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 sharply. Although the slowdown results from t'ha 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 years. 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


o Other exports suffer from production problems (wood

products,r on inability to competearge acale In Western markets (machinery, chemicals).

The Soviet herd currency position is still relatively strong; the debt-service ratio fs only about ercent. Nonetheless, prospective stagnation in the volume of 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 eurrtnt level of real imports and would result oubling of debt5uadrupling The debt-service ratio would approachercent level 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:

0 Avoiding overexposure by private banks, as has already occurred in lending to Eastern Europe, and the potentially costly claims 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 resultecline In import volume of about ercentnd keep the the hard currency debt within manageable proportions. Substantial reductions in government-guaranteed lending coupled with a

cessation of medium and lone term private lending would cut imports by nearlyercent.

Even moderate declines in hard currency imports can greatly complicate Soviet economic problems and make allocation decisions more painful. Large agricultural Imports are essentia) 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 ehemicals 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 heavy machinebuilding.

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.

Introduct ton

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 serious questions about the Soviet Union's external financial strength.

This paper assesses the extent of the USSR's rellanee 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 credits 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 Credits to the PSSRBackground 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 GKP. Although still small 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 complicated enormously by the artificiality of the official exchange rates for the ruble. For example, according to Soviet atatlstics, total inportsmounted5 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 supported 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 prices nabled Moscow to pay for increased imports of food and steel, to virtually cease commercial 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 lo the Western recession, bad crops, 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 crisis made Western bankers far more nervous. ew commitments turned upwardesult of business connected with the new gas export pipeline.

Soviet Use 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 fell eak 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 commitments 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.

Subsidised interest rates and long-term maturItles on most government-backed credits have helped Moscow conserve some scarce hard eurrency. The Interest rate subsidyecord level inthe orderllIlon--as commercial rates In most Western countriesercentage points more than those charged on official loans. Lest 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 conrnitted on concessionary terms, and many credits extended under earlier agreements can still be drawn at lower rates. The lengthy maturities available on official financing (upj years) 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 at 5 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 teleeommunications equipment, ships, and earth-moving vehicles.


Tabic 1

Official Credit Cbmxutnants to the USSRy Industrial Sector*

(Mion US 1)





Hydro and thermal

wood, pulp and

Aluminum, copper,



3il and gas



West Germany
















OECD Reports for all countries except'Japan. Data for Japan based on announcements of credits backing specific contracts.

" Value of contracts supported by official credits with an original maturity of more than 5


0 Presumably includes credits for pipe exports.

West Germany has been the leader in providing government-baeked financing to the USSR, accounting for more than one-quarter of Soviet drawings on new commitments extended by the West see Bonnrowing amount of guarantees lthough the volume of new German commitments remained well below4 peak. The upward trend accelerated1 on the strength of increased Soviet orders of machinery and equipment (largely for the gas export pipeline) and perhaps greater desire by lenders to insure their credits. West German commitments of guarantees on repayments of principal and Interest on loans to the USSR--largely because of recent gas pipelinemounted3 billion at0 and have increased since then. Despite the large volume of commitments, West Germany has depended less on government-backed financing to support exports of capital goods than other countries. Germany's estimated annua) disbursements0 millionovered justhird of its exports of machinery, equipment, and large-diameter pipe. 8hares for otherountries are aboveercent.

At the USSR's debt to West Germany on guaranteed credits stood at approximatelyillion. Undisbursed commitments on principal were probably on the order5 billion. To support pipeline equipment sales, Bonn has0 million In Hermes credit guarantees and established


Table 2

Est fan ted Drawings on Westernclally-baeked Credits

illion US t

6 7 8 9 0



Drawingsercent of Machinery and Pipe

Credit Drawingsercent of Total




Based on Western country trade data which generallymaller amount of exports to the Ft than Soviet trade data.



million supplier credit line through Its partially subsidised AKA (Ausfuhrkredit Gmbh) rediscount facility

Although Japan ranked second In the amount of official credit and guarantees extended to the USSR4ts share of total new commitments fell sharplyompared with earlier years. In large part this was the result of diminished Japanese Interest in Siberian resource projects. Showing its support for Afghanistan sanctions, Tokyo approved no new loans0 exceptmilllon official eredit for large-diameter pipe. New commitments climbed1 as Japan provided another pipe loan, credits0 million against Soviet purchases of pipelayers, as well as supplier credits for several other plant and equipment contracts. okyo alsoredit to financeillion In equipment purchases over two yearsiberian timber resources project.

Disbursements of Japanese credits averaged an5 million; drawings peaked5 million8 and fell back to0 million annuallys the reduction in new commitments contributedecline In Japanese exports of machinery and pipe5 billion2 billion. Athe USSR owed1 billion on official loans and anillion on guaranteed

commercial credits I

In contrast toJapan^France has been generally increasing Its share of Western credit commitments to the USSR in recent years. esult, French credit disbursements--which averaged




an5 million annuallyose rapidly0 million50 million The importance of the French export eredlt system In promoting sales to the USSR la demonstrated by the fact that official credits and guarantees financed an estimatedercent of machinery and pipe exports to the Soviet Union andercent of total exports , the highest shares for anyountry. Paris has reported that Soviet debt on official credits and guarantees3 billion at Undisbursed commitments are estimated to2 billion. Paris has also8 billion for financing Soviet purchases of French equipment for the Yamal pipeline; aboutillion has been committed In flrmcontrect Credit disbursements by 1taly increased from an0 million5illion per years large commitments madeelped boost exports of machinery and pipe. Rome's refusal toajor new credit line because of the Afghanistan sanctions and concern over mounting interest subsidies probably reduced drawings somewhat tn the past two years and perhaps lad to some decline in disbursements. Italy reportedly releasedmall amount of guaranteed supplier creditslthough terms were set formillion financing package offered to support Italy's pipeline-related exports. Final approval of credits for Nuovo Pignone's contract to supply compressors awaits the end of Rome's "pause for reflection" on participation In the project. Soviet debt on Italian officially-backed credits is estimated atillionillion In undisbursed eommitments



excluding those for pipeline ssles

Despite2 billion line of credit on very favorable terms5 the United Kingdom supplied less thanercent of Western official credits and guarantees provided to the USSR. Little more than half of the "Wilson line" was committed to firm contracts before London allowed the facility to expire as part of the Afghanistan sanctions. Nonetheless, nearly two-thirds of Soviet orders for British machinery have been covered byg.

British credit disbursements probably5 million0 (compared0 millionn .the strength of major commitments. The sharp falloff In new commitments0 may have reduced drawings last year. Atoscow probably owed0 million on British officially-backed credits and0 million in undisbursed commitments available. Although London has not yetpecial pipeline credit package, It undoubtedly Is prepared to provide preferential terms to support the UK's0 million In pipeline contracts

Loans guaranteed by Canada In support of capital goods exports to the USSR began0 but did not become significant until after establishment of5 financial protocol. Notid machinery exports and credit disbursements increase markedly over earlier years. Atanada had0 million to export eontraeta; disbursements on these commitments were probably no more0 million.



Ottawa reportedlyroion credit line in early. The Canadian Wheat Board has the authority to provide upear financing for grain sales, but apparently the USSR has not used these facilities to finance its purchases

Although other countries also extend official credits or guaranteed con-rnereial loans to the USSR, the overall exposure Is relatively small. US eommftments, mainly by Exlmbank and totaling less than JI billion, were made In the middle of. No new commitments have been authorized in recent years. In Western Europe, Austria, Belgium, Spain, and Sweden all heve made available financial facilities0 million or more. The largest milllon package extended by the Austrian government 0 to finance Austrian equipment and machinery exports. 0 million loan reportedly was under negotiation in2

Interest Rate Subsidies France and Italy probably provide over half of the Interest rate subsidy enjoyed by Moscow through its official credit operations. thanks to these subsidies, the Soviets saved an0 million in interest payments to France0 million on interest payments to Italy. If all official debt had been contracted at commercial rates, the Soviets would heve had toillion more to the United Kingdom andillion more to Japan. Any West German subsidy was undoubtedly quite small sinceercent of exports to the USSR have been financed through West Germany's AKA rediscount facility. When the Soviets demand interest rates below market

level* on Hermes guaranteed credits, the German exporter usually the financing cost by charging higher nterest rate subsidies have been viewed by some governments as an inexpensive way to promote employment and exports. The rise in domestic interest rates has increased the subsidy element In the past few years, however. Subsidy costs 1 probablyercent of the value of machinery exports to the USSR for France and Italy and roughlyercent for the United Kingdom. Paris, Rome, and London are concerned that elimination of subsidizedadequate restraint on German and Japanesedamage their competitive position because of the lower commercial Interest rates In West Germany and Japan

Soviet Demand for Import!

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 steel, 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 citizens believe that living standards have been declining over the past few years. If defense outlays continue to rise byercent per year (as we nowhey would preempt about two-thirds oT annual increments to GNPs 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 erop years, and to keep them from falling In bad years.

o Western pipe and compressors are essential for the rapid expansion of Soviet gas production) which will be the main source of additional energy supplies end hard currency in. Western equipment also la Increasingly Important In oil production.

o Imports of Western production equIpment--especia1ly advanced machine tools--would help 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 pest purchases of Western goods

The USSR, however, realises that it 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 Conrnittce Chairman Baybakov implied that the volume of trade with non-Communiat countries would grow byercent per yearompared with justercent llowing 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 goel cannot be achieved without an excessive Increase in Western financial exposure to the USSR.

SSR: Hard Currency tnporta

tfllllons of Current US Dollars

Total a


ther agricultural I products (Machinery

.Rolled ferrous metals Chemicals Other

Hons of Constant US)

Total Oraln

Other agricultural

products Machinery

Rolled ferrous metals





Prospects for Hard Currency Earning*

In the past, the USSR has been able to offset sfseeble trade deficits with large sales of gold and arrasut the outlook for Soviet hard currency exports Is ao 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

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 Isthe extent of the


* Oil production has been relatively stagnant since


b Net change In Soviet assets held with Western conmercial banksositive sign signifies an asset Includes intra-CEMA hard currency trade and other transactions.

SSR: Herd Currency Export!

Current OS ItolUra


end coke


end equipment


and wood products



Hen Constant



and Coke

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, will rise--although not 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 is used to full capacity Is uncertain since it depends on the growth of West European gas demand.

The volume of timber and wood productsercent of total hard currency exports--has trended 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

# *

ai 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 ehromite, 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 an increase in foreign exchange earnings of less thanillion.

Moscow probably has some chance of Increased earnings from sales of diamonds. eceipts from sales of diamonds8 billion, equalercent of commodity exports. Because Western demand Is highly volatile, however, earningsreat deal.

Machinery exports increased nearly aevenfold 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 auited to Western markets nor la It backstoppedeveloped network for aervlce or apare 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 industrialised 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. Oold

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 South Africa, but more than the combined output ofother world producers. Gold traditionally has ranked is one of the USSR's top export earners, with cumulative receipts inettingillion--an amount equal to aboutercent of Soviet hard currency requirements In the decade. the USSRold inventoryons.

In assessing goldource of hard currency in, Moscow will have to balance its potential for large sales 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 byoons by the end of the decade if domestic production continues to Increase steadily.

Arms Receipts

Military sales have become an important export earner for the USSR. In the past three years, the net cash inflow from arms deliveries has8 billion,ercent 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 bulged 0 but fell last year. The dramatic decline in surplus oil revenues of Middle East producers such as Libya will make ft more difficult for the USSR to demand cash for new deliveries.

IMpact of Credit Bestrletions The Reference Case

An assessment of the effect of credit restrictionsasis for compar1rojection 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 end 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 thst they do not overstate the Soviet need for Western credits.

Assumpt ions

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

The model keeps track of four types of financing: xport gas pipelinether government-backedthermedlum-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.


Key Assumptions About Soviet Bard Curreney Exports In

Energy exports

Oil1 $)



1 $)




1 8)

(bill1 8)



(bill1 8)

export earnings


addition, we assume that nominal prices for all Soviet exports (and for all Imports) riseercentercentndateercent.

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 decede. This keeps Soviet financing requirements within reasonable bounds; even so, the gap between Imports plus debt service and net earnings (which would heve to be financed with new credits) is still very large Debt would riseillion5 andillion The debt-service ratio would increase toercent3 andercent 0 Whether the International financialy would

support debt accumulation of this magnitude Is uncertain.

As suggestedtrong ease ean 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 per less than in the recentlead to clearly unreasonable financing requirements. Soviet hard currency debt would have to Increase from aboutillion dollars currently to SO billion 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.

Credit Restrictions

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 eervice ratio compared with the Reference Case

Table 6

of Credit

Importt--Hion Dollars, Current Prices

Reference 38 53

Plat 34 44

Severe credit 33 44

Inportson1 Prices

Reference 29 29

Flat 26 26

Severe credit 24 25

Gross Hard Currency Debt-Billion Current Dollars

Severe credit





Severe credit

1 Repayments of principal and interest on all debtercent of earnings from merchandise exports and sales of arms and gold.

Although many kinds of eredlt 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

" In al) eases, we assume that eredlt 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.


disbursements2 . The aeeondmlnad--the Plat Lend ing case--ls leis 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 recent levels. This keeps the rstio of commercial credits to official credits at the high end of the recent range- The two cases shouldide 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 eese level

evere Credit Restrictions limit Soviet imports significantly more than the Flat Lending case does, but the difference disappears tn 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 Plat Lending case. import capacity isercent lower In both eases.

Whether oneolicy which results In limiting disbursements on Western credits to present levels or Imposes more severe restrictions that leedecline In overall lending (In which guaranteed lending fells and conmercial lending



the effects on Soviet Imports ere quite similar.ffect on Hard Currency Debt. Compared with the reference ease, credit restrictions would avoid an undue accumulation of Soviet debt. Even so, In the flat lending case the projected borrowing for the gas export pipeline increases debt by nearlyercentS, although 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-service ratio. Is much sounder than in the Reference Case (Figure





Soviet Response lo Credit Restriction!

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 partIclpating 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 deniel, 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 grented 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, 8wiss, 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, limiting 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 toillion 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, fs not osition to offer the USSR any signifleant eredi ts .

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. Evenood record of sound financialnowerious 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 sble 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 for 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 Asslstence from Eastern Europe

Peeing 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 credit restrictions eould

threaten serious disruption in the Soviet eamp. 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.

The East Europeans could not replace the Westource of

imports because they are in no position to fill Moscow's

immediate needs for grain and meat or even the longer term

requirements for raw and industrial materials. Inew

selected instances such as coal and some kinds of rolled steel

does Eastern Europe offer good substitutes for Western exports of

raw materials and basic industrial products. The East Europeans

doarge volume of machinery and equipment to the USSR

--roughlyercent of all such imports by the USSR--but In the

main the machinery does not approach the quality or the

technological level of that available in the West.

Europe would continue to serve occasionallyonduit for high

The USSR, however, could help itself by scaling back its deliveries to Eastern Europe of goods marketable in the West in exchange for East European goods not readily saleable in the West. These cuts presumably would not affect Poland. Moscow is now concentrating Its assistance to CEMA on Poland to try to prevent further economic chaos there. Romania might also escape some of the damage resultingougher Soviet policy because


It already pays hard currency for the oil it purchases from the USSR. The USSR has already notified Czechoslovakia, East Germany, and Hungary that It intends to cut originally scheduled crude oil deliveries by aboutercent. iversion of thisillionear--to the Western market would add nearlyear to Moscow's hard currencyiversion to the West ofercent of current oil exports to Bulgaria and Poland would add0 imil ion.l

Cutbacks in deliveries of Soviet oil end other hard goods, however, woulderious blow to Eastern Europe. Given their financial problems, the East Europeans hsve little chance of buying oil or other goods on the world market or from the Soviets for hard currency. Since conservation efforts have largely been ineffective to date, the burden would fall on domestic growth end living standards. In Czechoslovakia and Hungary this would mean continued stagnation in national incomeecline in per capita terms. East German industrial growth rates would slide but remain positive. If the cutbacks continued over several years, slower growth could turn consumer dissatisfaction Into open unrest in several countries

The Soviets may reeson that most of the regimes will be able to adapt to lower levels of assistance and might even use the credit restrictions as an excuse to Improve the USSR's terms of trade with the East Europeans. Political considerations, however, are more likely to cause the Soviets to refrain from compelling Eastern Europe to export more to the USSR whileower volume of Soviet exports. Fear of growing


unrest and reduced Soviet leverage in CEMA would be primary concerr

In addition, Moscow might want to avoid some of the other consequences of forcing East European compliance. The countries bearing the brunt of Soviet demands (Ciechoslovakia, East Germany, and Hungary) might seek indirect amelioration of the burden through cutbacks In defense spending commitments and In aid to Soviet clients In the Third World. Latent anti-Soviet nationalism also might revive because of perceptions within Eastern Europeoviet return to the "colonialism" of the Stalin era. Less able to satisfy popular demands, the regimes would have to step up repression to maintain power if Soviet-induced hardships angered dissidents and "national communists"


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,

ong-term credits to pay for equipment required to develop related Infrastructure as well es the productionedium-line credits to cover consumer goods purchases needed to defray local costs, and (J) deferred 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 chsrm 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 reluctent 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 erms for Zamblan cobalt, trolleys for Creek citrus fruits, and fertilisers for Thai corn, these arrangements do not have much potential for casing 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 such cuts 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 annually.

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 thut-rmve led to severe bottlenecks in the economy.

Assuming agricultural production returns torend, imports of grain and other farm products eould fall by roughlyillion2, even after allowing for rebuilding of grain stocks. One-half of these potential hard currency savings would offset the cost of purchases for the gas export pipeline. arge part of the remainder will probably be allocated to growing purchases of the raw materials and Intermediate goods increasingly needed to feed Soviet industry.!

Imports of equipment and capital goods are likely to bear the brunt of any additional cutbacks that might be necessary over the next few years. Imports of machinery and equipment have in fact fallen fairly consistently In real terms in recent years. Orders turned up1 only because of the gas export pipeline# In the absence of pipeline1 orders with Western firms would heve totaled4 billion|

Even with some near term reductions in agricultural importsesult of better crops, and if Imports of raw and industrial materials were held constant in real terms, capital imports other than for the export pipeline would fall sharply. While the composition of recent orders suggests no clear trend in the pattern of machinery imports from the West, the priority given to

* The orders represented ino not reflect all orders butood indicator of trends In the level and composition of machinery orders.


Table T

D3SR: Orders of atechinery and Equlprwnt'



10 3



5 11









1 18

Excluding purchases of Western linepipe.

Including orders for the export gas pipeline3 billion.



the energy sector inlan suggests that energy-related machinery imports Mill more than hold their own and other machinery purchases would sufferesult of credit restrictions. The cuts might be severe enough to affect not only new capital purchases but also the sizeable and growing flow of spare parts and replacement machinery needed to maintain Western plants already in operation In the USSrI

Import decisions will become even more^crrTncult by mid-decade. As indicated above. Soviet economic growth is trending downward as the leadership searches for ways to accelerate productivity gains. To sustain popular morale and promote labor productivity, the Politburo would want to increase or at least maintain agricultural imports. 5 the gap between availability of meat and other quality foods and consumer demand is likely to widen substantially. Consequently, imports of grain and meat probably will trend upwards

The USSR could probably cut back on hard currency purchases of manufactured consumer goods, but such imports are relativelythanillion last year. Moscow might also be able to reduce some imports of raw and Industrial 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 continuing--If notof industrial materials can be expected in the fuiure."j

In the latter part of, however, Moscow will have much less room for maneuver In preserving imports of farm products and industrial materials at the expense of equipment and machinery purchases. Indeed, shortages of hard currency may be intensifying Just as interest in foreign machinery is reviving. 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 find that the productivity gains implied bylan are not materializing. It could then decide to try to increase Investmentaster rata with the help of foreign machinery and equipment in order to modernize the economy and deal with the bottlenecks that arise when plan targets are overambitlous and inconsistent

Net 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 machinerysource 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 Soviet leadersthat even now arealter policies of longg.

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 of revolution Is relatively cheap, 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

pn mirg^rift^

level of Involvement In countries men ei Cube end Vietnam. Already, Cuba may be under pressure to reduce oil imports while economic eld tosubsidized food and oil deliveries--ls 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 the Soviet euthoritles are moving to curb Imports road brush fashion reminiscent of their ections 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 bsck or delayed. For Soviet foreign trade organisations, this means deep cuts In some 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 enebled 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 ia 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 industr ies.

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 one-third reduction In plant and equipment expenditures cited above could cut total capital investmentoticeable amount.

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.

e Half of Soviet electronic productionector of high importance to the Soviet militaryf 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 civi1ian 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 purchese high-quality steel products could leadhange In production plans at facilities that menufeeture 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 end 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 powexis the West in. On the other


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

Original document.

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