly, available wheat exports could fall by 20 percent to
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1 /Brazilian Drought ,y
Damages Agricultural
Prospects
below 6 million tons. In addition to the wheat setback, Argentina's sunflower
seed crop is expected to be down at least 1 million tons and inability to plant
corn due to the wet weather will reduce yields. According to a USDA official,
current damage to the country's vital grain and oilseed crops could cost Buenos
Aires up to $0.5 billion in critically needed export revenues in 1986. Grain and
oilseed exports normally amount to $3 billion?roughly 40 percent of Argen-
tina's total export earnings.
Severe drought in southern Brazil since May?"the worst in 100 years"?
probably will play havoc with Brazil's agricultural production, commodity
exports, and domestic economy in 1986,
Desnite light rains in early November,
the 1986 coffee harvest will be less than one-half the size of
previous annual crops. Brazilian agricultural officials are concerned about
permanent damage to coffee bushes and citrus trees and about delayed
soybean plantings. Production shortfalls of these three crops, which together
account for more than one-fourth of Brazil's total export earnings, could
impede the government's efforts to bolster its trade surplus and meet its
foreign debt payments. Furthermore, drought-reduced harvests of beans and
corn will strain national food and feed supplies, fuel inflation, and put
considerable pressure on the government's new stabilization program.
Morocco's Mirage
Financing Efforts
\ Fizzle
Secret
13 December 1985
Morocco last month failed to convince France to provide credits for the
purchase of 24 Mirage 2000 fighters.
The decision reflects growing concern among Morocco's creditors
over Rabat's financial viability. Morocco continues to have difficulty market-
ing phosphates?Rabat's primary foreign exchange earner?while agricultural
exports are affected by drought and the likely loss of European customers after
Spain and Portugal join the EC next year. Nevertheless, Morocco is not likely
to abandon its three-year effort?the UAE, Libya, and Saudi Arabia have
reportedly offered funds in the past although none have materialized?to
finance the fighters. King Hassan believes Morocco urgently needs the aircraft
to replace its aging US-made F-5s and Mirage F-Is.
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ew Tunisian
Investment Measures
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ch-Improved
vthiopian Harvest
Tunisia has sweetened terms for export-oriented foreign investment to boost
the country's sagging finances. New investment incentives include an extended
corporate tax exemption period, increased profit tax exemptions, and eased
requirements for "Tunisification" of company personnel. The US Embassy
believes these provisions will help attract investors, particularly those interest-
ed in inexpensive labor and easy access to West European, Middle Eastern,
and African markets. Investor interest could cool, however, in the event of
strong response from unions to removing the requirement for training and
employing domestic labor. Unemployment is currently about 20 percent, and
government-labor relations already are tense over wage and other austerity
measures. Many investors will also remain reluctant until political concerns
about Bourguiba's successor are resolved. 25X1
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northern Ethiopia shows the harvest?to be complet- 25X1
ed this month?will be some 50 percent larger than last year. Rains in the re-
gion this year were near or above the norm of the past 15 years and the best
since 1979. Crops are poor in some areas, however, especially in Eritrea.
According to the UN Food and Agriculture Organization, about 2.5 million
people are likely to suffer from malnutrition in the entire northern region.
Although the crops are generally good in the north?the area hardest hit by
last year's famine?substantial aid will still be required for those areas with 25X1
poor crops because redistribution of the harvest will be limited and reserves
need to be rebuilt. 25X1
Zi babwean Harare has partially reversed its decision to double the minimum wage for an
gricultural Wage estimated 40,000 agricultural workers. Last August, the Mugabe government
Controversy decided to equalize minimum wages in the tea, coffee, sugar, timber, fruit, and
poultry industries with those of miners. This put a number of major
Zimbabwean agricultural exporters in a severe profit squeeze and spurred
demands by mineworkers for similar increases to restore the differentials,
according to US Embassy reporting. Some farm managers attributed the move
to a desire by the government to force the closure of large foreign-owned
farms, thus freeing some of the most productive land for domestic settlement.
The 26 November decision to exempt all producers from the new minimum
wage levels?except mainly foreign-owned large farms with processing fac-
tories?lends credence to this view. Pressures to exempt these farms are likely
to increase, if rising labor costs force the closure of these major employers and
foreign exchange earners.
J e Slump Brings
abor Unrest to
Bat,adesh
Reduced world demand for jute?Bangladesh's major export?has depressed
the prices jute farmers receive, leading to labor strikes and opposition agitation
for government subsidies. The price has fallen by about two-thirds from a year
ago?not enough to cover growers' production costs. Workers in Bangladesh's
largest jute mill went on strike in early November to protest threatened
government cuts in their wages. The government negotiated an end to the
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ood Prices Stable
\_} in Kabul
hilippine Economy
Bottoming Out
strike, but opposition parties and leftist labor unions held a national strike on
11 November to support the jute workers. The US Embassy reports that the
opposition is also demanding that the regime guarantee a higher price for jute-
growers. Depressed jute prices give the opposition an issue to use in national
elections tentatively planned for next year.
During the past year, food prices in Kabul have shown little chane and
supplies have been adequate, according to US Embassy reporting.
food prices outside Kabul have risen,
however, because war-related transportation disruptions cause occasional spot
shortages. The Soviets have kept Kabul adequately supplied with food despite
the city's rapid population growth over the past few years probably to avoid
undermining efforts to build support for the Karmal regime. Despite food price
increases in areas outside Kabul, weather date suggest that
supplies are generally adequate there as well.
According to our index of leading indicators?money, prices, trade, profit
expectations, government revenues, and manufacturing employment and pro-
duction?the Philippine economy remains in the holding pattern it entered at
midyear. Bullish signals for September include surging stock prices, money
supply, and imports, while bearish indicators include declining exports and low
inflation. The continued stability of the index suggests that economic growth
in the second half of 1985 will probably be close to zero?a considerable
improvement from the economy's 3.5-percent decline in the first half of the
year. We believe, however, that strong growth in export volume is required
before the economy can be judged to have safely turned the corner. Alterna-
tively, continued poor export performance?or a particularly divisive presiden-
tial election campaign and heavyhanded manipulation of balloting in Febru-
ary?would unsettle the business climate and contribute to a further
contraction of the economy.
Communist
Soviets Seek Western The Soviets are seeking Western assistance in the construction of a turnkey
Assistance for steel project to be built in Orel, I The
New Stee Complex complex will cost over $1 billion and produce nearly 1 million metric tons
annually of high-quality steel sheet and strip. Consortiums from Austria, Italy,
Japan, and West Germany are bidding on the project, and Moscow is
reportedly playing off bidders against each other to obtain the best price. The
complex is one of several steel projects mentioned in the 1 2th Five-Year Plan
1986-90.
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13 December 1985
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East Germany Buys
Soviet Steel Mill
New Bulgarian Energy
Measures
East Germany has purchased a hot-rolled steel mill with a 2.5-million-metric-
ton annual capacity from the USSR for its main steel complex at Eisenhuet-
tenstadt. The deal suggests a change in the recent East German policy of
buying modern steelmaking equipment from the West, in particular from West
Germany and Austria, and may preclude new Western contracts for whole
steel plants for some time. East Berlin might have decided to heed Moscow's
call for greater CEMA cooperation or found Soviet soft-currency terms offset
technology that does not match Western standards. We estimate a mill this
size would cost about $500 million if built in the West. While details remain
sketchy, the plant could be completed by the end of the decade and could add
significantly to East German rolled steel production-5.4 million metric tons
in 1984, according to East German statistics. East Germany probably will use
the new capacity to reduce imports?which come mainly from the USSR?but
may also want to boost steel exports to the West
The government has restored nearly full electrical power to homes and shops in
Sofia, at least temporarily suspending the rationing in effect since February,
according to the US Embassy. According to Bulgarian press sources, Soviet
leader Gorbachev agreed during his October visit to supplement Bulgarian
electricity supplies from the Soviet power grid. A Council of Ministers decree
effective 1 December set limits on household consumption. Violators will be
subject to a surcharge, while rates will be cut for consumers who use less than
the limit. Energy Minister Todoriev also warned of sanctions for chronic
abusers of the new system. The increased Soviet supplies are probably a
temporary measure to help with increased demand this winter. The regime will
quickly reinstate central electricity rationing if the voluntary program fails, or
if bad weather this winter strains reserves.
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