THE VALUE TO THE USSR OF ECONOMIC RELATIONS WITH THE US AND THE WEST (ER/77-105

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THE VALUE TO THE USSR OF ECONOMIC RELATIONS WITH THE US AND THE WERT

57

Tho Value to the USSR of Economic

Relations with the US

Foreword

Tho attached paper examines key elements of the US-Soviet economic relationshipin technology, energy, credit, grain, and MFNand concludes that, in thecontoxt, and taken individually, "these elements do not provide tho US or.tho West with policy lovers thnt could bo used to exert significant influence upon Soviot behavior.

But the assessment is focussed narrowly on thesituation and on specific economic instruments. To do justice to the potential for leverage and influcnco in the Bast-Wast relationship, the problem shouldore dynamic and comprehensive contextong term political-economic-military competition. An assessment in those terms would place far moreon the dcopening economic problems and rcsourco stringencies facing the Soviet economy over the next five to ten years, and the strains and pressures these will increasingly place on the Soviet resourceprocess, particularly in the military sphere. In tho context of such deepening problems, the potential for using East-West economic relations for political influence might bo much larger, particularly if conceived as part

roador strategy for long-term competition. .

possibilities deserve far more attention and analytic effort than they have so far received.

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CONCLUSIONS

Tho importance of Western technology, credit, and grain to Soviet economy has increased in recent years, and will increase further during tlie next decade. Moscow is determined to avoid exploitable dependence, howevor, and expects to bo able to do so.

In the great majority of instances, alternatives to US xourccs arc

ther Western countries havo uhownillingness to sacrifice economic gainsoncerted, sustained policy of using East-West economic relations for purposes of exerting influence upon Soviet behavior.

The Soviets believe that, in the US itnelf, conflicting domestic interests place severe limits on the US ability to use its policy instruments for theoc same purposes.

Tho growing dependence of Soviet economic growthising productivity of labor and capital will put an increasing premium on Western capital goods and technology during the next decade. In addition, Moscow will need vast amounts of Western equipment to sustain production of oil in some fields, minimize declines in others, and dovalop new sources of oil and gas. Some of this oqutp-mont will hava to coma from tlie United States. '

Technology

In importing Western technology and oquipmcnt, tho USSR is playing "cntch-up." Specific sectors of Soviot induotry such as tho fortilizor and automotive industrtoaore buing helpod grootly by Wcstoin technology and equipment, increasing the quality and quantity.of output and reducing costs. The Soviets will bo especially dependent on Western energy technology in the future, such as high capacity oil lifting equipment diacusscd separately bolow. Tho magnitude of Soviet imports of Western equipment, howovor, is too small to havo much impact on ovorall economic growth.

Illew Areas is the United Suites tlio solo supplier of the most advanced technology of interest to the.Soviets. In mnny of those fields, US prc-ominonco is being increasingly challenged by technological advances in Western Europe and Japan. Moreover, less advanced technology is oftengood to satisfy immediate Soviet needs. In tho nrnny instances where US technology in available from US licensees or subsidiaries abroad, the Soviets can turn to these.

Tho United Statos must rely primarily on persuasion in marshaling effective support from its nllios for control of technology exports. The record on this score isat best. Our allies' see little or no need to limit Soviet acquisition of technology unrelated to items on the COCOM List. Even in COCOM, they havoendency to push for relaxation of definitions to permit the sale of thoir own goods while supporting the embargo on those higher technology goods produced only in tho United States. Their reluctance in the past to go along with the United States in controlling anything but the most sensitived equipment affords little hope for consent to broader vigilance now.

Energy;

Tho supply of oil in the USSH willritical problem in tho next few years, with production peaking perhapn ns early as next year but not: later than theefore declining. To stave off or clow tho expected production decline, the Soviets will need substantial amounts of Wostarn oil field technology and equipment. Because of its superior technology, tho United Statos is the mostal source of much of this equipment and know-how. Without assistance in the form of Hostorn technology and equipment espocinlly high capacity lifting equipment involving US technologygas lift end electric submersible pumpsSoviet oil production will fall sooner and more sharply than would otherwise be the caso.

Although the USSR, and somo Host European countrios produce low capacity oil well pumps, tho only pumps adequnto to doal with tho Soviet lifting problem are produced in tho United States. Tho USSR has boon buying sovoral hundred annually In tho US and rocontlyurnkey plant for thoir manufacture Thus far neither of tho.two US producors hns boon interested in supplying tho production technology.

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The US la tho preferred source of other equipment nnd technology such as drill pipe, rock bits and rotary drilling rigs, nona of whicli io und or export control ran triot lone, as well as certain COOOM-controlledeismic and gravimotric measuring ond recording instruments. There are close substitutes for those in other Western countries, however.

Credit

The Soviot hard currency debt increased fromt the end4illion at the endnd it will probably grow toillion by the end of this year. What pushed up the debt was mainly tho Western economic recession, which nearly halted the growth of Soviet hard currency oxports nnd the massive Soviet grain imports56 following the5 harvest.

The USSR's hard currency trade deficit3 billion5 and SS billionG. The traditional moans of financing deficitsWastern government-backed credits and goldwore no longer udequate, and the Soviets hod to borrow heavily on the eurodollar market at higher interest ratesubstantial amount on short term.

enult of heavy Soviet borrowing, many major banks reached ox at least approached their legal or self-imposed ceilings on credit to the USSR. Moreover, the international banking community has grown concerned about the growth of the Soviet debt nnd the persistence large trade deficits. Although bankers rum-tin confident about the USSP. ability to repay its debt, thoy fool that additional creditequire higher interoat rates.

Moscow's stubborn stance on. terms is hampering progress In negotiations for govornmenl-backed export credit linos. Tho "goiitlemon's agreement" on export credit tortus is now in effect, and tho Sovictn arc unwilling to pay thenterest rates required. Soviet negotiations withvo dragged on sinceith Franco, Japan, and tho United kingdom watching closely to nee whether the Italians can withstand Soviot pru3sura to break the agreement by offoring bottor terms. Tho batting is that Italy vlll cave in.

A reduction in tho trado deficit is expectod7 with contlnuodif sluggi.ihWestern growth loading to

expansion of Sovietharply lower grain bill will reduce imports. eficit ofillion or less3 billion increase in debt is anticipated. urther doclino in the deficit is likelyiven continued economic growth in the West and the bumper grain crop Moscow expects this year. Oil exports could fall, but probably not oncugh to prevent an increase in total exports while imports should be stable or lower.

Prospects in the longer run, however, oro much dimmer because the oxpocted doclino in Soviot oilnd exports will seriously aggravate the Soviet hard currency position. Western bankers will probably have increasing doubts about Moscow's ability to maintain its foreign exchange earnings and manage its dcbt3 in. Substantial new credits are likoly to depend upon Soviet willingness to undertake largo compensation deals, particularly forent of energy resources) that provide assurances of export capacity.

Grain

Even with normal harvests, Moscow will need toillion tons of grain annually to support announced livestock expansion programs during tho next several years. If past practice holds, about half of Soviot importwould be filled by the United States. The need for US supplies obviously depends both on tho size of Soviot requirements and on production and stocks in other supplier countries. Attempts to apply US leverage on the grain issue might lead to minor concessions in the short run but would carry longer run costs. The threat of withholding grain, oven if not exercised, would compromise US reliabilityupplier and lead the Soviots to pursue alternatives.

Our leverage is* lessenod by'the wide range of options availablo to tho Soviets in the eventoratorium on US grain shipments.

the short run, othor countrios would bo 'able to provide additional grain, especially

at premium prices.

Ovor tho longor run, tho USSR could probably orrango for alternative supplies, perhaps with tho aid of long-term contracts.

Domestic demand for grain could be substantially roducod rationing and othor conservation

xport cuts,urthcr slaughtcring of lives tool: if need bo.

n dire circumstances, Moscow could fall back on strategic grain stocks.

Soviot exports would bo little affected iry the granting of moot-favored-nation status. Most Soviot exports to tho United States either enter tariff free or carry tariffs little higher than MFN-rates. ew million dollars' worth of manufactured goods would boncfit fran MFN treatment, particularly if quality and servicing deficiencies were overcome. MFNnor issue in the broad context of US economic relations with the USSR. Thoof the Trade Actn any case, blunt the effectiveness of using MFNargaining

issing from microfilmed orig No hard copy original

USSR: Hard Currency Trade 1/

Million US S

Exports

Imports

Balance

on Soviet statistics.

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of Western dquipment ond technology and proposed several joint projects with Western firms to develop Soviet resources. Western governmentsFrance, Italy West Germany, tho United Kingdom and Japanhavo extended substantial low interest, guaranteed, long-term export credits. These credits hove boon critical to Moscow's rapid expansion of trade with tho West since the Soviets have not been,able to increase exports rapidly enough to pay for imports. *

Expanded trade with the USey to the detente policy of the USSR. Anxious to acquire US technology and capital, Moscow set goals for rapid'increases in trade volume. Eximbank credits were available24 and equipment orders from the US increasedillion05 million Soviet contracts placed in the US have fallen off since that time. Imports based on these orders0 million' but it has been mainly Soviet grain requirements that have generated

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large imports form tho Unitedillion2 billion,6 billion Soviet sales to tho United Statos havo consistently fallon far short of purchases. osult tho USSR liasumulative trado doficit5 billion with tho US Tho deficit4 billion0 alono.

Trado with tho United States

US S

Exports Soviot Ziuoortu

ualnncc

'

liascd

soviet statistics, .

'*

7 figures willa decline in US-Soviet trade as US grain shipments and scheduled deliveries of equipment fall off.* According to US statistics grain imports from the US by the and of June wore down by almost"half from first6 and machinery by almost one-third. US imports from tho USSR will bo highereducing tho US surplus to somewhat more than half of last year's. Technology

Soviet loadors recognize that rapid growth con now bo achieved only by accelerating technological progress. Although past development relied heavily on rapid growth in the labor forco and the stock of plant ond equipment, the USSR can no longer sustain development of this kind. The leadership recognizes that growth will depend mainly on rapid productivity gains through tho adaptation of now technology. Tho problem is that thoector has lagged in doveloping and applying now technology. As result, tho USSR inas turned increasingly to imported

*

technologyeans of accelerating technological progress and economic growth.

Tho major moans of acquiring Western technology is by purchasing machinory and equipmont. Othor

channels havo included the acquisition of technical data, contacts with Wootorn firms and scientists, and formal

* Soviot Deputy Foreign Trade Minister Sushkov said at tho US-Soviot Commercial Commission mooting in June that equipment deliveries from the US would be down sharply this year.

arrangements for joint research and exchange of scientific and technical information. None of these meant have lived up to Soviot expectations. Soviot industry is alow to got foreign technology into operation and even slower to spread itiven industry. Soviot labor is unfamiliar with complex foroign machinery, spore parts for foreign equipment are often in short supply, and maintenance programs are frequently inadequate. esult. Western equipment is not as productiveo"lct sotting as it is on native ground. Attempts to exploit foreign teennical data or copy foreign machinery havo had mixed success. In some military fields, tho results have been good; in civilian sectors, the outcome has been less impressive.

Moreover, the volume of Western machinery in small relative to domestic invootmont in machinery in the USSK, although the share has doubled in recent years to roughlyf total domestic invostioont in equipment. The US share is only about ono-half of It. Tho small scale of imported equipment couplod with problems of assimilation and diffusion, loads ua to bo loos snnguino than the Soviets

technological gap with the Industrial Wost.

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about tho contribution that foroign technology will maketo

Although Western equipment has not substantially impacted-on overall Soviet economic performance, the impact has been relatively large in some areas. In addition to keyof the chemical industry, foreign technology has raised technological levels in such sectors as computers, electronics,.oil field exploration, and automotive manufacturing"

Soviet dependence on tho West for equipment in these high-priority areas, however, does not equate with Soviet dependence on the Unitedhe Soviets recognize that other countrios often can provide technology that is as good or nearly so. Although the US share of Soviet machinery imports from the West more than tripled2t isf total imports of Western equipment.2 tho Soviets imported lessillion worth of machinery and equipment from the United States, or less% share of the Western total. 6 it4 million. Imports from the United States have featured earthmoving equipment (bulldozers,quipment for theiver Truck Plant, and oil field and pipelinehile US companies are the preferred sources in these fields as woll as for computer hardware and software, the USSR .has obtained, for example, computer hardware and various kinds of automotive equipment and machine tools from Western Europe and Japan.

outlook

With increased emphasis on raisin" productivity in the current five-year plan, tho Soviet leadership may fool the need fcr Western equipment and technology even more acutely than in tho past. But tho USSR probably will not havo the foreign exchange to pay for substantial increases in machinery imports. Tho growing expense of debt service may limit machinory imports to6 billionrices) for the next two or three years. Thereafter, tlie expected fall in crude oil production (and oil exports) threatens to squeeze furthor Moscow's capacity to import Western manufactured gocds.*

The fall in import capacity will force the Soviet loadorship to make hard decisions regarding trade with the West. olicy to maintain equipment imports in tho face of shinking hard currency resources would dictato sharp reductions in imports of other goods such as stocl. Imports directed toward energy production and conservation will probably take precedence, as failure to obtain such equipment and technology would only oxacerbato Soviet problems and increase Soviot hard curroncy expenditures for oil over the longer run. Imports of plant and equipment designed to increase futuro export capacity will have priority second only to energy-related imports.

* See section entitled "Energy" below.

Soviet contracts placed in the United States for machinery and equipment have fallen off since Eximbank. credits have been unavailable to tho USSR. 6 tho US share of Soviet contracts placed in tho West fell tot, down

hare of importsS equipment would only bo equivalent% of the total value ofscheduloa to be installed in the Soviet economy.

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In short, US leverage is limited because the USSR can gofor roughly equivalent machinery and technology, exceptew sectors orew giant projects. The United States is the preferred source of oil field technology and equipment that tne Soviets will need to stave off or slow the expected production decline. But even in this area non-US suppliers can provide much of what the Soviets will require.

.ow there seems little chance that tho Unitedconvince.its allies to band together to exert leverageUSSR. Tho past record in the export controlthat the COCOM countries' concern for the commercial of technology exports to Communist countriesthoir fears of the possible strategicthe technology.' With tho growing economic problemsUSSR, especially in oil production, and thoneed for Westorn technology ond equipment,may'

riof survey of tochnology areas in which tho Soviets have shown interest, and somo judgements about technological levels in tho US and other Western countries.

Knt-rgy Oil

The Soviet oil supply willritical problem within the next few years. New deposits are not being found and developed rapidly enough to offset declines in older fields, and production techniques now in use have focused on gains in annual output at the expense of maximum lifetime recovery.esult, production will soon peak, perhaps as earlyand certainly by the. Production46 was closo to the estimated maximum potential, and output is likely to fall to0 Production of other major energy sources is being pushed about as hard as Sovietcapabilities permit. Thus, ovenajor stop-up in allocation of investment capital to the fuel producing sector, growth of domestic energy production will slow in.

The downturn in oil production seems inevitable and probably will be sharp, but its* timing in not as predictable To stavooff or slow tho expected production'decline, the Soviets will need substantial amounts of western oil field technology and equipment. Because of its superior technology, tho United States is tho proferred source of much of this equipment and know-how. Without such assistance, Soviet oil

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production will fall sooner and more sharply than would otherwise be the case.

Items from the West that could provide the most rapid and offective help in exploiting existing fields includct high capacity submersible pumps and gas-lift equipmont, drill pipe, casing, drill collars, rock bits, rotary drilling rigs, drilling mud technology, ond multizono completion equipment.

To increase total fluid (oil and water) recovery, large numbers of high capacity submersible pumps and/or othor fluid lifting equipment will be needed. The only pumps adequate to deal with the Soviet lifting problems are produced in the US and aro in relatively short supply. Tho USSR has boon buying several hundred submersible pumps annually in the US for theears and has tried tournkey plant for their manufacture. Thus far, neither of tho two US producers has been interested in supplying the production technology to the Soviets.

As an alternative to high-capacity submersible pumps, the Soviets are negotiating for large-scale purchases of gas-lift oquipment. They hopo toontract for about SI billion worth of oquipment for this project from US, West European, or Japanese suppliers by the endnly the us haa the technology to produce the downholo ga'o lift equipment/ thus all equipment other than compressors

(valued0 million) must be bought in the US. because of the long load times in tho design, production, and

installation of such equipment, tho USSR probably could not

have all the units installed before the.

The quality of Soviet drill bits generally is poor

compared with Western bits. The Soviets recognize that better

quality bits would improve drilling efficiency and would permit

wells to bo drilled more rapidly. They havo bought small

quantities of US bits and have been trying for years to buy

a turnkey plant to produce US-design bits. But the price of

the plant has escalated during the negotiation period, and

tho Soviets are now seeking US assistance to re-equip an

existing Soviet plant to produce those bits. Tho contract

for -the re-equipment dealillion) is expected to be

signed this year.

US. rotary drilling equipment and technology would be a

distinct asset to the Soviets in searching for and developing

new oil fiolda. About throe-fourths1 Soviot drilling

is done with the turbodrill, which becomes increasingly

inefficient at depths greatereters. Soviet'

drilling capabilities continue to lag behind those of the West

where rotary drilling is used'. As the average depth of

drilling inoroasos in tho USSR, rotary drilling would be more

efficient than the Soviet turbo rigs. Rotary rigs in operation

in theercent of tho total rig park) are comparable

to US equipment produced in.

cra*cY^

The supply of drill pipe, casing, and drill collars in tho USSR is not adequate in the sizes, quantity, and quality required for fiold development, especially in poor climates and under difficult well conditions. As the requirement to drill to greater depths increases, both onshore and offshore, the USSR will heed larger amounts of high-quality drill pipe, most of which will have to come from the West.

Scientifically planned drilling fluid programs are almost unknown in the USSR. Most drilling crews use local clays mixed with water andfterell is completed, the mud is stored for future use regardless of requirements. Such practices cause formation damage, reduce recovery rates, and cause wells to be abandoned needlessly. elated problem is the need for bettor cementing practices to improve well completion and to seal the well bore against the entry of ground water. The Soviets have indicated interest in US technology in these areas.

*

Multizone completion equipment is relatively scarco in

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the USSR, necessitating the drilling of separate holes for

each producing zoho in manycquisition of multizone

completion equipment frora the West would permit important

economies in reduced drilling- costs, savings in casing, tubing,

flow lines, and drilling and pumping equipment.

For the long run, finding new oil reserves is even more

important than increasing the yield ox existing fields. In

the present five-year plan, sizable reserves must be found,

primarily in West Siberia, to maintain production at or near current lovola as output declines in tho older fiolda in the Western regions of the country. Discoveries must be made in East Siberia and in offshore areas of the, Arctic Seas to prevent sharp declines in production.

In general, Soviet exploration equipment lagsears behind that used in the US. Tho USSR is particularly deficient in advanced seismic equipment and digital field computers for on-site evaluation of geologic structures in permafrost and in deep-faulted formations. Although somo equipment is available in Western Europe ond Japan, the best for Soviot needsespecially portable field computers and softwarearo made in the US.

The most obvious deficiency in Soviet oil field operations is the lack of modern offshore equipment and technology. Tho USSR now has only four mobile offshore drilling rigs (jackupll in the Caspian Sea, and only one is capable of drilling in water as deep aseters. For the USSR to movo to dooper water in tho Caspian, or to tho Arctic Seas, or to tho Sea of Okhotsk off Sakhalin, Western experience, technology, and equipmont will bo essential. Although the US is the world loader in thie technology, Dutch, French, Norwegian, British, and Japanese firms can supply some offshore equipmont and know-how. The Soviets recentlyontractS firmoat European company toard on tho chores of the Caspian Sea to produce offshore mobile drilling rigs.

Gap

Natural gas output is expected to Increase toillion cubic meters4f oil equivalent^ This is almost double tho level of production5 and probably will5 crude oil output in caloric terms. The key to growth will be tho pipeline capacity needed to carry large volumes of gas from hugo new West Siberian fields to tho western USSR and Europe, The main bottleneck will bo high-capacity compressors, turbines, and valves;f these aro imported from the West and have long load times for negotiation, manufacture, and delivery.

Gas consumption will continue to increase substantially in industrial sectors that oro already large gas consumers, particularly chemicals. Whllo tho possibilities for substituting gas for cool have been all but exhausted, gas could be substituted for oil in somo industrial uses, notably as fuol for industrial boilers. Household use of gas will increase but will not Involve gas-for-oil substitution, since Oil has not generally been usod directly for heating or other purposes.

Coal

Coal production will grow slowlyprobably at an average annual rateorcentduring tho nextoears. Tho actual, rate will depend largely on the spoed with which tho Soviets dovolop the eastern coal basins. This coal,

though cheap to mine, ia expensive to transport over long distances to the main consuming centers, and much of it is of poor quality. An increasing share of output probably

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will be allocated to electric power production at tho

coal fields, in part toecline in fuel oil supplies.

Imports of coal mining equipment frora the West will be of sorae significance during the next few years as tho USSR is in the process of purchasing giant mining shovels and high-capacity dump0 tons) from tho US and Japan for developmentine in tho scuthern Yakutsk coal basin. Although the Soviets must import large-capacity equipment in tho short run, they are taking steps to eliminate this dependence by .programming production of such equipment in domestic plants.

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Financing Trado with the Wont: Tho Credit Factor . '-'.

Moscow's equipment import drivo has been mode possible largoly by Western govornmonto which have offered credits at subsidized rates to encourage exports and to maintain employment and production in their capital goods industries. Inho USSR has drawn uomo billions in governnent-guaronteod credits mairily from Franco, Japan, West Germany, Italy, Canada, and Austria. Tho US Eximbank was in the running2 untiluthorizing credits8 million, matched by US commercial bank credits of the same amount.

The USSR's heavy reliance on Western government-backed credit to help finance hard currency trade deficits lasted5 when the Soviet hard currency deficit4 billion. At the timo that equipment deliveries were soaringesult of orders placed in the West, the Soviets wero hit by two unexpected events: tho Western recession, which cut the demand for Soviet raw materials,isastrous grain harvest, which lad to massive Soviet imports of Wostorn grain. esult tho Soviets wore forced to borrow honvily in the Eurodollar marketat interest rates higher than for government-backedubstantial amount on short-term. Moscow was able to reduce tho trado doficit6 becauseump in exports (mainlynd somo import cutbacks but only toillion.

Tho largor-than-anticipatcd doficitfl56 forced theo use bant; credits not only for grain, but for srr.jll cquipniont purchases and other purchases which normally would havo boon for cash. Tho ohnrc of total Soviot hard currency debt held by Western banks roseercent at tho ond4 to almost SOI at tho end*

Tho borrowing to financo grain and equipment purchases pushed the Soviet debt to tho West from S5 billion at tho ond4illion'at esult of heavy borrowing, many major banks reached or at loast approached thoir legal or solf-impoacd ceilings on credit to tho USSR. Horoovor, tho international banking community has grown concerned about the growth of the debt and tho persistence of largo trr.de doficlto. Although bankers remain confident about tho USSR ability to repay its debt, thoy feel that additional credits require higher lntorost ratoa. 0 million Eurodollar syndication for tho 'USSRlthough complotcdas poorly rccoivod, with several major, banks refusing to participate.

Tho USSR has not activelyurodollar loan this yoor and reportedly will borrow on tho Eurodollar market only if it can receive primo rates. Although tho

growth of the Soviot debt has caused concern In Western financial circlos, Moscow can still got credit thanks largely to slack demand in Western money mnrketuearth of other creditworthy borrowers. Westernf tho growth and tlie level of Uie USSR'sowever, insist on higher rater, than the Soviets judge acceptable.

Moscow's stubborn otanco on terms is also hnmporing progress in negotiations for government-backed export credit linos. The "gentlemen's agroomcnt" on export credit torms is now in effect, and the Soviets arc unwilling to pay tho higher interest rntos required. Soviet negotiations with Italy have dragged on sinceith France, Japan, and tho United Kingdom watching closely to sec whether the Italians can withstand Soviot prcssuro to break tlic agreement by offering hotter terms. Tho betting io that Italy will cave in.

a further reduction in thu trade deficit is expected7 with continuodif sluggishWestern growth loading to expansion ofharply lower grain bill will reduco imports. Soviot trade data for tho first halfower deficit than in tho first half of last year, with oxports upercent and importsercent. Tho improvement should continue for tho romaindor of tho yoar, resultingrado deficit7 of S4 billion orurther doclino in the deficitikelyiven continuod economic growth in tho Wast and tho bumpor grain

crop Moscow oxpocta this year. Oil exports could fall but not enough to prevent on increase in total oxports, whUo imports should bo stable or lower.

7 trade deficit should boost tho debt by about anotherillion, bringing the Soviet debt to the Westillion ot yeorend. Thoro havo been several indications of Soviot hard currency stringencies this year, o The Soviets sought andear doformcnt on repayment of halfillion note due in July, o Some US banks havo experiencedhan usual delays in Soviet payments of accounts, o Soviot buyers have asked Japanese

companies to extend payment terms fromoays.

Moscow's current cash problems arc probably only temporary. The Soviets could have sold considerably more gold than thoy have. Gold prices havo boon attractive for mostut Soviot sales wore low for tho first half of tho year.

Thus, despite Moscow's roccht financial difficulties, its payments problems appear to be manageable for the time being. .The Soviets should bo able to handle7 trade deficit as it didy borrowing, albeit at higher rates than Hoscow wishes to pay* cutting lower priority Imports} delaying payments occasionally; ond probably selling gold before tho year is out.

Prospects in the longer run, however, are much dimor with the'expected-decline in Soviet oil production in thor. Although the range of uncertainty regarding future oil production and consumption make it difficult to predict the impact of tho looming oil problem, the decline in oil production will serious aggravate the Soviet hard currency position.

Although Moscow willto continue financing a

major share of machinery through long-terra credits, it will find it increasingly difficult to do so Western bankers, previously confident of the USSR's reputationood credit risk, will probably have increasing doubts about Moscow's ability to maintain its foreign exchange earnings and manage its debts in. Bankers are

likely to-demand more financial information and higher interest rates frora the USSR as they realize the impact of the oil problem on Moscow's hard currency position. Substantial new credits are likely to depepd upon Sovieto undertake large compensation deals, particularly

for development of energy-resources, that provide assurances of export capacity.

USSR: Hard Currency Balance of Payments and Outstanding Indebtedness

Million US S

imports,

trado,^

gold

and transfer payments, not

ACCOUNT BALANCE

and longrterm capital,

BALANCE

indebtedness

n Preliminary.

Official Soviet foroign trade statistics.

Including estimated revenues from arms solos and hard currency expenditures for Cuban sugar? excluding hard currency trade with other CEMA countries.

Including medium- and long-term syndicated- Eurocurrency

.

Soviet DopondcncQ on US drain

The USSR probably will need toillion tuns of grain annually in the next few years even if normal weatherrain outputillion tons. In poor harvest yearsgrain productionillion tonsSoviet purchases could fall inillion ton range. rain harvest is very good as it was6 and is likoly to be thisillion tonsimports probably will rangendillion tons.*

These imports are needed because the Soviet demand for grain continues to outpace increases in production. Grain output in the USSR increased by more0 and the record harvest yearowever/ the program to improve consumers' diets, largely by increasing theof meat, more than doubled the demand for grain as livestock feed in this time period. Moreover, the Tenth

Fiye-Voar Planndicates ajrapidexpansion planned

* Grain harvest estimatesssume that the trend ih the use of fertilizer and othor technological improvementsoading to higher grain yields will continue0 but that -the.average weather conditions experienced ih theill prevail. The average annual demand for grain ineG is estimatedillion tons, based on projections of normal requirements for food, seed, industry, exports and fead. The level of imports would not necessarily-equal the difference between production and requirements: smaller crops could result in lower requirements because of other options open to Soviet planners such as curtailed demand.

livestock inventories ond meat production after the disastrous harvestequiring supplies above the annual average level of.the past five years. Presumably the USSR will also want to replenish normal carryover stocks.

The demand for US grain depends on the size of tho Soviot requirement as well as on production and stocks in other supplier countries. If past practice is followed, about hnlf of Soviet grain imports will be filled by the United States. In this connection, the Soviets have committed themselvesong-term grain import agreement with tho US for the deliveryillion tons per year for the five years beginning* Presumably, after buying grain under this agreement, the Soviets would then buy' from non-US sources to maintain access to those markets before coming back to the US. For example, if the Soviets needed es much asillion tons pur year, they could be expected toillion tons under the long-term agreement, exhaust non-US suppliesillion tons, and rely on the United States for their remaining needs.

Despite the continued Soviet need for grain imports, there does not seem to be a. strong case for US leverage. From the

e

US side'* political and economic interestsolicy of

* The United States may sell lessillion tons if it

hortage. It may sell moreillion tons

: ; .

cultivating large, stable agricultural exports. US ihtcroats asido,oratorium wore to be levied on US grain shipments to tho USSR, tho rango of options open to tho Soviets would weaken such an action. Zn the short run, other countrios could provide additional amounts of grain boyondillion tons of normal available supplies if stock positions were favorable. Over the lonqor run, tho Soviets could develop the markets of other exporting countries, effectively shifting the pattern of Soviet imports away from the US. Long-term contracts with Canada, Argentina, Australia, Brazil, and Prance would require extensive negotiations but could serve to stimulate grain output in these countries, adding ns muchillion tons to the amount available for export.

Domestically, the USSR could substantially reduce the demand for grain. Ashey could:

livestock on alternative feeds,

-- raise the extraction rate forhus loweripg bread quality but saving grain,

nonstrategic grain stocks, and

necessary, slaughter livestock.

Further, purchases of meat could be substituted for grain and,ast resort, the leadership could authorize the use of strategic grain reserves. Prolonged belt-tightening is not out of the question, although the leadership's commitment to provide more moat is strong.

mar

5 tho USSR also canceled longstanding exportto Eastern Europe, thus savingillion tons of grain. This option could bo used again. It would reduce the USSR's need for grain but force Eastern Europe into thograin market. The effect on the Eastern Europe economics could bo substantial, particularly in light of their hard currencyhey would have to compete with tho USSR for grain and pay the higher prices for grain caused by the massive Soviet purchases.

USSR: Grain Production and Trade 1

2 3 4 5 6 7

Million metric tons

Imports 2

Million metric tone Million US .$

Exports 3

Million metric tons Million US" S

4.0

Production data are for the crop year preceding the stated fiscal year. Trade data aro for fiscal years, July through June.

Including some shipped to third

Data are an average of two calendar years derived from official Soviet foreign trade

on Soviet Exports to tho United States

The denialFII status to the USSR hat* little effect on Soviot exports to tho US since most aro either duty-froo or aro subject to relatively low rntoq. Tho Soviets, aro owaro of this, but want MFN for political purposes. Its granting by the US would indicate in Soviot eyes US recognition of tho USSR as an equal.

Of the.total imports for US consumption from the USSR65 million,ercent entered duty-free. Tho duty on the remainderercent. In tho case of several of the major dutiable goods, the tariffs were low and MFN would have mado little difference. For example, the tariff on Soviet salcaillion of crudo oil and fuel oil wasillion (one-half cent pernder MFN the bill would have boon0 (one-oighth to one-quarterallon). Similarly, the tariff on diamonds iscr-cont ond would fallercent under MFNnot enough toubstantial impact on, salca. '.

MFN. status could havo somewhat more of an impact on Soyiot exports of manufactures. In recent years, Moscow has tried to boost exports of manufactured -goodsparticularly tractors, watches, cameras, and machine toolsto the Unitod States. Except for agricultural tractors, which oro duty free, MFN couldajor difference. Soviet machine

tcols currently0 percent tariff hurdle, comparedercent under MFN. Similar differences apply to cameras and watches. Soviet vodka exportsutyor gallon, compared with an MFN rateallon. While MFN treatment of Soviot manufactured goods oxports would sub* stantially reduce the prices to US consumers, the Soviets would still have the problem of quality, distribution, and serviceparticularly in high-technology goods such as machine tools, for which price carries loss weight in the buyer's decision. Although MFN treatment would meanomewhat greater share of Soviet exports would be manufactured goods, the increase in total exports would be small.

Areas of potentially large Soviet exports to the United States ire those resulting from such projects as theof LNG and other raw materials. Various projects discussed by the USSR with US companies have involved largo, long-term exports of Soviet products in return for USknow-how, and credits. Credit rd.ther than MFN is tho major barrier to US participation in those projects.

APPENDIX'

Soviet Interest In Western Technology: Some Examples

Because of the importance of semiconductor technology to the development of modern computers ,and especially to military electronics systems, (the USSR hasajor effort to overhaul its badly outdated industry andodern one based on Western technology. In the past three years the USSR, mostly through illegal channels, has acquired in the United States and Japan large quantities of production machinery ond testllegal acquisitions ought to make it possible for the USSR to produce at least small quantities of high-quality integrated circuits. Whether they will enable the USSR to produce advanced microcircuits in very large volume may depend crucially upon the further acquisition of comprehensive production know-how.

The United States until recently held unrivoled world leadership in semiconductor technology, but the expinsion of US subsidiaries abroad and the sale of licenses to Western firms have greatly narrowed the technology gap. The United States continues to excell in two crucial areas of semiconductor productionmask-making and finalnd in new fabrication techniques such as ion-implantetion.

Eastern Europe needs advanced microcircuits to build modern data processing computer systems which are in great demand throughout Eastern Europe.- Poland has acquired one turnkey facility from France for tne production of relatively simple types of integrated circuits, and other turnkey facilities for other semiconductor devices and complementary products. Other countries in Eastern Europe have managed to acquire only discrete items of-Western machinery.

The. Communist countries have bean trying to acquire .Western production.technology across the entire spectrum of

*. *

T Semiconductors aro electronic components thatreplaced vacuum tubes as the basic building blocksequipment. Major types of semiconductorsdiodes, and, in their most advanced form,j

computer related equipment, including disc drives and packs, tape driven, printers, core memories, and other items. Somo technology, of minor significance, has been purchased through legal channels and somo illegally. The Soviets also may be acquiring some useful information in design, development, or production through SfiT agreements with OS firms.

Tho Communist countries have bought large quantities of computers and peripherals because of the poor quality and inadequate supply of domestic computers. To free itself of long-terra dependence on the West and to catch up with Western state-of-the-art, the USSR, in tho,ooperative venture with East European countries to produce RYAD machinesthird generation computers based onesigns. Production of these computers, which are only now being serially produced in several countries, was made possible by Soviet and East German acquisitions of hardware, design information, and technical documentation in the period beforo salos were licenses for Communist countries.

The Soviets prefer us computer products because only the United States can provide hardware and software across the board. In the case of very large scientific computers and very high capacity magnetic disc drives, tho United Statesnique source of supply. Although the computer industries of other Western countries collectively can provide the components to assemble most types of computer systems, only the US industry has largo volume production of the full range of equipment.

The economic impact of Western Imports in the USSR and Eastern Europe is difficult to measure. In Eastern Europo, the spread of small but powerful minicomputers to small plants and institutes, as well as large well-known facilities*ariety of industries, almost certainly will help to improve efficiency and productivity in research and In the USSR, Sovie't computer capabilities generally may have been enhanced substantially by recent imports of very large US computers to Aorbflot and Kama.These sales include crucial training of pnxjraimurs and engineers and will provide the USSR with important expeiience in large data handling operations which can be applied to future indigenous development of large systems. Even so, the Soviet record in developing and implementing the managerial, service and industrial infrastructures needed to plug Western technology into tho Soviot economy i? not good.

Numerically Controlled Machine

Numerically controlled (NC) machine tool technology is highly prized by the USSR as one solution to the problem of raising labor productivity. NC technology permits the automation of the small nnd medium batch productionwidely employed in all industrialized countries and is particularly important for aircraft production.

Tho Soviet machino tool industry, concerned for many years with the mass production of highly standardized, general-purpose machine tools, has not kept up with US and Western advances'in NC state-of-the-art. In particular, the Soviets aro deficient in the production of contouring NC machine tools capable of operating in three or more axes simultaneously, of machining centers and of computer-controlled (CNC) machines and direct numerical control (DNC) systems.

To breach the gap dn NC technology, the USSR has enteredumbergreements with firms in France, Italy, West Germany, nnd Japan. As far as is known, no agreements have been concluded with US firms. In addition, the USSR hasarge number of multiaxis NC machine tools and machining centers from Italy, France, Switzerland, and Sweden, many with capabilities which excood embargo limits. Moot East European countries also havo ontered into licensing or cooperation agreements with various Western firms to develop and produce NC machine tools.

Firms in Western Europe and Japan produce mostNC machine tools currently produced in the Unitedin tho most advanced areas cf'NC technology (CNCin which tho United States for many years was the leader, Japan and West Germany are now able tocapabilities. ;

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Oil

The USSR, the world's leading producer of oil, has vast resources, but the supply of oil willritical problem within the next few years. New" deposits are not being found and developed rapidly enough to offset declines in older fiolds, and production- techniques now in usesuch as excessive water floodinghavo focused on gains in, annual output at: the expense of maximum lifetime recovery.esult, production will soon peak, perhaps as early8 and certainly by the.

A downturn in oil production sooms inevitable and probably will bo sharp, but its timing is not as predictable. Although the discovery of new fields may arrestow the doclino, such respites aro likoly to be temporary because depletion of existing fields is now rapid and exploration and development of frontior areaslow nnd costly process. TO" stave off or slow the expected production decline, the Soviets will need substantial amounts of western oil field technology and equipment. Because of its superiortho United States is the preferred source of much of this equipment nnd know-how. Without such assistance, Soviet oil production will fall sooner and more sharply than would otherwise be the case.

Items from the West that could provide the most rapid and effective help in exploiting existing fields include: high capacity submersible pumps and gas-lift equipment, drill pipe, casing, drill collars, rock bits, rotary drilling rigs, drilling mud technology, and multizone completion equipment.

Because of severe water encroachment in fieldsthe bulk of Soviet oil production, increasinglyof water must be lifted for each barrel of oil To increase total fluid (oil and water)numbers of high capacity submersible pumpsfluid lifting equipment must be used in theregion and in the newer fields in Westthe USSR and some West European countrieswell pumps, tho only pumps adequate to deal withlifting problems aro produced in the US and areshort supply. The USSR has been buyingsubmersible pumps annually in the US for theyears and has tried tournkey plant for Thus far, neither of the two US producersinterested in supplying the production technology

As an alternative- to high-capacity submersible pumps, the Soviets are negotiating for large-scale purchases of gas-lift equipment for use in- two of the largest oilfields in West SiberiaSamotlor ond Fedorov. They hope toontract.for about SI billiqn worth of equipment for this project from US, West European, or Japanese suppliers by the end The technology to produce the downholc gas lift equipment does not exist outside the US. all equipment for the proposed gas-lift project other thanalued0 million) must be bought in the US. Given the long lead times involved in

dcnign, production, nnd instillation of such equipment, it is doubtful that the USSK could have all the units installed boforo tlie early to.

The quality of Soviet drill bits generally is poor compared with western bits, and they must be replaced much more frequently. The Soviets recognise that better quality bits would improve drilling efficiency and would pormit wells to be drilled mora rapidly. They have purchased small quantities of US drill bits, and have been tryingears tourn-key plant to produce US-design bits. Ilowover, as the price of the plant escalated during the negotiation period, tho Soviets docided to seek lower-cost US assistance to recquip nn existing Soviot plant to produce those bits. Negotiations for the re-equipmentillion) are in tho final stages,ontract is expected to bo signed this year.

About three-fourths of oil Soviet drilling is done with the turbodrill, which becomes increasingly inefficient at depths greatereters. Soviot drilling capabilities are improving, but continue to lag behind those of tho West where rotary drilling in used. In the West, wells can bo drilledeters in about one month, compared with an overage ofonths in the USSR. As the average depth of drilling increases in tho USSK, rotary drilling would be moro efficient than the Soviot turbo rigs. Rotary rigs in operation in theercent of the total rig pork) arc comparable to US equipment produced in. US rotary drilling equipment and technology wouldistinct os_et to the Soviets in searching for and developing new oil fields.

e

The supply of drill pipe, casing, and drill collars in tho USSR is not adequate in the sizes, quantity, ond quality required for field development, especially in poor climates and under difficult wells the retirement to drill to greater depths increases, both onshoreoffshore, tho USSR will need larger amounts of high-quality drill pipe, most of which will havo to como from tho Wo3t. The US is preeminent in tho production of drill pipe that can take tho high stresses of deep rotary drilling.-

Scientifically planned drilling fluid programs are almost unknown in tho USSR. Most drilling crews use local clays mixed with wator and additives. all is completed, the mud is stored for future use regardless of requirements. Such practices cause formation damago, reduce recovery rates, ond cause wells to be abandoned needlessly.

.>EtrtttT

A related' problem la tho need for bettor cementing practices to improve well completion and to seal the well bore against the entry of ground water. The Soviets have indicatedin US technology in these areas.

Multizone completion equipment is relatively scarce in the USSR, necessitating the drilling of separate holes for each producing zone in many fields. Acquisition of multizone completion equipment from the West would permit important economies in reduced drilling costs,in casing, tubing, flow lines, and drilling and pumping equipment.

For the long-run, finding new oil reserves is even more important than increasing the yield of existing fields. In tho present five-year plon, sizable reserves must be found, primarily in West Siberia, to maintain production at or near current levels as output declines in the older fields in the Western regions of tho country. Discoveries must be made inEast Siberia and in offshore areas of the Arctic Seas to prevent sharp declines in production.

In general, Soviet exploration equipment lagsears behind that used in the United States. Tne USSR isdeficient in advanced seismic equipment and digital field computers for on-site evaluation of geologic structures in permafrost and in deep-faulted formations. Although some seismic and geophysical equipment is available in Western Europe and Japan, the best for Soviet needsespecially portable field computers and softwareare made in the US.

The most obvious deficiency in Soviet oil field operations is the lack of modern offshoret and technology. Soviet offshore experience thuss been limited chiefly to relatively shallow waters of the Caspian and Black-Seas where operations aro conducted chiefly from trestles extending from the shoro, or from man-made islands. The USSR now hasobile'offshore drilling rigs (jackupll in the Caspian Sea, and only one is capable of drilling in water as deep aseters. For the USSR to move to deeper water in tho Caspian, or torctic Seas, or to the Sea of Okhotsk off Sakhalin, Western experience, technology, and cqc'pmcnt will be essential. Although the US is'the world leader in this technology, Dutch, French, Norwegian, British and Japanese firms can supply some offshore equipment and know-how. The Soviets recentlyontractest European company toard on the shores of the Caspian Sea to produce offshore mobile drilling rigs.

Chemical

The USSR has beenuge volumo ofquipment for the pastears. Purchases consist mainly of complete inntnllatlons for producing synthetic materials, fertilizers, basic chemicals, and chemical intermediates such as ammonia. lone, Soviot imports of chemical-petrochemical equipment from the West were valued6 billion. The US hadmallercentillionf Soviet imports from the West, but participation by .US firms is growing.

US firms generally have provided advanced chemical process technology or engineering design rather than In many casos Japanese and West European firms have been the major contractors ond equipmont suppliers even where US technology is involved. In the past five or six years the Soviets have purchased US processing technology for producing butadiene, ,ethylene, and vinyl chloride. They have also purchased complete US installations for producing acetic acid and ammonia.

Although inefficiency in construction and operation of chemical plants based on Western technology has denied the USSR the full potential benefits of its purchases, the Soviets havo realized large increases in production of nitrogen fertilizers and modern synthetic materials, as well as economies of scale and manpower use. Chemical plants based on Western technology continue to make an important contribution to Soviet output of ammonia, urea fertilizer, polyethylene, and other major chemical products. Western supplied installations provided aboutercent of Soviet ammonal production capacity introduced, and large plants based at least in part on Western technology are to provide more than three-fourths of the new ammonia production capacity to be introducedost of this capacity will be based on US .technology.

Tho USSR has been negotiating with US firmsor chemical equipment and/or technology to produce ethylene oxide, fiber glass and fiber glass pipe, fungicides, herbicides, potassium chloride fertiliser, ond synthetic rubber.

Communications Technology

The USSR has had few dealings with the West in the area of communications technology, relying on indigenous production and imports from Eastern Europe. This policy has

*

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resulted in highly uneven programs: someserving only the military establishment ^iro upstote-of-the-artj the others, serving mainlyare far behind those of the West. The Sovietsparticularlyswitching systems.

To overcome the gap in switching technology, while maintaining long-term independence from Western sources of supply, the USSR6 was negotiating"major turnkoy deals with the French for plants to produce electronicexchanges that would involve several hundred million dollars. The USSR has also ordered highly specialized computer-controlled telegraph message switching systems from France.

astern Europe has been importing Western know-how and turnkey production technology, including cablo, microwave, multiplex, and switching systems. US participation has been limited largoly to sales by West Europoajjjubsidiaries of large multinationals/^

. East Europeans are thus acquiring capabilities to bulla ul most modern communications systems in general use anywhere in the world, saving themxpenditures and years of development time. By thehey snould bo supplying the USSR with largo quantities ofbased on Western designs.

Motor Vehicles

The USSR has derived major benefitslow of automotive technology under contractual arrangements with foreign firms since the. The USSR has acquired plant design, production technology, licenses, and machinery for large-scale production of Western style passenger cars at the Volga {Tol'yatti) car plant, and for heavy diesel trucks at the Kama truck plant. Machinery has also been bought to outfit supplier plants that have been modernized or newly built to make parts and materials for Tol'yatti and Kama and to modernize other Soviet truck and car facilities.

Italy and other Wost European couritries were the major suppliers of technology and equipment for Tol'yatti. The United States hasuch, larger role in providing technology and equipment for Kama, supplying aboutercent of the SI billion being spent in the West. US firmsmanufacturing engineering services and machinery for theighly automated facility, incorporating the

mostVi6gy.r

. Because of the international character of thewidely interchangeable technologies areWest European, countries and Japan most ofmachine tools and other equipment that thebought from the United States could have beenotJier firms. Only :the gear cutt.ing machinery, fora dominant position :in the world, may

we con3iaereoTJ unique because of its high productivity and reliability. Nevertheless, the USSR had put out feelers -for US assistance iri.laying out and equipping new shops for the ZIL truck production association which would produce castings, stampings and pressings, ond complete truck dieselsorgc scale. Other preliminary discussions with US firms for truck technology in the last two years have been concerned with help in organizing the production of axles for very heavy highway trucks, turbochargers for diesel engines and electric wheels for large off-highway dump trucks.

although the dominance of US machinery producers has declined in many areas as foreign firms master masstechnology and offer low-cost alternatives, US machinery still enjoys the confidence of the. world auto industry. It is distinguished by high productivity,accuracy, and rugged durability under mass production conditions. It costs more than many foreign alternatives, but tends to be worth the extra cost in the long run.

Tractors

The USSR produces more tractors than any" other country but.lessercent are designed and equipped for nonagricultural applications, and few of these are adapted for use under difficult climatic and.geographic conditions. As exploitation of petroleum and mineral resources in the USSR has expanded into -remote-permafrost and desert areas, the Soviets have shownrowing interest in procuring .large, high-powered, specialized, industrial-type tractors from the United States and Japan.

the United States and Japan haveoreractors in horsepower ranges. Those in the upper horsepower ranges are used for such tasks as" laying pipelines, for ripping frozen ground in thend for construction of the BAM railroad.

Most of the tractors imported from Japan, many of which are produced under US license or incorporate US engines, are for use primarily in forestry projects in tho Soviet Far East.

The USSR appears to be striving for long-term self-sufficiency in tractor production. Among'other things, it has an agreementarge US tractor manufacturer for cooperation in the design end development of tractors. Manufacturing machinery and equipment has been procured in the West for the large Cheboksary tractor plant which, when completed, will produce heavy-duty tractors inorsepower range, thus reducing the need for Western imports.

JNCLASSIFIErSEPARATED FROM /

MEMORANDUM FOR

Attachment

NATIONAL SECURITY COUNCILC1

August7

The Secretary of State

The Secretary of Treasury

The Secretary of Defense

Tho Secretary of Commerce

Director, Central Intelligence Agency

Tho Assistant to the President for Ene-rgy

Tho Assistant to the President for

Domestic Affairs and Policy The Chairman, Joint Chiefs of Staff

PRC Meeting Regarding US/ Soviet Economic Relations

room no.

BUILDING '

Rc attached memougrom NSC requesting US/Soviet Economic Relations papers to be discussed at Policy Review Committee meeting.

5

FROM:

POOH WO.

TENSION

1

Distribution:

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Original document.

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