LC

# FINANCE

* Sources: National Foreign Assessment Center. Joint Economic Committee of the Congress

## Now Russia asks for time to pay

Is the financial rot in eastern Europe now spreading to Russia? Western banks and governments are getting jittery now that Russia has joined the queue of commu-nist countries trying to delay payment on debts due to the west. For the first time since 1945, Russia wants to put off paying debts that have already fallen due. Twice in the past Russia has bullied West Ger-man banks into rescheduling some of its debts on more favourable terms, but it did so well before payment was due.

Last week, it asked 16 West German firms (including Krupp Stahl) and 10 Japanese trading companies for permission to extend payment from three months to six months on an estimated $1.26 billion in short-term credits. That request, promptly denied, left western banks looking at their east European debts in a new light.

None of the banks fears that Russia will become as bad a credit risk as Poland, which had $71m of its government-guaranteed debts picked up by the Reagan administration this week (see page 25). Even so, they can no longer assume

that Russia's financial resources are more than enough to keep its Comecon allies from going bust. Most of Russia's $18 billion hard-currency debt consists of private trade credits, about half of which are guaranteed by national export credit agencies such as West Germany's Hermes and Britain's Export Credits Guarantee Department. There is a small amount of direct government-to-government debt, mostly West German. Half of the $3 billion Russia must repay the west this year is due before March 1st. This problem would have disappeared had the West German and Japanese firms granted the Russians an extension.

Russia's problems arise partly from its handouts to Poland, though pressures on Russia's cash resources come from all directions. Only with $2 billion in hard currency pumped in by Russia was Poland able to meet its obligations under the Paris Club's agreement of last spring and make some interest payments to commercial banks. American and British bankers have been hoping to squeeze even more out of the Russians when

Poland asks to reschedule the $7.5 billion it must repay in 1982. Rumania, which rescheduled $1.2 billion in short-term debts last week, would have had to do so earlier without Russian handouts.

Western governments find it hard to assess how much Russia doles out to its Comecon allies. This and the level of its reserves are among the most closely guarded of Russia's many financial secrets. Only the threat that Poland might be declared in default forced Russia to reveal the extent of its, aid to that country. The chart shows the American government's best guess of the extent of Russia's hard-currency handouts.

Ominous rumblings that Russia was having trouble meeting its hard-currency requirements have sounded for months. According to the Bank for International Settlements, Russia's deposits with western banks plummeted from $8.6 billion to $3.1 billion in the six months to June, 1981, and may now be less than $2 billion. Russia was rumoured this week to be testing a chilly Euromarket for a $137m loan to help finance the gas pipeline from Siberia to western Europe which it hopes will bring in up to $5 billion in hard currency each year by the late 1980s. Despite their governments' support for the scheme, West German and French banks balked at the request.

With the cut-off in western lending, Russia has been selling oil, gold and diamonds to get hard currency. The world's oil glut has cut back its oil earnings, which may have increased only by $900m in 1981, despite a 10% reduction in sales to its Comecon allies to leave more oil for export. Gold and diamond sales have also been made into soggy markets, but South Africa is said recently to have bought privately $2 billion in Russian gold to prevent the world price from dropping through the floor. De Beers may also have been lumbered with even more Russian diamonds in order to keep the world price up.

The sanctions America imposed on Russia after the invasion of Afghanistan have also hit Russia's cash resources. Although Russia easily found new suppliers, it was forced to pay Argentine and French grain traders cash on the bushel. Most American grain deals had been financed with bank credits. By one French estimate, the hard-currency cost of these sanctions was over $5 billion.

Most western banks are now unwilling

THE ECONOMIST FEBRUARY 6, 1982

79

FINANCE

to offer more loans to eastern Europe until Poland's debts are rescheduled. Even Hungary, the most robust Comecon country, has found it impossible to borrow from the west. Western governments have also informally agreed not to extend any new credits until martial law is lifted in Poland. That still leaves the unsolved problem of some $80 billion of doubtful Comecon debt and an assumed Russian long-stop that may have retired hurt.

## Wall Street

### Book profits for the brave

NEW YORK

Heavy tomes about how to prepare for a coming crash on Wall Street have suddenly disappeared from American bookstalls. Shelves are stacked instead with bullish investment books that almost promise a fortune from the Reagan stock market. One upbeat volume, "The Roaring '80s on Wall Street", claims that "almost all stocks, as represented by the Dow Jones industrial average, are poised for an explosive upward action." Really?

Many investors may have thought so on Thursday, January 28th, when the Dow rose 21.59 points, followed by a 6.85 point increase the following day to 871.1. Among the front-runners were old favorites like IBM and the oil service company Schlumberger, as well as stocks such as Heublein, the Kentucky fried chicken and booze outfit in which General Cinema this week bought a stake of over 9% and says it plans to add to it—up to 15%.

Investors had taken heart from De-

cember's 0.6% rise in America's leading economic indicators, which suggested that the recession would soon be over. They were cheered, too, by a report from the Wharton School, at the University of Pennsylvania, which showed that Wall Street's 36 biggest institutional equity investors expect their 75 largest holdings to show an average return of 18.68% (from earnings and dividends) over the next decade. The New York securities firm Drexel Burnham Lambert chipped in its nickel's worth, hoping for a "belated stock market rally to set in over the next couple of months" on the back of lower interest rates.

They all reckoned without the poor money supply figures, which showed a decline of only $600m in the latest week, disappointingly small after the recent upsurge, and the banks' immediate reaction—a hike in prime lending rates to 161.61%. On Monday (February 1st), the Dow slumped by almost 20 points to 851.7, and, by the close on Wednesday, it had retreated even further to 845.03. There was little joy in the bond market, which had weakened ahead of a record $10 billion federal financing.

Some Wall Street folk think the Dow could fall to 750 or lower before any sustained bull market develops. If a boom is around the corner, however, as those prepared to stake their reputations between hard covers imply, it might be in fixed-interest stocks. Morgan Guaranty's current economic survey predicts that the "recent run-up of interest rates will reverse itself. . . . It is extremely doubtful that interest rates will climb to anywhere near the stratospheric peaks that they reached in turbulent 1981." Are you listening, Mr Henry Kaufman?

## Gold

### The once and future thing

Gold bears have been on the loose for the longest period since America ended the dollar's convertibility into the metal in 1971. Having dropped $63 to $367 an ounce between the end of October and the middle of January, gold has regained a little glitter, but is still less than half the $850 level it reached at the time of Russia's invasion of Afghanistan just over two years ago.

Gold, which yields nothing, has been buffeted by dollar interest rates. It rose $15 in the week to Friday, January 29th, on hopes that America's money-supply bubble would soon burst, only to lose half the gain on the following Monday, when two American banks raised their prime

rates by 1% to 161%. Investors who borrow dollars to buy gold fear that interest rates will rise further still despite the official line that present high interest rates will last six weeks at most.

In the past two years, money-market rates have come to seem more important than politics to gold bugs. Each political crisis since Afghanistan has had less effect on the gold price (see chart) than the one before. The metal rose only $7 after the declaration of martial law in Poland, partly because the Russians were heavy sellers at the time. They are thought to have unloaded 250 tonnes on to the market in 1981, more than twice as much as in the previous year.

Roughly half of Russia's 1981 sales took place in the last quarter, probably when it became clear just how mean its grain harvest was going to be. To minimise the impact of big sales on a weak market, the Russians now sell not only in Zurich (their traditional market), but also in London, New York and Hongkong. Russia may sell more this year; it produces over 300 tonnes a year and has built up its stocks over the past three years. Russian sales, however, are part of the wider problem of Comecon debt. If that were to cause a crisis among western banks, gold might not seem such a bad investment.

That fear apart, nobody has a good word to say for gold at the moment. The world's largest producer, South Africa, mined 657 tonnes in 1981, the smallest amount for 22 years. Historically high gold prices before the present dive made it worthwhile to dig out lower grades of ore. Falling prices this year will not make much difference to output, though: big increases in capacity will not come on stream until 1984.

On the consumers' side, demand from jewellery makers totalled around 500 tonnes last year, nearly a third less than in 1979. If the recession continues, jewellery buying should stay flat.

One literary bull among many

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Bechtel Power Corporation

Interoffice Memorandum

MAR 16 1982

G. P. SHULTZ

To G. P. Shultz

Subject Soviet Union Technology and Manufacturing Capability of Oil Field Production and Distribution

Copies to E. C. Stokes

File No.

Date March 16, 1982

From L. E. Pfeifer

Of Procurement

At 50/3/B-11 (07) Ext. 5442

MAR 19 1982

In reply to your above request, we have surveyed our most experienced Procurement personnel as well as talking to John James, Chairman of the Board of Dresser Industries, and John Soden, President of National Supply. Further we talked with K. H. Crandall, one of the foremost geologists in the United States and consulting professor at Stanford in the School of Mineral Sciences.

The consensus of the above is as follows:

* The Soviets have the technical and manufacturing capability to sustain their present eleven million plus barrel per day production.

* Down to 15,000 feet their drilling technology is sufficient. They lack deeper drilling capability.

* They have some of the best arctic capability in the world.

* Their pipelaying capability and their construction equipment is antiquated by approximately 15 years plus but for internal Soviet construction it does suffice.

* They are very interested in our offshore technology and are some years behind the West in this field.

5024, REV 1/78

G. P. Shultz

-2-

March 16, 1982

Major procurements are being made in the West, by the Soviets, because of the added capability required for pipeline construction to meet the demands of the Western markets as well as the availability of supplier credits. These procurements may allow them to complete the construction in a shorter time frame.

LEP:hm

April 9

CLARK SPECIAL GROUP DRAFT

April 8, 1982

We are entering an era of deep and dangerous change in our relations with the Soviet Union. Its leadership is in transition. The ability of the Soviet system to transfer power smoothly is no greater now than it has been for the past sixty years. Its economy is in grave difficulty, its relations with its neighbors troubled in every quarter from Poland around to China, and it seems unable for domestic reasons and unwilling for ideological ones to relax its headlong pursuit of military power.

For our part, the changing nature of East-West relations has introduced new strains into the Alliance. Western financial banks are at risk because of their exposure in the East. Official Western trade policy is unsettled. Western attitudes about nuclear policy and the significance of Third World issues such as Salvador for the superpowers is sharply divided.

As Afghanistan and Poland made clear, the industrial democracies respond to Soviet behavior ad hoc, without a settled overall strategy. This is unsatisfactory in the long run.

A few comments about the nature of trade are therefore in order:

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-- From an economic standpoint, trade takes place
only when it is to the mutual advantage of both parties:
trade is a plus not a zero sum game.

-- The gains from trade are not necessarily evenly
distributed and the division of the total gain between
the parties is subject to bargaining (including the use of
non-economic trade-offs) but is also constrained (sometimes
tightly) by the market prices of items traded.

-- With or without the use of loans in producer
countries (themselves an indication of where bargaining
power lies) both buyers and sellers can ultimately be
severely squeezed by over-dependence on one buyer or seller.
This factor has always led to efforts to diversify
sources and markets.

a. The USSR sums all its buyers or sellers
together as it approaches a western market;
whereas, many participants are characteristic
on the western side and collaboration is
prohibited by U.S. participants by our
anti-trust laws.

-- A special feature of East-West trade involves the
ideas embodied in the transactions.

a. The principal items from the East of interest
in the West are raw materials: oil, timber,
minerals. They contain ideas at the stage of

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E. production (and western goods containing ideas are being purchased) but contain no ideas as articles for sale.

b. Western manufactured goods are in demand in the East and, by contrast, they are typically loaded with scientific and engineering ideas.

-- Broadly speaking, the balance of relative advantage seems somehow to have been turned upside down.

a. The USSR has much more to gain from trade than do the western nations. Furthermore, a kind of dependency on advanced products, let alone grains, would seem, one would think, to have developed.

b. The situation now appears at least to be the reverse, with producer pressures and concern about rippling effects of a financial squeeze putting more apparent pressure on the West than the East.

c. Obviously, a key point is that the East is better coordinated in its approach than the West.

This suggests two conclusions: 1) Greater coordination of the trade and credit policies of the industrial democracies is essential; 2) some of the quid pro quo for the industrial democracies must be sought in the political field. With respect to trade or credit policy:

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-- Stop-start does not work. To try to respond with new penalties to every irritant in the relationship is too episodic and ineffective. Trade and financial relations are built over the long term. They cannot be turned off and on overnight.

-- Conventional sanctions are less effective all the time. We have virtually exhausted the list of trade measures which hurt the Soviets more than they hurt us. Witness the difficulty over grain and the gas pipeline.

-- In the past, sanctions have been announced but there has been no follow-through. "Ringing proclamations of truth, but no consequences," as George Shultz has called this practice. Our reputation for firmness and reliability suffers.

-- Finally, but not least, the debate over sanctions in the abstract splits the Alliance.

The West possesses the overwhelming share of the world's economic power. Given the stakes and the opportunities it is unthinkable that we should continue to deal with the Soviet Union in the disorganized, disoriented way we have in the recent past. The West must not permit the Soviets to assault the geopolitical balance without penalty or to solve its economic problems by means of

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Western aid without paying the political price -- if that
is the right word -- of contributing to restraint and
stability in international conduct.

-- To act otherwise is to license Soviet adventurism.

-- It is to forego the opportunity for a comprehensive
negotiation including both political and economic
components.

-- And it also exposes the Western financial system
to Soviet political pressure. Our banks run the risk of
becoming hostage to the economic policy decisions of Moscow.
For the governments of the industrial democracies to tolerate
the further uncoordinated mushrooming of credits to the
East would expose them to ever more serious pressure from the
East. And it throws away a major tool which if properly
used could influence Soviet conduct.

Poland made clear that the Communist economic
system is rotting. This rot represents an historic
opportunity for the West. Poland alone will require more
than $2.5 billion of new Western credits this year just to
keep its economy afloat. The Soviet bloc is increasingly
dependent upon credits and technology from the industrial
democracies.

-- The issue is not whether Poland should formally
be declared in default. Indeed, the majority of the Group

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is opposed to a formal declaration of default. It holds
that default on the Polish debt might precipitate a race
between Western creditors for the meager Polish assets left
in the West. It could decrease, not enhance, the prospects
that Western banks and governments will be repaid without
bringing real pressure on the Soviet Union.

-- The issue is long-range: whether and on what
terms Poland--and the other nations of the Soviet system--will
have access to Western trade and financial resources in the
years to come. They need that access. Whether, and how,
and on what terms they enjoy such access is far more than
a banking question.

The Group conceives it to be a matter of the highest
priority that the United States and its allies develop a
coherent, long-term strategy to govern the future economic
relationship between the East and the West in the years ahead.

-- A period of coordinated restraint could be a prelude
to a wide expansion of economic contacts. A comprehensive
economic deal for a comprehensive political deal. An increase in
trade and credit in return for a real restraint in Soviet
conduct. We must know what we want from our allies and from
the Soviets in both the political and economic areas.

-- It is the view of the majority of the Group that
considerations of overall strategy must govern that
relationship. Some think the market should continue to rule,

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but most feel the issue too consequential to be left entirely to the bankers and the traders. They believe that the West must design a political framework for the economic links: to preserve its own alliance, to avoid enhancing the vulnerability of its financial and trading institutions to political manipulation by the Soviets, and over the long term to take advantage of what is probably the most significant lever on Soviet behavior around the world -- a lever that could end up in a global negotiation.

-- All the Group believes that the policy must be a coordinated Western policy. The United States cannot act effectively by itself. Even as to grain, an embargo would hurt us more than the Soviets unless Argentina, Canada and Australia went along. And it cannot be excluded that in the right framework a majority might go along.

-- Our policy must offer inducements and incentives as well as penalties, carrots as well as sticks. We must develop a package of positive measures that the U.S., Europe and Japan are prepared to undertake towards the East in the trade, investment and financial field if the political framework is appropriate.

-- The Group is fully aware of the magnitude of this task. It will not be easy to persuade the Allies to go along. Earlier attempts have failed. It will be even more difficult to design a global bargain which will be

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at the same time adequately specific and comprehensive
enough to take account of the contingencies of the future.

In doing so we shall have to determine the balance
to strike in those negotiations between demands for
concessions in Poland, in the nuclear arena, in conventional
armaments, or as to Soviet and proxy behavior in the Third
World. We must define our objectives.

The Group is persuaded that in designing such a
strategy we hold by far the stronger hand than the Communist
nations. The problems of the West are serious problems
of policy, but the problems of the Soviet system are structural
and basic. To the West belong the vast bulk of the world's
resources and its heritage of human values. It cannot
be beyond the wit of the West's leadership to put together
a strategy which takes full advantage of the historic
opportunity before us.

The effort should be initiated at the Versailles
summit conference. The proposal should include but go
considerably beyond the Buckley mission's call for
harmonization of official credit policies and exchange of
financial information.

-- The proposal should include a call for a
comprehensive declaration which would establish the

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principles of a common policy within the Alliance on dealing
with the Soviet Union (excluding nuclear weapons talks). It
would make clear that the West sees the issue of its relations
with the East in terms far broader than military--economic,
cultural, social and ideological.

-- Within this framework, the Versailles initiative
would emphasize that the strength of the West turns on its
ability to present a harmonious face to the East, and
would suggest that the West consider a number of specific
and concrete measures to improve coordination and
discipline. These might include:

1) A commitment to update regularly the *common list of prohibited exports*.

2) An agreement to review regularly and actively the respective *policies on export credits* and financial guarantees, with the end of establishing a common and non-competitive policy in this area among all the OECD members.

3) A mechanism for *exchanging information* among all OECD governments about new credits to the East, public and private.

4) An Alliance institution to conduct an intensive ongoing *country risk review* of the East bloc economies, drawing on the facilities of the IMF but under the mandate of the Alliance governments.

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5) An informal _clearing house_ for information and communication among all Western banks active in Eastern Europe.

6) Above all a definition of the ultimate goal of what economic incentives we can offer as governments and what we desire in return both as to economics and as to political restraint.

We must define both tools at hand and objectives.

The deterioration of the Soviet system is both a danger and an opportunity for the West. An effective Western response along the lines proposed here should be seen in the same ambiguous way by the Soviet Union--as a threat that the West will respond in a more disciplined fashion to future Soviet assaults on the international system, and a promise that there might be real benefits ahead in the form of Western economic cooperation if the Soviet Union is prepared to conduct itself with the restraint that our dangerous age demands.