Created: 4/21/1982

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One of the most difficult problems for the Soviet leadership Inill be how to dealevere scarcity of hard currencyime when the economy Is slowing eharply. Although the slowdown results from the interplay of many forces, and the overall weight of hard currency Imports in the economy is small, these imports play an Important role in easing food shortages, raising energy production, sustaining technology and productivity, and making up for unexpected shortfalls of key products.

But while the Soviet need for Western goods and technology is rising, duringhe purchasing power of Moscow's hard currency earnings is likely to decline.

0 The volume of oil exports will be steadily squeezed

between rising oil consumption and oil production that is now constant and will fall later, o Soft oil markets probably will keep real oil prices from

rising for several yean, o Gas exports will increase substantially if the gas export pipeline is built, but not enough to offset the drop In oil exports.

O Hard currency earnings from arms sales are unlikely to increase much because LDC clients will be less able to pay.

O Other exports suffer from production problems (wood

products,r an inability to competearge scale In Western markets (machinery, chemicals).

The Soviet herd currency position is still relatively strong; the debt-service ratio Is only aboutercent. Nonetheless, prospective stagnation in the volume of exports means that any attempt toubstantial Increase In imports will quickly push up hard currency debt to an unacceptable level. arge Inflow of Western capital would be required just to maintain the current level of real imports and would resultoubling of debt5uadrupling The debt-aervice ratio would approachercent bylevel high enough to cause concern in financial circles--and reach dangerousercent)

In this tightestern credit policy of restricting the volume and hardening the terms of government-guaranteed credits can play an important role in.

O Avoiding overexposure by private banks, as has already occurred in lending to Eastern Europe, and the potentially costly clulms on Western budgets if guarantees have to be made good, o Putting added pressure on the Soviet authorities to reexamine their priorities. To illustrate the potential impact of Western credit restrictions, we have projected the effects of some possible sets of restrictions. eveling off of new Western lending at the average rateould result ecline in import volume of aboutercentnd keep the the hard currency debt within manageable proportions. Substantial

reductions in government-guaranteed lending coupledessation of nwdium and long term private lending would cut imports by nearly IS percent.

Even moderate declines in hard currency imports can greatly complicate Soviet economic problems and make allocation decisions more painful. Large agricultural imports are essential to the growth of meat consumption even in normal crop years. Expansion of gas consumption and exports requires massive purchases of Western large diameter pipe. Large imports of metals and chemicals are an integral part of Soviet economic plans. Orders of Western machinery and equipment have already been sharply curtailed; further cuts would certainly impinge on priority


programs in steel, transportation, agriculture, and

It is unlikely that Soviet military and foreign policy programs would go unscathed if sizeable cuts in allocations of foreign exchange had to be imposed. The economy is so tautindeed, it is already rent with widespreadthe repercussions of any substantial cuts are bound to spread widely, even to military industries with all their traditional immunity. Moreover, such programs as aid to Cuba or third world countries, which directly or indirectly use up foreign currency and are already unpopular within the USSR, would encounter greater opposition.

The recent sharp turnaround In Soviet hard currency trade coupled with the difficulties that several East European countries are having in paying their debts is raising aerious questions about the Soviet Union's external financial strength.

This paper assesses the extent of the USSR's reliance on Western credits and the consequences for Soviet hard currency debt and Import capacity of unrestricted credits as well as reductions In the volume of eredlta granted to the USSR. The assessment beginseview of the credits provided or guaranteed by Western governments. It then discusses the Impact of credit restrictions on hard currency debt, debt-service ratios, and Soviet import capacity. The USSR, of course, would try to sidestep the effects of restraints on Western credits, so the range and effectiveness of possible Soviet responses are analyzed. The paper concludes with some judgments regarding the Impact of credit restrictions on the Soviet Union and on the level and composition of East-West trade.

Official Credit! to the USSRBackground and Current Status Recent Trends

Duringhe USSR and Eastern Europe took advantage of political detente to greatly increase imports from the West. The volume of Soviet hard currency imports more than tripled during the decade, for an annual growth ofercent. Hard currency imports increasedhare of total Soviet imports and in relation to CWP. Although still traall in the aggregate (lessercent ofard currency imports are Important to many high priority Soviet economic programs, including raising meat consumption and energy production. They comprise perhapsercent of investment In machinery and equipment.*

The expansion of hard currency imports Inas financed mainly by increased earnings from higher oil and gold prices, gas exports, arms sales for hard currency, and Western credits, particularly through mid-decade. Exports other than oil, gas, and arms have on balance barely held their own. Startingery low base, Soviet hard currency debt reachedillion by the endnd the net inflow of Western capital after Interest payments paid for more thanercent of hard currency imports. The net inflow

"Comparisons of inports with domestic values are corplicatod enormously by the artificiality of the official exchange rates for the ruble. For example, according to Soviet statistics, total importsmounted5 billion foreign trade rubles. esearcher in one of the leading Soviet scientific research Institutes, however, estimates the total value of inports for this periodillion rubles in internal prices. Western researchers have also argued that using the official exchange rate significantly understates the domestic ruble value of Soviet imports.



then slowed greatlyndmall net outflow

Aboutercent of the total Soviet hard currency debtillion at1 was guaranteed by Western governments. Drawings on officially aupported credits rose rapidly and steadilyhen they leveled off. Use of private credit has fluctuated widely. Medium and long-term private credits have been raised mainly In the Eurodollar market and were used for general balance-of-payments purposes, unlike government guaranteed credits, which are tied to particular exports and projects.

The large jump In Soviet export earnings resulting from higher oil pricesnabled Moscow to pay for increased imports of food and steel,ual ly. cease corrrncrcial borrowing, and to build up its hard currency assets. In the past year or so, however, softening oil prices, weak markets for other Soviet exports due to the Western recession, bad erops, and unexpected hard currency expenditures in support of Poland turned the Soviet hard currency balance of payments from surplus to deficit. Moscow drew down its hard currency balances, resumed large gold sales, borrowed on short-term from Western banks and suppliers, and took steps to cut imports. But they could not borrowarge scale in the Eurodollar market as they didecause deteriorating East-West relations and the Polish erlsis made Western bankers far more nervous. ew corrmiurned upwardesult of business eonnected with the new gas export pipeline.

Soviet Dse of Official Credit

Since the USSR began large purchases of Western technology in the, Moscow has used official and officially-backed credits to finance one-third of its imports of plant, equipment, and large-diameter pipe from the West. Annual Soviet drawings on government-backed credits Jumped from an average5 milliono nearlyillionut have held5 billion per year The volume of new commitments felleak of nearlyillion6 to less thanillioneflecting falling Soviet orders for Western machinery and equipment.

Although heavy drawings in recent years have reduced the backlog of undrawn commitments, Moscow still hadillion in undisbursed credits available at1 (excluding corrrni tments for pipeline orders). Perhapsillion of these commitments were pledged, however, to contract proposals that have now been scrapped. The combination of rising debt-service payments and level drawings has steadily reduced the net resource inflow to the USSR on official creditsaximum2 billionheremall net outflow from the USSR as debt service exceeded drawings.

Subsidized interest rates and long-term maturities on most government-backed credits have helped Moscow conserve some scarce hard currency. The interest rate subsidyecord leveln the orderillion--as conrriercial rates in most Western countriesercentage points more than those charged on official loans. Last October's Increase in the

OECD interest rate guidelinesossible reclassification of the USSR into the "rich country" category will reduce the subsidy, but only slowly. Several years will be required to pay off the official credit contnitted on concessionary terms, and many credits extended under earlier agreements can still be drawn at lower rates. The lengthy maturities available on official financing (upears) reduced1 debt service bill by0 million compared with what It would have beenaturity limit of five years.

, contracts for sales of large-diameter pipe and chemical plant were the primary beneficiaries of government-backed financing Pipe contracts backed by official financing totalled at5 billion;illion in contracts for other energy-related equipment also received official guarantees or credits. Officially-guaranteed credits0 billion in contracts for complete plants; two-thirds of these commitments were for chemical plants with the remainder going for steelluminumnd factories for machinery and consumerillion together). OECD data report someillion in official credit commitments for machine tools and other plant equipment. Small amounts of credits have financed orders for telecommunications equipment, ships, and earth-moving vehicles.

For many Western countries officially-backed credits covered about one-quarter of total exports to the USSR They were far more important, however, In financing sales of machinery and pipe.

Table 1

Official Credit Qjimitrrents to the USSRy Industrial Sector8

(Million US $)

All products

Cttrplete plants Steel plants Qvemieal plants Hydro and thermal power Wood, pulp and paper Aluminum, copper, zinc Other

Machinery, and equipment


exiTniinn s

Road vehicles

Oil and gas equipment


0 44

7 2



West QertTBiiy












OECD Reports for all countries except Japan. Lteta for Japan based on announcements of credits becking specific contracts.

* Value of contracts supported by official credits with an original maturity of moreears.

D Presumably includes credits for pipe exports.

Table 1

ussr: Ritbrnted LVewirigi on western Offielal ly-bat*od Crediti

DrawingsMillion US $

Credit Drawingotal Imports*

Annual Average

Credit Drawingsercent of Machinery and Pipe Imports*



on Western country trade data which generallymaller amount of exports toR than Soviet trade data.

Soviet Demand for Imports

Despite the help from large infusions of hard currency Imports in, the performance of the Soviet economy Is worsening. Although the economy Is still expanding,Its rate of growth has fallen drastically. The slowdown stems mainly from rising resource costs, systemic inefficiencies, shortfalls in agriculture and in key industries such as iteel, and an accumulation of planning mistakes. esult, growth of labor productivity has slowed markedlyime when demographic trends have greatly curtailed the supply of new labor.

Economic growth In, projectedercent per year or less, will probably be Insufficient to both support past rates of increase in defense spending and toerceptible rise In living standards. Indeed many Soviet cltUens believe that living standards have been declining over the past few years. If defense outlays continue to rise byercent per year (as we now project), they would preempt about two-thirds of annual increments to CfiNPs compared with one-fourth now. Leadership choices will be far more difficult; in particular, allocations to consumer industries, agriculture, and transportation would inevitably suffer.

The resource bind confronting Soviet leaders in turn suggests that hard currency Imports will be even more Important to the USSR Inhan In.

o Moscow needs large Imports of Western farm products,

especially grain, to Increase food supplies even in good crop years, and to keep them from falling in bad years.


o Western pipe and compressors are essential for the rapid expansion of Soviet fas production, which will be the main source of additional energy supplies and hard currency in. Western equipment also la increasingly important in oil production.

o Imports of Western production equipment--especlally advanced machinehelp to raise labor productivity, which Is the key to Soviet economic growth in.

Soviet requirements, in other words, will match fairly well the pattern of past purchases of Western goods

The USSR, however, realizes that ft will not be able to expand hard currency imports in real terms at the breakneck pace of the first half ofercent per year) or even at the more leisurely pace of the last half of5 percent per year). The cautious formulation of the foreign trade section inlan contrasts sharply with the bullish trade prospects expressed in previous five-year plan guidelines. In remarks to the Supreme Soviet In November, State Planning Committee Chairman Baybakov implied that the volume of trade with non-Ckmrnunist countries would grow byercent per yearompared with justercent. Allowing for some rise in the Soviet hard currency trade deficit, the Plan might envisage an average annual growth in hard currency importsercent per year. As will be shown below, even this relatively modest goal cannot be achieved without an excessive increase In Western financial exposure to the USSR.

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In the past, the USSR has been able to offset sizeable trade deficits with large sales of gold and armsut the outlook for Soviet hard currency exports is so poor that Moscow will not be able to stave off large and growing requirements for hard currency by using the gold/arms option. In, the USSR relied primarily on sales of petroleum, natural gas, timber, and wood products, chemicals, metals, and diamonds. Machinery exports were not an Important factor In, however, the volume of energy exports Is likely to decline substantially while the other exports, on balance, hold their own. Gold and arms sales cannot save the situation.

Merchandise Exports

Oil production has been relatively stagnant since

We think that Soviet, oil production will begin to decline by mid-decade and that domestic consumption will continue to rise slowly.* Unless Moscow elects to reduce exports to Eastern Europe beyond the cuts introducedhe stage is setontinued fall in exports of oil and oil products for hard currency. (They dropped in volume byercent8) Because of the uncertainties concerning the future of production, consumption, and prices for oil and the relative priorities of the various domestic and export uses of oil, projections of oil exports cannot be made with any precision. In our view, however, the trend Is clear--only the extent of the

Table 4

USSR: Hard Currency Ps^rrritfi Poaltlon

(Million U3 %)


>ld sales

it Interest*

ttb receipts

'her Invisibles and transfers

Current account balance

Irect Investment abroad

ross drawings Goverrrntnt backed Orrmerelal

cpayments Government backed Qjimerclal

ending to other countries*1

Capital account balance

Statistical discrepancy0












ESRi Hard Ojrreney feports

[on Cbrrent OS Dollars


and coke



and wood products





Dollara (im)



and equipment


and wood products


decline is uncertain. Soviet oil exports could disappear entirely by the end of, although It Is highly unlikely that the Soviets could afford any sizeable oil Imports. Alternatively, Moscow could chose to maintain small hard currency oil exports at the expense of Its own consumers and/or those of Eastern Europe-Gas exports, in contrast, willnot by enough to offset the expected fall In oil exports. Potential gas exports can be projected on the basis of the capacity of the export pipeline and the contracts signed with West European countries. Whether the pipeline fs used to full capacity is uncertain sine* It depends on the growth of West European gas demand.

The volume of timber, and wood productsercent of total hard currencytrended downward In, and we expect little or no growth In. Shortages of labor and equipment will limit timber harvesting operations, which must come increasingly from remote areas. In addition, rising domestic demand for lumber and paper products has caused persistent shortages In the past several years.

Chemical exports grew dramatically inut still account for less0 million in foreign exchange receipts. Most of the growth in exports resulted from buy back deals under which Western firms provided the plant and equipment In return for future product exports. In fact, Western help has allowed the USSR to become the world's leadingillion tons Exports of other chemicals are not

as large nor are they likely to grow substantially in. Western exporters already have begun to voice concern about the dumping of Soviet polyethylene and polyvinyl chloride in their markets.

- Duringoviet exports of platinum group metals (mainlyickel, copper, and aluminum probably will increase, while exports of chromite, manganese, lead, and sine will at best remain steady but more than likely fall. The USSR produced about half of the world's platinum group metals duringnd is assured of large increases in production of platinum group metals ins byproducts of expanded copper and nickel production in Northern Siberia. ajor surge in Western demand that doubled the price of these products, however, would yield the Soviets en increase in foreign exchange earnings of less thanillion.

Moscow probably has some chance of increased earnings from sales of diamonds. eceipts from sales of diamonds3 billion, equalercent of commodity exports. Because Western demand is highly volatile, however, earnings

reat deal.

Machinery exports increased nearly sevenfold duringnd now accountercent of total Soviet hard currency exports. The largest customer for these exports has been Iraq, with whom relations are now tenuous at best. Most Soviet machinery is not well suited to Western markets nor is it backstoppedeveloped network for service or spare parts. The Soviets can mass produce, at low cost, simple machinery and

equipment like standard machine tools and have had limited success in exporting such products to the West. The market for these products, however, is generally stagnant while competition from newly industrialized countries is growing. Moreover, given the growing stringencies in steel and other raw material supplies, Soviet machine builders will have all they can do to meet the demands of the domestic economy. Gold

The USSR ranks second to South Africaroducer and marketer of gold. Duringhe Soviet Union accounted for about one-third of annual world gold production and about one-quarter of the newly mined gold moving in world trade. old productionons, roughly one-half that produced by Southut more than-the combined output of all other world producers. Gold traditionally has ranked as one of the USSR's top export earners, with cumulative receipts Inetting Moscow SISamount equal to aboutercent of Soviet hard currency requirements In the decade. he USSRold inventoryons.

In assessing goldource of hard currency In, Moscow will have to balance Ita potential for large aales against the market's ability to absorb Soviet offerings. Initially, the USSR couldons or more ofear If all production net of domestic requirements were offered for sale. This volume could rise by SO toons by the end of the decade if domestic production continues to Increase steadily.

Military sales have become an important export earner (or the USSR. In the past three years, the net cash inflow from arms deliveries has6 billion, IS percent of foreign exchange receipts. It Is unlikely that the volume of arms sales for hard currency will continue to Increase. Indeed, they could fall. The USSR's military order book bulged0 but fell last year. The dramatic decline in surplus oil revenues of Middle East producers such as Libya will make It more difficult for the USSR to demand cash for new deliveries.


Impact of Credit Restrictions The Reference Case

An assessment of the effect of credit restrictionsasis forprojection of what would happen to hard currency imports, debt, and debt-service ratios in the absence of formal credit restrictions. We call this estimate the Reference Case. In developing the Reference Case and later assessing the potential effects of credit restrictions on Soviet import capacity, we haveetailed accounting model of Soviet debt accumulation and balance of payments. The model can be used to estimate Soviet ability to finance hard currency imports, as well as associated debt accumulation and debt-service ratiosange of import and credit assumptions.*

We believe that our projections of'earnings capacity and imports are conservative in the sense that they do not overstate the Soviet need for Western credits.

Assumpt ions

* The model keeps track of four types of financing: (l) export gas pipelinether government-backedther conmercial medlum-and long-term credits,hort-term credits. The model also takes account of the different maturity and interest rates applicable to each category of financing.

The key determinants of future Soviet hard currency earnings are based on the preceding discussion. They can be summarized as foilows.

Key Atsumptions About Soviet Hard Currency Exports In


Oil1olume (mbd)





1olume (bcm)cm)


es Sales1 S)

1 S) Volume (mt)z)

Sales1 $)

export earnings1 $)


addition, we assume that nominal prices for all Soviet exports (and for all imports) riseercentercent ndateercent.

To calculate the requirements for Western credits, we have assumed In the reference case that the Soviets would attempt to at least hold import volume constant at1 level through the decade. This keeps Soviet financing requirements within reasonable bounds; even so, the gap between imports plus debt service and net earnings (which would have to be financed with new credits) is still very large Debt would riseillion5 andillion The debt-service ratio would Increase toercent5 andercent 0 Whether the international financial community would

support debt accumulation of this magnitude is uncertain.

As suggestedtrong case can be made that the Soviets need substantial growth in the volume of imports from the West over the decade to achieve medium and long term economic objectives. But with our earnings projection, growth of real imports atercent perless than in the recentlead to clearly unreasonable financing requirements. Soviet hard currency debt would have to increase from aboutillion dollars currently toillion dollars5 andillion dollars The debt-service ratio would rise concurrently, from aboutercent now toercentnd toercent Neither Soviet financial watchdogs nor Western bankers would be likely to allow debt to accumulate so rapidly.

estr ict ions

The Reference Casearge net Inflow of capital just toonstant volume of hard currency imports. Western restrictions on lending would compel the USSR to reduce its imports In real terms; restrictions would also hold down the growth of debt and the debt service ratio compared with the Reference Case

f Credit Restrictions

ion Dollars, Current Prices

Reference 38 53

Flat 34 44

Severe credit 33 44

1 Prices

Reference 29 29

Flat 26 26

Severe credit 24 25

Gross Hard Currency Debt--Billion Current Dollars

Reference 43 78

Flat 29 23

Severe credit 22 13


Reference 28 45

Flat 20 15

Severe credit 15 7

* Repayments of principal and Interest on all debtercent of earnings from merchandise exports and sales of arms and gold.

In all cases, we assume that credit restrictions do not apply to lending related to the new gas export pipeline. The projections of debt, debt-service ratios, and import capacity do reflect the pipeline credits and purchases.

Although many kinds of credit restrictions are possible, the implications of two particular options are outlined here.* In one case we look at the effect of Severe Credit Restrictions In which, beginninga) disbursements under government-guaranteed credits to the USSR fall at the rate ofercent per year and (b) commercial lenders, interpreting this cutbackarning about Soviet credit worthiness, cease all new

disbursements The seeond caseFlat Lendingless restrictive. It assumes that disbursements under government-backed credits are held constant at the average level4 billion) and that disbursements from medium and long-term commercial lending areear, the average levelut far above reeent levels. This keeps the ratio of commercial credits to official credits at the high end of the recent range. The two eases ehouldide range of possible restrictive policies.

Effect on Imports. Both cases representing the formal imposition of restrictions on official credits to the USSR limit Soviet Imports considerably Imports drop3 and then stay below the reference case level

evere Credit Restrictions limit Soviet imports significantly more than the Flat Lending case does, but the difference disappears In later years. 6 the additional debt-service requirements associated with the greater borrowing permitted in the Flat Lending case offset the larger flow of new credits that Flat Lending represents to the USSR. In1 dollars, imports affordable In the Severe Credit Restrictions case areercent less than In the Reference Caseercent less In the Flat Lending ease. import capacity isercent lower in both eases.

Effect on Hard Cnrrtnc? Debt. Compered with the reference ease, eredlt restrictions would avoid an undue accumulation of Soviet debt. Even so, in the flat lending ease the projected borrowing for the gas export pipeline Increases debt by nearlyercentlthough debt declines subsequently. In the severe restrictions case, debt declines throughout the period.

esult of recent lending and credit disbursements for the gas export pipeline, scheduled principal repayments overtake assumed credit drawingsew years In both credit restriction cases. Thus,ebt declines, and the Soviet financial position, as measured by the debt-aervice ratio. Is much sounder than In the Reference Case

Soviet Response to Credit Restrictions

To soften the impact of credit restrictions on Soviet ability to import hard currency goods and services, Moscow couldariety of responses. It could seek credits in countries not participating in credit restrictions or attempt to obtain some relief from the assistance it has been giving to Eastern Europe and other client states. It might try to reduce the drain on its hard currency balances by stepping up its search for compensation deals and barter arrangements. If these options proved to be unrealistic or insufficient to offset the impact of Western credit denial, the USSR would have to divert commodities from domestic use to export or cut back imports paid for in hard currency. These alternatives are considered in order.

Finding Alternative Credit Sources-

Moscow would surely try to borrow from other sources if It confronted credit restrictions in major Western countries. The most likely sources of new funds would be in Austria, Sweden, and Switzerland. Already this year, Austria and Sweden have granted general trade credits to finance exports to the Soviet Union. While these countries all sell machinery that the USSR wants, they do not have the capacity to fill the broad range of Soviet requirements. In addition, the Austrian, Swiss, and Swedish banking communities generally follow policies similar to those of the major banks through Europe. If most large European banks adopted policies to limit or reduce their exposure to the USSR, the Austrian, Swiss, and Swedish banks would be unlikely to

Increase their exposure unless new loans were tied to .exports to the USSR.

Borrowing from OPEC countries could also help supplant Western credits. Although most East European countries have raised funds in the Middle East, the USSR has not In the past obtained any substantial loans from OPEC financial Institutions. In the last few months Moscow has shown considerable interest in gaining access to OPEC petro-dollar reserves, however. Delegations from Soviet-owned banks In the West have visited several Middle Eastern countries in an effort to persuade them to increase their deposits in Soviet banks. But the financial resources of many OPEC countries, particularly those most friendly to the USSRibya) will probably be strained for some time, Mmiting Moscow's chances for obtaining hard currency loans.

Funds might also be sought in Latin America, notably in Argentina and Brazil. Both countriesarge volume of agricultural commodities to the USSR. But Brazil allowed Poland to5 billion debt to finance Brazilian exports andesult of this experience would be extremely careful about extending large credits to another Communist country. In late March, Soviet officials began negotiations with Argentine officialsmillion credit for grain purchases. Argentina, however, Is notosition to offer the USSR any

significant credits.

Eastern Europe will not be able to borrow to make up for the cuts in credits to the USSR resulting from Western

restrictions. Poland's bankruptcy and the beginning of rescheduling negotiations on Romania's debt have by themselves greatly reduced CEMA's access to credits. Evena good record of sound financial managementis nowerious hard currency bind. The chilly borrowing climate also has recently extended from banks and the Eurocurrency markets to the export credit agencies of Western governments. Moreover, if the West restricts credits to the USSR, the ability of the rest of CEMA to borrow would be further weakened. Eastern Europe might be able to escape some of this negative spillover only if Western governments were able to make clear that their policies will differentiate between Eastern Europe and the USSR.

Even if the East European countries enjoyed more favorable credit ratings,It would be difficult fflr them to borrow on behalf of the Soviets. Bankers and private creditors would be aware of any borrowing in excess of Eastern Europe's own requirements. Moreover, since official credits are tied to purchases of specific equipment, plants, and projects needed by the USSR, it would be immediately obvious if Eastern Europe attempted to obtain credits to purchase similar items.

Economic Assistance from Eastern Europe

Facing critical economic and financial problems of Its own, Eastern Europe will be neither able nor willing to provide much assistance to Moscow. In fact, the flow of assistance traditionally has been in the opposite direction as Moscow has extended large amounts of aid to enhance its political leverage within CEMA. Soviet insistence that Eastern Europe assist in

softening the effects of Western eredlt restrictions could threaten serious disruption in the Soviet camp. Moscow might well decide that the resulting damage to its political interests would be greater than the marginal help that might be squeezed out of its CEMA allies. Compensation Trade

The USSR's ability to use compensation agreements to avoid the consequences of Western credit restrictions is quite limited. No major deals are now under negotiation, and the depressed economic conditions in the West will make it difficult for the Soviet Union to conclude large new initiatives forme.

The enthusiasm of Western firms for most of the compensation deals proposed by Moscow has cooled considerably since the. Western firms compare the potential projects in the USSR with projects elsewhere where conditions regarding equity participation and managerial participation are far more favorable. The Soviets often table harsh financial demands, long-term credits to pay for equipment required to develop related infrastructure as well as the production facilities,edium-line credits to cover consumer goods purchases needed to defray local costs,eferred payments on the credits during the full period of project development. Western companies alsoumber of pitfalls in agreeing to accept deliveries of Soviet productsong period. Commitments to buy specific quantities of raw materials and semimanufactures are attractive when world supplies are tight and


prices are rising, but they lose their charm when demand is slack and the Western partnerompensation agreement finds It hard to market the products or to use them In its own plants.

Some Western companies are also reluctant to conclude compensation agreements because they do not want to sponsor additional competition on their markets. For example, the USSR purchased many chemical plants during. Under the terms of some of the contracts for these plants, large Soviet chemical deliveries to depressed markets in Western Europe have begun and will continue over the next several years. These exports havereat deal of opposition and have made Western companies wary of entering into contracts involving products that do notolid market.

Barter Arrangements .

Although In the past the USSR has bartered Soviet arms for Zambian cobalt, trolleys for Greek citrus fruits, and fertilizers for Thai corn, these arrangements do not have much potential for easing the Soviet hard currency position. Barter deals presently account forery,small portion of Soviet trade, mainly with less developed countries. Since most of what the USSR wants from LDCs can be sold by these countries in world markets, they have little reason to make barter deals with the Soviet Union.

Domestic Diversions

Lacking other alternatives, the Soviet leadership could decide to divert domestic production to the export sector. With respect to oil, at least, this option already may be under active consideration, although it depends in large part on meeting plans


for substituting gas for oil In the domestic economy. ignificant volume of domestic production, however, wouldeavy cost simply because the goods most marketable In the West are also in high demand In the USSR. Import Cuts

Moscow thus would have little choice but to reduce imports. How the Soviets might choose to allocate auch euts cannot be predicted with confidence. It will depend on the degree of credit restrictions and developments within the economy. According to our calculations, Soviet planners face import reductions ofoear in real terms if credit restrictions limit access to Western goods. By the end of the decade, import shortfalls would be closer toillion.

In their deliberations, planners will have to balance the needs of consumer-oriented programs against the desire to continue industrial modernization and the urgent requirements for raw materials and industrial products to deal with domestic shortfalls that have led to severe bottlenecks In the economy. Food exports should decline In the next few years assuming Moscowreak In the weather, but are then likely to rise unless consumer programs are curtailed substantially.

Moscow might also be able to reduce some imports of raw and induatrlal materials after the middle of the decade If two large steel complexes now under construction at Novolipetsk and Kursk begin operation. The Soviets would then be able to reduce but not eliminate purchases of many types of Western rolled steel.

The USSR also Islant to manufacture one million tons of large diameter pipe annually. If production reaches this level, Soviet Imports of large diameter pipe could be halvedaving of0 million. On the other hand, large purchases of raw materials and basic industrial products haveixture in the Soviet import list since the. Moscow has used foreign trade to alleviate domestic shortages, and with the poor performance of Soviet basic industries contfnuing--if notof industrial materials can be expected in the future.

Moscow will have little room for maneuver in preserving imports of farm products and industrial materials at the expense of equipment and machinery purchases. As noted, the USSR already had curtailed Its equipment and machinery imports In the latter part of, and these imports are likely to be fairly low In the next few years except for energy equipment. By the, however, the Politburo Is likely to realize that the planned productivity gains are not materializing and decide that larger imports of Western machinery are badly needed. Moscow would then find the necessity to make further cuts especially painful.


He! Impact of Credit Restrictions

A reduction in the availability of Western credits will make even more difficult the decisions Moscow must make among key priorities insustaining growth in military programs, feeding the population, modernizing the civilian economy, supporting its in East European clients, and expanding (or maintaining) its overseas involvements. Because economic growth will be slow through, annual additions to national output will be too small to simultaneously meet the incremental demands that planners are placing on the domestic economy. Even now, stagnation in the production of key industrial materials is retarding growth in machinery output--the source of military hardware, investment goods, and consumer durables. Under these conditions, restrictions on government-guaranteed credits, coupled with the likely negative reactions of private lenders, would increase the likelihood of shortfalls in both civilian and military programs. This will intensify the pressures on Sovieteven now are building--to alter policies of long standing.

In casting about for alternatives, the Politburo might well look long and hard at foreign aid expenditures or the cost of involvements In Third World countries. Support for revolution is relatively eheap, although Moscow might give greater weight to cost considerations In the future. More important, the USSR

might become more reluctant to undertake major commitments to new or existing client states because of the heavy outlays these

commitments entail. It might even consider reducing its present


level of involvement in countries such as Cuba and Vietnam. Already, Cuba may be under pressure to reduce oil imports while economic aid tosubsidized food and oil deliveries--is apparently not increasing, despite urgent pleas from Hanoi.

As the Soviet hard currency problem developedoscow began to delay payments for imports and reduced purchases of certain non-critical items, including civilian machinery and chemicals. Now there are Indications that Soviet authorities are moving to curb importsroad brush fashion reminiscent of their actions during the hard currency crunch of the. Specifically, major Western exporters of industrial goods to the USSR have been notified that Soviet purchases are being scaled back or delayed. For some Soviet foreign trade organizations, this means deep cuts--on the orderercent. The very top priority programs no doubt would be spared, but many relatively high priority ones, including some military programs, could be hurt at least indirectly.

Cuts in machinery imports, for example, would retard progress inumber of industrialmachine building, oil refining, robotics, microelectronics, transportation, and constructiona time when Moscow is countingtrategy of limited investment growth and relying instead on productivity growth. Unlike in the, however,acklog of undigested Western equipment enabled the USSR to live off old machinery orders, very few new projects involving Western equipment are now underway, and the


need to modernize existing facilities la great. Because growth in domestic investment is being held back by shortages of steel and deficiencies in machinery production) Moscow's only alternative to Western equipmentehicle for modernization wouldhift away from the high priority accorded defense Industries.

In the long term, sustained credit restrictions would force Moscow to reappraise Its priorities. No one can predict how various Soviet programs would be affected. It is reasonable to assume that those requiring the largest hard currency expenditures would be the most vulnerable to cuts. There would be growing pressure from various institutional Interests to spread the burden of hard currency shortages widely. Moreover, the tautness of the economy and the critical role Western imports play in many areas virtually assure that sizeable import cuts in almost any industry would have adverse repercussions In other areas.

o Imports of Western machinery are equal to about 10

percent of Soviet capital Investment In equipment. The reduction in purchases of Industrial goods cited above could cut total capital investmentoticeable amount.

o Imports of oil and gas equipment, for example, couldifferenceillion barrels per day of oil equivalent production In the middle and. The larger part of this would be gas.

o Half of Soviet electronic productionector of high importance to the Soviet.mi 1itary effort--is of Western origin. Continued access to Western technology will be important for further expansion. Hard currency shortfalls could also impinge on defense production through their effect on civilian ministries that support production of military hardware. Forutback In purchases of numerically controlled machine tools could hamper defense-related industrial processes such as the manufacture of gears and disks for high performance turbojet engines. An inability to purchase high-quality steel products could leadhange in production plans at facilities that manufacture military items such as submarine hulls.

The trade-offs among these major domestic programs will not be easily resolved, particularly if the issues become politicized during succession maneuvering. Soviet leaders will become increasingly tempted to bridge the gap in domestic resources by borrowing abroad. Bytringent credit environment could force Moscow to choose between programs that promote the health and well-being of the domestic economy and the economies of its allies and those that foster continued international tension and military competition with the West.

Failure to modify domestic resource allocationime when credit restrictionsarge net inflow of resources from abroad would set back Soviet economic progress and, in turn, jeopardize the USSR's ability to sustain growth in military and industrial poweris the West In. On the other

hand, the potential of Western credits as partrogram to deal with growing economic difficulties might auggestew set of Soviet leadersess aggressive international posture would work to their advantage.

Original document.