CURRENT OUTLOOK FOR THE SOVIET ECONOMY; MAJOR CREDIT NEEDS AND AVAILABILITIES F

Created: 3/1/1977

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BACKGROUND PAPERSI oR THEaAJo*CEPs

at- sower PpojeoTi :

Current Outlook for thai Soviet Economy _

OWLr*

ho Soviet economy grew atn part because: it was Still; recovering from theharvesturther recovery is expected7 but growth still will be below the trend of the last daeade. Construction lags will hamper industrial:growth, and the consumer will;continue to suffer unusually severe foodIn.the longerlowdown in the rate of growth, of labor and raw materials is forcing Moscow toew growth strategy stressing productivity gains in order to keep growth rates up. One of the most serious problems ofill be the likely downturn in oil production-which wjave implications both for domestic economic growth{and. for; the balance' of payments.

confidential"

BACKGROUND PAPER

Currant Outlook for the Soviet Economy

he Soviot aconony was still recovering from tho disastrous harvest Livestock herds were down after tha distress slaughtering of the previous winterj industry suffered shortages of agricultural .raw materials! and the consumer was set back in iio.riQ cases to his consumption level of. Even so, the leadership probably gave itself high marks for its stewardship through the most severe economic crisis of the last decade. The situation never became serious enough to impose constraints on Soviet foreign policy or military programs.

Soviet gross national product (GNP)%6bout the average achieved inut substantially above thef the previous year. growth slumpedhe worst performance of the post-waxhortage of raw materials. from agriculture was the principal cause, althoughtleups and fuel problems wera contributing factors. Farm output bounced backrowth rate followingeclineS. harp increase ir. crop-production, ledecord grain harvest, more thenecline in the livestock sector.

For the6ear of unusual shortages, resulting in the worst food supply situation in moreecade. Heat shortages intensified throughtout the year, and per capita meat consumption for the year,hole dropped to roughly0 level. Although grumbling*was widespread, the:nhappiness apparently was not translated into openonsumers fared better on other, fronts. For example, housing conditions continued'to graduallys more.thanillion people moved into new apartments.;

Economic recovery should'continue7 but not as' fast ae the regime would like. Although the flow of agricultural raw materials will pick up, continuing lags|in bringing new^plant and equipment on stream will

'confident

keep industrial growth down. During th* first two months.of the year industrial output grew only slightly faster than therat* posted Shis compares with ths annual goal of

Beoauaaiof the dominant effect of ^weather, agricultural'performance remains uncertain. Protpocta for wintor grain, which normally account for one-third of total Soviet grain output, are favorable. The area aownjto wintor grain was the largestnd winterkill losses ware below normal. The livestock sector should make alow but ateady progress due to last year's bumper grain harvest. The consumer, however, continues toisuffer food shortages, mainly of meat anduch shortages have eased substantially onlyj in major cities. The long anticipated upturn in neat^output has not yetoviet official recently estimated that the meat situation would not return to normal for another six months.

The current slowdown in growth is not justof recent harvest shortfalls but thea| general slowdown in growth begun in. has been caused by the using up ofresources as well as the Soviet failureefficient use of these inputs. Thethat the growth strategy of the pastuaa of capital and laboris no longerthey must focus their attention on They haveumber of measuresproductivity including the large-scaleWestern equipment and technology and thebetter managerial methods that encourageand application of new technology. measures will not bring back the. growth ratesthe economic pace over the next severalbe sufficient:to continue their basic gunspolicy. In,he Sovietsresource problems. One of the mostths-downturn.in oil production whicheconomic growth and create aerious balance;

Drafted bvi: CXA/OEfl

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BACKGROUND PAPER

Major Credit Scads andtne USLR

SUMMARY

The rapid growth of Sovietof Westernand pipe en-credit and large hard currency trade deficits have;ledharp rise in the USSR'icurrency debt.oviet indebtedness to the Heat amountedillion byO percent held by Western commercial'oscow aeems reasonably assured of obtaining most.of the medium and long-term government guaranteed credits it will require to finance future capital good imports from the West. Western governments remain basically optimistic with regard to Soviet creditworthiness. However, the USSR's ability to obtain[non-guaranteed credits haa become increasingly constrained. Because of peat heavy landing to the Soviets, many Western banks have approached or hit lending limitsis the USSR. As long as Soviet Eurocurrency indebtedneas remains.at or above present levels, Moscow will probably attempt to limit trade deficits to levels which can be financed without resorting to. general purposeBased on the6 grain harvest and good export prospects, we'believe it unlikely that the Soviet hard ;currency trade deficit7 will4 billion or that Moscow will have to rely on general purpose financing.

Major Credit Heeds and"the

^ growth of soviet equipment imports from the [West.and large hard currency trade deficits have combinedghteniHoscow's need for Western credit. The'concomitant risejin the USSR's hard currency debt haa (limited Moscow's.ability to obtain'nowt desirable interest ratesfrom Western banka. The USSR.will continue to face these conditiona, ot least for 'the near term.

(The-Soviet Union relies heavily on Western credita to manage its hard currency balance of payments; the availability of long-tern credit weighs heavily in Soviet decisions to buy equipment from the West. Large-scale development projects are particularly dependent on long-term Western!financing. The USSR also has used credits to finance unplanned hard currency deficits, particularly in recent yeara.

The growth in imports oTlWesterniequipment and pipe on credit and the unexpectedly large deficitharp riae in the Soviet.Union's hard currency debt, forcing Mosoow,to cut non-grain importset indebtedness, which rose;byillionrewillion6illion. Roughlyer cent' of .this, total was JBedium- and long-termhe ahare of Soviet-hard currency debt held by iWaatern commercial banks, has risen)sharply, ironer cent at theJendo abouter,cent' at,the end of laathejUSSR'a net liabilitiesbanks'--'a large part of whichi ihcreaaedbillion infr^eri6d.

nionssured of ob ta

irequireVto;:finance; future? capital:goods', imports:he!Japan, ;

-thr^oXj; CsnadaV'.and; (domestic condition! ipermitting) rltaavrjeither,ihaye.advanced orarge credit" ovtrfahthe. expected to do ao.iyi .the.future on"the oviet.Although'Western govern* ing tnbre; closely at'the'rapid growth in dnessy theyremain baaieallyo^Sovieti oreditworthineaa.

triClfos'cowability to obtain-non-guaranteed credits will.be7 just as

Becauee of pastheavy lending to the Soviets^.'manyiWestern banks have approached or hit* lending limitsis the USSR. esult, these banks;Jhave become more; selective in granting new loans; many want higher-interest ratesiand front-end fees for syndicated medium-term!loans despite the fact that loan demand^ie alack. Mosttbankera seem to prefer suppliers' credits, whereby loans'are tied to Western exports and financing is often undertaken at the behest of the Western exporter. This type of'financing not onlyrofitable return but also enhances the lending bank's relationship with the Western exporter.!

.The USSR realizes, that its heavy past borrowing will continue to limit; its ability to tap the Euromarket for new funds, Soviet borrowers remain extremely sensitive to: the nominal interest rates they must pay and view any rate increase, relative to what other borrowers pay on: similar syndicated loans, as an adverse reflection on tbeir credit standing in the West. To protect its credit rating and borrowing capacity, Moscow;will continue the' cautious financial posture it adopted6 in order to minimize its dependence on the Euromarket for financial credits. The steps that tha USSR.ii expected to take includei

limiting the growth of machinery, and eouipment imports according tovailability of:redits 'and growth in hard currency export learnings

'.continued use 'of medium-term promissory notelvfinancihg for some aquipraont-imports initead of paying .Cash;?

eONFWXNT-IAt-

of gold5 billion Tho gold market has -rebounded since lastow point, and Moscow can be expected to continue moderately heavy sales;

The USSR will exercise restraint inurocurrency loan syndicationBecause of. continued market liquidity, interest rate spreads have narrowed since Moscow0 millionelativelyyer LIBOR; laat July. The Soviet Union'has been quietly sounding' out bankers for syndicated creditsoverate that the USSR thinks is desirable. However, moat banks are not interested in lending |to Moscow atate.

Aa -long as Soviet Eurocurrency indebtedness remains at or above present levels, Moscow will probably attempt to limit trade deficits to levels which can be financed without resorting to general purpose borrowing. Moscow will continue to make greater use of government-backed credits and promissory noteogether with revenues from' gold and armsransportation earnings, and tourist;receipts; such tied borrowing should allow the USSR to finance moderate annual trade deficits for the foreseeable future. Should the USSR again incur Unexpectedly largejtrade deficits, it will probably have tc place greater :emphasis on expanding exports.and/or cutting back on.non-grain imports than3, when general purpose borrowing was used tc make up much of theased on the6 grain harvest and good export prospects, we believe it unlikely that.the Soviet hard currency trade deficit7 will4 billion or that Hoscow will |have to-rely on general purpose financing.

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Major industrialized West-Soviat Projects'

SUMMARY

Since the, the Soviet Union haa proposed that Western firms supply equipment andfor several huge projects in priority sectors. Although large Soviet hard currency trade deficits havo caused sere delays and scale-downs, most of the projects arejstill alive. US participation in Soviet projects has not. been as? as it might have been if-Exlmbanx credits had been available. Moacow canjget. government becked credits in. Western Europe and.'Japan. The Soviets have urged Western firms to accept long-term deliveries from output of the projects to repay the credits>

Major Industrialised West-Soviet Projects

in ncint years, the Soviet Onion hieumber of huge projectsseveral valued atillion or moreto be undertaken with assistance by Westernegotiations have proceeded slowly in Boat canes, but nearly all the proposala are atill alive and some projects are.well under way (albeit substantiallyew instances). Most of the project* are foroviet energy, chemical, and metallurgy ndustries.

willingness to commit future resources to repay billions of dollars in credits testifies to its strong desire for Western equipment, technology, andome projects are expected to play an important role in the long-run development of the Soviet economy. For example. Western equipment and technology would be useful in developing oil reserves in Siberia and essential in off-shore Arctic areas. These reserves are pivotal to Soviet plans to increase production in. Similarly, Soviet hopes to increase agricultural production restonsiderable dagree on the output of several chemical fertilizer complexes the Soviets have bought from the West. Although the Soviets could probably handle most if not all of the projects on their own, Western participation will allow them to be completed earlier, and Western equipment,'and technology will increase the productivity of the Installation in question.

Becent Soviet difficulties in borrowing in the West may not affect Moscow's ability to obtain long-term 'credits 'for .the projects because Western lenders prefer to provide project-associated credits rather than Igeneral financial credits for which the uses are not specified. Moscow, however, has delayed some projects'or reduced the Western share in others, apparently' in response to the growing Soviet debt.

Credit availability hasactor in Moscow's shift among potential Western suppliers. UShas virtually closed the door to Eximbank creditc for Sovietesult the Soviets .have sought'alternate'sources of financing for the projects. While the Soviets still request'bids from UShe'US role is largely limited to selling licenses and technology, with firms in Western Europe and-Japan.supplying equipment. The beat example is the proposed Worth' Star LUG project,'which in its present form calls for* nearly'all equipment to.be purchased fromhe UK, arid West Germany whore credit lines aren recent months, the Soviets have also;UKland Canadatwo countries which havo large Uncommitted governmbnt-guaranteed jexport credit lines -lopen toor financing major projects.

The projocts generally involve no-calledagreements-. Western firms export equipment and. other materials on credit to-be repaid by Soviet exports from the output of theestern negotiators haveine in[recentthe product-payback provisionslof the compensation agreements. The Frenchough stand on,product-payback at6 session of the Franco-Soviet Mixed Commission. |Wiatern firms are! concerned that future large;Soviet exports of fertilizers and other chemical intermediate products may, disrupt Westernhe French government, for example, reserves the right;to restrict Soviet exports to France of competitively sensitive goods. Current Soviot efforts to include manufactured goods in.compensation agreementsool reception from:firms uncertain of thu marketability of these products in the West. The Soviets have'hadnd should-continue to havebetter success in selling theirirsw materials.

Drafted byt CIA/OER

Clearancesiatheson Treasury/Mi Searing"olbf.rt/H.X 1MBg

Major Project! with US Participation

fertilizer complex

Aluminum complex

North Star LNG

Yakutsk LNG

billion Project well underway;

production ; moot equipment from US.

illion 6 contract with French firm for alumina refinery; US-German group negotiating for smelter contract.

illion Revived interestith equipment and credits sought from Western Europe; nroject recently shelved for various roasons, including uncertainty over US LNG import policy.

illion Reserves announcedillion cubic metors inevelopment decision will be reached when proved reservesrillion; would call for annual exports ofillion cubic maters of LNG each to US andximbank credits would be required fcr the US to participate in the project in its present form. It is uncertain whether the project will, cono future US energy policy.

Tabic 2

Major:Prbjecta with Other Western. Participation

.billion

Xurak iron andbillion

complex

Sakhalin oftehora..A.

and gaa

Odokan coppers

Comments

ConstructionompletionRG, France, Italy major aupp3lara.

General agreement with German coraortiumoviets recently balked at increaeed cost estimates resulting from design and specification changes.

Exploration began6 under agreement with Japanj Gulf Oil has small stake; development several years away.

Negotiations for past decade unsuccessful because of hugo outlays requiredi interest recently revived with tho start of the BAM railroad. Soviets are requesting bidsilot plant and are starting^ preliminary mine development.

MEMORANDUM FOR: Mr. J. Mtahell George

Director East-West Country Affairs

Departirent of CCnrcerce

Attachec* are. the Background Papers to be used at the Jcint OS-USSR Conjiercial Commission Meeting.

Office of Eoonomic Research

Attachments As Stated

DATE)

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