Foreign Relations of the United States, 1981–1988, Volume X, Eastern Europe

202. Memorandum From the Executive Secretary of the Department of State (Bremer) to the Interagency Group on Yugoslavia¹

Washington, November 17, 1982

SUBJECT

• Circulation of IG Memorandum and Draft NSDD

The interagency group on Yugoslavia met November 15 to review an analysis and options paper regarding U.S. policy options toward the Yugoslav debt situation.²

Attached is a revised version of the IG paper tabled November 15, an executive summary, and a draft NSDD. The last document draws up in succinct form the substance on which White House decisions will be required. Addressee agencies are requested to review the package, particularly the executive summary and draft NSDD, at a senior policymaking level (Under Secretary or above). Comments or clearance are requested by telephone to Mr. Tain Tompkins at 632-5804 by COB Friday, November 19. Based on the results, we will plan to move the package either to a SIG meeting November 24³ or, if SIG-level agreement can be obtained in this clearance round, to the White House for Presidential approval.

L. Paul Bremer, III⁴

Attachment 1

Draft National Security Decision Directive⁵

Washington, undated

UNITED STATES POLICY TOWARD YUGOSLAVIA

I have reviewed the interagency report on United States policy toward Yugoslavia. I have determined that the U.S. should maintain its policy of support for the independence, territorial integrity and national unity of Yugoslavia, and should continue to encourage Yugoslavia’s gradual liberalization. An independent, economically viable, stable and militarily capable Yugoslavia—in a position to resist pressures from the Soviet Union and the Warsaw Pact—serves Western and U.S. interests. Yugoslavia is an important obstacle to Soviet expansionism and hegemony in southern Europe. An independent and economically viable Yugoslavia is also a useful reminder to other countries in Eastern Europe of the advantages of independence from Moscow and of friendly relations with the West.

In implementing this policy, the U.S. Government will continue to pursue the now-traditional political dialogue with Yugoslav leaders on issues of mutual interest and concern. In doing so, we recognize Yugoslavia’s choice of nonaligned status, and that U.S. and Yugoslav positions on major international issues may differ. Our dialogue enables us, however, to encourage Yugoslavia to play a moderating role within the nonaligned movement and to counter Cuban and Soviet influence in that organization.

The U.S. will also seek to expand economic relations with Yugoslavia in ways which benefit both countries and which strengthen Yugoslavia’s ties with the industrialized democracies. We wish to promote the trend, already well underway in Yugoslavia, towards a more market-oriented economy.

In line with the established U.S. arms transfer policy toward Yugoslavia, the U.S. Government will seek to expand military cooperation with that country. We will be forthcoming in approving sales of arms and equipment required for Yugoslav defensive needs as circumstances warrant, and encouraging our Western European Allies to follow similar policies.

The severe financial situation facing Yugoslavia is cause for serious concern and makes the successful implementation of U.S. policy more difficult, but no less important to U.S. strategic interests. An economic crisis so severe as to require a general rescheduling of foreign debts and/or entailing an extended period of Yugoslav financial weakness and uncertainty carries serious political implications for Yugoslavia and the West. Our Allies and all of the major industrial democracies have a stake in the preservation of Yugoslavia as an independent, viable bulwark on the Warsaw Pact’s southern flank. I have noted the interagency report’s conclusion that, unless Western Governments are able to generate a substantial amount of financial assistance for Yugoslavia, that country will probably be forced into a general rescheduling in early 1983.

In order to seek to avoid the uncertainties and possible dangers of a general rescheduling in a country as politically sensitive and potentially vulnerable to Soviet pressures as Yugoslavia, I direct that the following measures be undertaken:

— The U.S. Government will complete on an urgent basis a contingency financial assistance package for Yugoslavia. This package will be drawn from a variety of sources, including CCC guarantees and, as appropriate, the Economic Support Fund, as well as from U.S. participation through the BIS in a short-term loan bridged to a larger multilateral package. The U.S. contribution to a BIS loan would be provided by the Department of the Treasury’s Exchange Stabilization Fund. In addition, the U.S. Government would be receptive to Yugoslav requests for a stretch-out of EXIM maturities on uncompleted projects. Western, including U.S., financial assistance should not be a “bail-out” of Yugoslavia, and pressure should be kept on the Yugoslavs through international organs such as the IMF or BIS to proceed with needed domestic fiscal and economic reforms.

— The U.S. Government will seek, in consultation with other friendly countries, to work out a sufficiently large multilateral assistance package to help Yugoslavia solve its financial difficulties without a general rescheduling. If other countries are willing to participate in a significant multilateral effort, the U.S. package will go forward as one of its components.

If U.S. efforts with the Allies and other countries are not successful in arranging a satisfactory multilateral assistance package, the U.S. Government will continue to evaluate on their merits specific Yugoslav Government requests for trade-related financing. Should a general Yugoslav rescheduling prove unavoidable, the U.S. Government will cooperate fully with other official creditors and the Yugoslavs in seeking a mutually acceptable agreement.

Attachment 2

Executive Summary of a Paper Prepared by the Interagency Group on Yugoslavia⁶

Washington, undated

I. U.S. SUPPORT AND ASSISTANCE FOR YUGOSLAVIA

Executive Summary

In accordance with NSDD–54 of September 2, 1982⁷ (United States Policy Toward Eastern Europe), which provided that Yugoslavia be treated in a separate NSDD, an Interagency Group has reviewed the implementation of U.S. policy toward that country in light of the current serious Yugoslav economic and financial crisis. The group agreed that the U.S. should maintain its policy of support for the independence, territorial integrity and national unity of Yugoslavia, and should continue to encourage Yugoslavia’s gradual liberalization. An independent, economically viable, stable and militarily capable Yugoslavia—in a position to resist pressures from the Soviet Union and the Warsaw Pact—serves Western and U.S. interests. It was also agreed that Yugoslavia is an important obstacle to Soviet expansionism in southern Europe. The Group noted that an independent and economically viable Yugoslavia is a useful reminder to other countries in Eastern Europe of the advantages of independence of Moscow and of friendly relations with the West.

The Group believes that the U.S. Government should employ a combination of political, economic and other measures in the implementation of our policy. The Group noted the value of high-level visits and discussions and felt that the U.S. Government should seek to expedite progress in those fields of cooperation already underway, especially in the military area. The group noted that the basis for this already exists in the reaffirmation of U.S. arms transfer policy toward Yugoslavia, as stated in the White House Memorandum of June 1, 1981 to the Secretary of Defense.⁸

The Group reviewed the Yugoslav economic situation and concluded that Yugoslavia faces a severe financial crisis. The group believes that, without special measures by the Yugoslavs themselves and help from foreign governments and/or banks, the country faces the likelihood of being forced soon to reschedule its large foreign debt. The Group noted with concern increasing indications that a major rescheduling could have serious domestic political consequences within Yugoslavia and for Yugoslav foreign policy. It was the Group’s view that a protracted Yugoslav economic crisis could undermine Yugoslavia’s ability to withstand Soviet pressures and undercut Yugoslavia’s relationship with the West. The Group felt strongly that other Western countries also have a major stake in preserving Yugoslavia as an independent bulwark and as an alternate model for the communist world. The Group noted that the U.S. by itself is probably not in a position to provide sufficient assistance to enable Yugoslavia to meet its massive foreign debt burden without a major rescheduling. The Group believes that the Allies should be closely consulted and encouraged to participate in arranging for the provision to Yugoslavia of Western financial assistance.

The Group concluded that, to deal effectively with the immediate economic and financial crisis facing Yugoslavia, the U.S. Government should prepare on an urgent basis a contingency financial assistance package for that country. The Group considered various options for such a package and decided that it should be drawn from a variety of sources. These should include CCC guarantees and, as feasible, the Economic Support Fund, as well as U.S. participation through the BIS for a short-term loan bridged to a larger governmental package. The U.S. contribution to a BIS loan would be provided by the Treasury Department’s Exchange Stabilization Fund. In addition, the U.S. Government would be receptive to Yugoslav requests for a stretch-out of EXIM maturities on uncompleted projects, on a project-by-project basis.

The Group agreed that the U.S. Government should seek, in consultation with other friendly countries, to work out a sufficiently large total assistance package to help Yugoslavia solve its financial difficulties without a general rescheduling. It was the Group’s view that such assistance should not be a “bail-out” of Yugoslavia or of the Western commercial banks, and that pressure should be kept on the Yugoslavs through international organs such as the IMF or BIS to proceed with needed domestic fiscal and economic reforms. The Group agreed that an international assistance package, to be successful in meeting U.S. policy objectives, must be completed as soon as possible. It was decided by the Group that, if other countries are willing to participate in a significant multilateral effort, the U.S. package will go forward as one of its components.

If such efforts are not successful in arranging an appropriate multilateral assistance package, the Group decided that the U.S. would not provide the U.S. part of the package, but would continue to evaluate on their merits specific GOY requests for trade-related financing. The Group felt that, should a general Yugoslav rescheduling prove unavoidable, the U.S. Government should cooperate fully with other official creditors and the Yugoslavs in seeking a mutually acceptable agreement.

Attachment 3

Paper Prepared by the Interagency Group on Yugoslavia⁹

Washington, undated

II. U.S. SUPPORT AND ASSISTANCE FOR YUGOSLAVIA

Preambular Statement

The purpose of this study is to reaffirm the U.S. policy of support for Yugoslavia’s independence and gradual liberalization—and to examine its implementation in light of Yugoslavia’s financial crisis. The study addresses in particular the question of whether the U.S. Government, in upcoming consultations with key Allies regarding the Yugoslav situation, should encourage a special Western effort to assist the Yugoslavs to meet their foreign debt payment obligations and avoid a general rescheduling. The study examines the possible nature, sources, and size of the U.S. share of such a Western assistance package. The study concludes with policy recommendations for consideration by the National Security Council and, subsequently, for decision by the President.

I. The Problem

Yugoslavia is in deep economic trouble. Two and one-half years after the death of Tito, the country is at a political and economic crossroads. We and our Allies will need to consult closely in coming weeks regarding the political and strategic implications for us of Yugoslavia’s looming crisis. How we respond now to Yugoslavia’s problems could be a critical factor in sustaining Western interests over the long-run in this independent country on the Warsaw Pact’s southwestern flank.

In this connection, we need to consider what the U.S. can do to help secure Yugoslavia’s anchor to the West during what promises to be a period of unusual difficulty and uncertainty. The immediate crisis demands particular attention to the economic and financial areas. Our long-term success, however, in keeping Yugoslavia independent of Soviet influence and moving in the direction we want also requires attention in coming months to our political and military relations.

II. U.S. Policy Towards Yugoslavia

It has been the policy of the United States over the past three decades to support the independence, territorial integrity and national unity of Yugoslavia, and to promote its gradual liberalization and integration into the West. This basic policy was most recently reaffirmed in the June 1, 1981 (secret) memorandum from the White House to the Secretary of Defense, confirming U.S. arms transfer policy toward Yugoslavia. The 1981 memorandum also reaffirmed that a militarily capable Yugoslavia is a key element in preventing Soviet expansionism and hegemony in southern Europe.

III. U.S. Interests

Yugoslavia’s unity and stubborn independence of “blocs” has served our strategic interest in the Balkans and Mediterranean as well as our political interest in encouraging the attenuation and eventual dissolution of the Soviet empire:

a. Geopolitical

The Adriatic is an open sea, the Warsaw Pact is denied bases there, and the Soviet threat to NATO Allies Greece and Italy and to the Middle East is, as a consequence, substantially less. Yugoslavia controls the only air corridor from the Warsaw Pact to the Mediterranean and the Middle East through non-NATO airspace. The Soviets are denied Adriatic airfields. Thus they have no tactical air support for the Soviet Mediterranean Fleet. The Yugoslav ground defense is primarily geared to repelling an attack from the Warsaw Pact. It is presumably determined to block any move through northern Yugoslavia by Pact forces seeking to enter northern Italy via the Gorizia Gap.

b. Economic

U.S. economic interests in Yugoslavia are substantial, relative to other countries in Eastern Europe. The Yugoslavs have purchased billions of dollars worth of U.S.-made industrial equipment, agricultural products, and manufactured goods ($6.3 billion since 1965). Yugoslavia welcomes foreign private investment and, despite currently restrictive Yugoslav laws relating thereto, the U.S. is the largest foreign equity investor. Yugoslavia is a full member of the GATT, the IMF, and the World Bank. The presence of well-known U.S. and other Western products throughout the country constantly underscores the efficacy of the industrial democracies in producing a rising standard of living and the material well-being associated with Western life.

The Yugoslavs have continued to work toward a market-oriented economy, seeking to stimulate their firms to greater efficiency through competition with foreign firms, both in export and domestic markets. This takes place under a system that is nominally socialist, greatly magnifying the Yugoslav example’s impact on its neighbors to the East. In part due to lingering ideological bias but mainly because of other factors peculiar to Yugoslavia’s internal situation, further structural change in the direction of a more market-oriented economy is a slow process. Yugoslavia’s decentralized economic and banking system, controlled for the large part at the level of the republics, reflects a delicate internal political balancing act. Structural reform has been complicated by the difficulty in reconciling the various, and often competing, interests of the ethnic and national groupings comprising Yugoslavia.

It is in U.S. interests to support the determination by the current Yugoslav leadership to better coordinate transactions by the country’s regional banking institutions. The ability of the current pragmatic and market-oriented top Yugoslav leaders to carry out badly-needed, long-range basic structural economic reforms depends on their getting over the near-term debt hump without losing political credibility. The Yugoslav leadership hopes to overcome the current fiscal crisis without having to turn the clock back on economic decentralization in general, which has become a Yugoslav political as well as economic hallmark.

c. Political

Yugoslavia, the prize that eluded Stalin in 1948, has not been forgotten in the Kremlin. The U.S. gave Tito the help that was essential to keep Yugoslavia independent while he began the slow process that has resulted in opening Yugoslavia to the West and permitted evolution in the direction of pluralism, and fostered receptivity to Western attitudes and culture. As a result, Yugoslavia is now well along a course that is the envy of the Eastern European countries of the Warsaw Pact (with the partial exception of Hungary), and has made significant progress toward liberalization. What happens in Yugoslavia has obvious implications for future developments with respect to Romania and other Eastern European countries.

As a coalition of historically-warring national groups and economically-disparate regions, Yugoslavia is not easy to govern—especially by committee with no strong leader—even in times of prosperity. Growing economic strains could interact with the latent nationality problem, leading to increased domestic unrest. Major instability in Yugoslavia, especially during a period of uncertainty regarding Soviet policy, is no more in our interest than it is the Yugoslavs’. The choices before the top Yugoslavs over the next few months pose a serious test of the post-Tito leadership and perhaps the greatest challenge since the 1948 break with Stalin. If the present leaders are discredited, the old-style, directed-economy types would be in a position to pose a serious challenge. A shift back toward communist orthodoxy in the economic area would likely be accompanied by a parallel move toward tighter and more repressive political controls, undoing progress over the years in that country’s gradual democratic evolution.

U.S. interests in Yugoslavia are affected by that country’s perception of our commitment. The Yugoslavs recognize that their independence hinges on internal stability and the country’s economic viability. They also believe that American perceptions and interests coincide with their own in this respect. This seems to explain why the leadership, despite its suspicions and desire to avoid dependence on either “super power,” has turned first to us. Examples include then-President Kraigher’s discussion with the President at Cancun, Foreign Secretary Mojsov’s westward-looking inaugural foreign policy address this summer, and President Stambolic’s July letter to the President asking support for Yugoslavia’s loan effort.¹⁰

As Yugoslavia’s economic situation becomes more critical and Western commercial banks decline even normal roll-over of loans, we are hearing comments from influential Yugoslavs that the West, and the U.S. in particular, have decided to “abandon” Yugoslavia. Some of this is a form of pressure, but most of these persons are well-disposed to the West and all of them want Yugoslavia to remain truly nonaligned and politically and economically independent of the USSR. Yugoslav leaders have shown concern over the expansion of the Yugoslav trading relationship with the Soviet Union, as Yugoslavia’s ability to buy and sell in Western markets has diminished.

Yugoslav top political leaders have expressed their stubborn opposition to major debt rescheduling. This point was made forcefully by Yugoslav Foreign Secretary Mojsov in his October 4 meeting in New York with Secretary Shultz. The reasons are more political than economic. The top leaders are worried that a worsening of the financial situation, to the point where a general rescheduling became necessary, would be widely interpreted outside Yugoslavia as symbolizing the failure of the Yugoslav alternative to traditional, centralized communist control. It would also, in their view, project weakness so serious as to leave the country vulnerable to outside pressures. Foremost, of course, is Yugoslav concern over potential Soviet pressures for concessions in political and military areas.

We do not underestimate Yugoslav toughness and resolve in dealing with the Soviets, even from a weakened position—so long as the Yugoslavs continue to count on at least some backing from the West. There is currently no significant, organized “pro-Soviet” faction in Yugoslavia. This could change over time, however, if the current crisis spawned an anti-Western xenophobia. U.S. interests would suffer if the trend to blame the West for “abandoning” Yugoslavia became widespread and if suspicions gained ground that the West (as well as the East) was hoping to be able to take advantage of an economically prostrate Yugoslavia.

A protracted Yugoslav economic crisis accompanied by a loss of faith in the West could lead that country in several possible directions, none of them in our interests. At a minimum, the Yugoslav model would stand as a less powerful example of the benefits of pluralism for the communist world, and could be seen as a negative example of the results of closer association with the West. A prolongation of Yugoslavia’s problems could lead to serious internal instability, threaten that country’s independent course and seriously weaken its resolve and ability to withstand Soviet pressures.

IV. U.S. Military Cooperation

The U.S. is involved in other forms of political support—especially military cooperation—which are important to our overall relationship with Yugoslavia. The central elements of U.S. arms transfer policy toward Yugoslavia are:

— To support the independence, territorial integrity and national unity of Yugoslavia.

— To be forthcoming in approving sales of arms and equipment required for Yugoslav defensive needs as circumstances warrant.

— To expand further the International Military Education and Training program for Yugoslavia commensurate with Yugoslav desires, U.S. disclosure policies, and available funds.

— To encourage our Western European Allies to follow similar policies.

Areas of military cooperation receiving particular attention now include:

— Procurement of U.S. weapons systems. A significant group within the GOY leadership is concerned by the degree to which Yugoslavia is dependent upon the Soviet Union for military hardware. U.S. policy has sought to assist the Yugoslavs in the procurement of specialized weapons systems based on the premise that diversification of supply would strengthen Yugoslavia’s independence from Moscow. Yugoslavia’s severe financial constraints have compromised our efforts to develop a meaningful military sales program. There are, however, a number of areas where we see scope for close military cooperation with the Yugoslavs over the long run, and where major purchases would not take place for a number of years.

— F–5G2 and release of the PW1120 aircraft engine.¹¹ Discussions for the purchase of the F–5G2 are at a relatively advanced point. The next step is to obtain NDP approval. If Washington approval for release of classified information and an eventual sale is forthcoming, a possible sticking point will be financing for the aircraft and the degree of offset purchases that Northrop may be willing to accept. We may wish to encourage Northrop to be flexible in this area, but as a matter of policy the USG does not become involved in the specifics of commercial offset arrangements. We may also wish to explore the possibility of FMS credits, although this approach does not look promising during the FY 85 budget cycle in view of current budget stringency. (Heretofore the Yugoslavs have seen FMS credits as inconsistent with their nonaligned status.) The planned visit of Secretary Weinberger to Belgrade in early December will provide an occasion for discussions on this topic.

— IMET Training. While not a substitute for expanded cooperation in arms procurement, an expanded IMET program in FY 85 would provide an important signal to the Yugoslavs and enable us to monitor more effectively attitudes in the Yugoslav armed forces. Our access to the upper echelons of the Yugoslav military should be enhanced as officers with exposure to the U.S. military move up the command chain. Our current program for FY 83 and 84 will fund about six students. We should be able to give Yugoslavia a high priority if IMET funds become available late in FY 83 for reprogramming.

V. Bilateral High-Level Dialogue

Visits by senior U.S. officials can complement the measures listed above and have an intrinsic value of their own because they visibly give value to and stimulate the bilateral relationship. The recent conversation in New York between Secretary Shultz and Secretary Mojsov is a good example of the worth of high-level talks. The GOY expects, however, that material support will be linked with these exchanges. In other words, there must be substance to such bilateral exchanges as the prospective visit of Secretary Weinberger, in order to achieve the desired intact.

VI. Encouraging the NATO Allies

There is only so much that the USG can do to help the Yugoslavs economically and to bolster their confidence in our general support. Much depends upon the U.S. and international commercial banking community, over which we have some influence but no control. Other Western countries have as great a stake as we do in preserving Yugoslavia as an independent bulwark and as an alternate model for the communist world. Our own bilateral measures need to be in a larger framework of actions by others. The Allies should be encouraged to initiate bilateral actions of their own, namely debt relief, bilateral trade, as well as joint Franco/Anglo/German initiatives to alleviate EC trade policies which have hampered Yugoslav trade with western Europe. We will need to consult closely with our key allies regarding multilateral measures as well.

VII. Economic/Financial Outlook and Measures

Yugoslavia is winding up 1982 with a current account deficit for the full year which is larger than anticipated, foreign exchange reserves equal to less than one month’s imports, and strong inflationary pressures which will be exacerbated by its recent 20 percent devaluation. It has run into difficulty in wrapping up a recent $200 million loan syndication and a request for a $500 million three year loan from the BIS is on hold for a number of reasons. In a broader context, Yugoslavia suffers from a lack of strong leadership to rationalize the economy and consolidate power which is segmented among the various regions.

The immediate problem is one of cash flow. Yugoslavia will soon enter the first and cyclically weak half of 1983 with the need to finance a large current account deficit, roll over short term debt, and meet existing amortization payments. The economic situation in the second half of 1983 should ease as the current account is expected to shift into surplus. But if the Yugoslavs are unable to increase reserves, they will face the beginning of 1984 in a similar situation to the one they face today.

a. Magnitude of Financing Requirement in 1983

It is not clear exactly how significant Yugoslavia’s cash flow problem is for the first half of 1983 and for the year as a whole. Our best estimates indicate that the Yugoslavs will have an overall 1983 financing requirement of $4.2 to $4.7 billion dollars, of which some $3.8 to $4 billion will have to be raised in the first half. Potentially available short and medium-term credits will total $2.6 to $2.8 billion, and even this amount is not assured. The financing gap could be appreciably smaller or larger depending on the strength of Yugoslavia’s export performance, how much further room there is for cuts in imports, the size and volatility of worker remittances and withdrawals from private foreign exchange accounts, and Yugoslavia’s ability to attract new net medium term-capital.

The most volatile and difficult element to estimate in assessing Yugoslavia’s financial needs is short-term capital flows. Yugoslavia’s year end stock of short-term credits stands at $1.6 billion and matures in roughly half a year. Unless the private banks agree to roll over the majority of these credits in 1983, there is little chance that Yugoslavia can avoid requesting a debt rescheduling. In this regard, Yugoslavia’s current efforts to secure its $200 million syndication are key, for far more than the $200 million is at stake. Should the Yugoslavs fail to reach an accord with the banks, the banking community’s confidence in Yugoslavia’s ability to roll over the short-term debt will be severely weakened.

The attached tab1e¹² projects Yugoslavia’s sources and use of funds for 1983 in a manner that demonstrates its weak first semester, and relatively stronger second semester. Two points are key: (1) it assumes that the bulk of Yugoslavia’s short-term debt is rolled over; and (2) it assumes a $600 million buildup in Yugoslav reserves in the second half. Without this, Yugoslavia will face the first half of 1984 in much the same position they are in today.

The conclusion which emerges is that there is an urgent need for some timely U.S. and allied government financial assistance—without prejudging the amount or nature of that assistance—to help Yugoslavia through the first half of 1983, and to put them on a stronger footing in the latter part of the year to deal with the first half of 1984.

b. U.S. Objectives:

Any U.S. assistance effort for Yugoslavia must be geared to accomplish a number of key objectives:

— Preserve the U.S.-Yugoslav bilateral relationship and avoid negative political fall-out from the current Yugoslav economic crisis.

— Contribute to a long-range solution to Yugoslavia’s economic problems. Stop-gap measures to see the Yugoslavs over their immediate liquidity crisis, such as a short-term governmental bail-out, might not leave the GOY in an appreciably strengthened position going into the first half of 1984. Thus, we might consider including a substantial medium-term component to any financing package we select. In addition, appropriate conditionality should be affixed to any Western assistance package.

— Support the IMF structural adjustment program. To put the Yugoslav economy on a sound medium-term footing, the GOY must act decisively to create a rational industrial structure, eliminate distortions in foreign exchange and capital markets, and gain more control over the process of wage/price determination. Yugoslavia’s IMF program focusses on reforms in a number of areas designed to improve Yugoslavia’s external competitiveness, reduce underlying inflationary pressures from the system of wage/price formation, and improve the efficiency of the domestic resource allocation process through basic price reforms. So far, however, Yugoslav adjustment efforts have proven inadequate. U.S. economic assistance should therefore be predicated on improved Yugoslav action in these areas, and in particular on reform of the domestic banking system, foreign exchange markets, and credit policies.

— Ensure equal burden-sharing both among the U.S. and its NATO allies and between governments and private bank creditors. The U.S. share of a joint assistance package for Yugoslavia would be based most appropriately on the U.S. share in total Yugoslav external indebtedness, i.e. roughly 20 percent. Every dollar of U.S. assistance would therefore be leveraged 5 times with the West Europeans and Japanese contributing the balance. However, it is by no means clear how receptive our allies will be to such an assistance effort, and consultations would be necessary before any U.S. financial commitment could be made.

More problematic is the comparable undertaking that we would expect from the private banks, whose exposure in Yugoslavia dwarfs that of the governments by a factor of more than 5 to 1. We wish to avoid at all costs a situation where governments bail out the private banks. For the short run, private bank willingness to maintain existing short-term credit lines is thus a sine qua non for going forward with a governmental assistance package. This, together with a sound stabilization program, could pave the way for a lagged private sector response to help Yugoslavia through the first half of 1984.

c. Rescheduling vs. Balance of Payments Assistance

There are two basic ways in which Yugoslavia could close its 1983 financing gap: a) through a general rescheduling of Yugoslavia’s 1983 debt service obligations—which can only come through Yugoslavia’s request, or b) through new governmental/private economic assistance and financing, assuming the banks are willing to maintain their short-term exposure. The pros and cons of rescheduling versus providing new financial assistance are presented below:

Rescheduling

Pros

— Since the private banks would not appear to reject a parallel rescheduling exercise, the governments would achieve public/private comparability.

— From the Western point of view, it would be easier to organize a rescheduling than a multilateral assistance package.

— The Allies might favor rescheduling over new official assistance.

— A rescheduling could “clear the air” and could lead to the resumption of private lending, especially if accompanied by a satisfactory IMF-approved stabilization program.

— The rescheduling—if large enough—could permit some rebuilding of Yugoslav reserves even if the banks do not resume medium/long term lending.

Cons

— The Yugoslav top political leaders remain opposed to any major rescheduling (and made this point forcefully to Secretary Shultz on October 4). Rescheduling (especially the timing thereof) is a GOY, not a U.S., decision. Given GOY attitudes toward rescheduling there is a substantial risk that the Yugoslavs will wait too long, building arrears and breaking the IMF program. As the U.S. and other Western banks would not agree to reschedule absent a new IMF program, a considerable period of financial uncertainty would loom (a la Romania). In this case, an ultimate rescheduling would probably not “clear the air”.

— A Western rescheduling of Yugoslav debt might have an adverse impact on Hungary.

— Rescheduling would eliminate the prospect of using the CCC program to gain market shares in Yugoslavia and to reduce surplus U.S. stocks of agricultural commodities.

— While we should not be pushed around by Yugoslav “rescheduling paranoia”, we should recognize that the GOY might be right—a rescheduling may be interpreted as a confession of failure and could thus shake the post-Tito leadership.

— Rescheduling, combined with failure of the West to avert it, would damage our bilateral relationship.

New Multilateral Financial Assistance

Pros

— New governmental assistance would provide the most tangible proof of Western support for Yugoslavia.

— USG funds could be used as “seed money” to leverage (at a 5 to 1 ratio) the remaining funds out of the Europeans and Japanese, whose combined economic trade interests in Yugoslavia are substantially greater than ours.

— A major portion of the USG financing could come from CCC and would provide domestic political benefits by helping reduce our agricultural surpluses and increase our market share in Yugoslavia.

— Use of the Economic Support Fund, though nominal, would signal the high degree of political importance we attach to Yugoslavia (we used ESF for Poland).

— New governmental money, particularly medium-term money, would constitute a public vote of confidence which would in turn help restore private confidence and private lending.

— We are considering more CCC/EXIM financing unless a rescheduling seems imminent. By adjusting the timing and packaging of these programs, we could lever the money upward, helping ourselves and the Yugoslavs.

Cons

— There is no assurance that other governments will follow the U.S. lead and fill 80 percent of Yugoslavia’s financing gap.

— The Administration could be accused of violating the spirit, if not the letter of the CCC and EXIM statutes, if these funds were used in a period of imminent rescheduling.

— Use of ESF and PL–480 Title I monies may be constrained by possible negative congressional reaction to the necessary Presidential certification required under section 620 (f) of the FAA, though we did get a waiver for Poland, a Warsaw Pact country.

— If the Economic Support Fund is used, money will have to be taken from other countries that are also important to U.S. interests.

— The governments will be putting new money in Yugoslavia, while private banks may nevertheless reduce their exposure. If so, governments would be bailing out the private banks rather than helping the Yugoslavs avoid a liquidity crunch and rescheduling.

d. Possible Sources for a Financial Medium Term Assistance Package

Potential sources of medium-term USG financing that would also not involve recourse to supplemental appropriations are listed in addendum 2 to this paper.¹³ An optimum financing package should be: (a) quick disbursing; (b) large enough to reduce the probability of rescheduling directly, and indirect through its positive impact on private lending behavior; and (c) should present a minimum risk of non-repayment. There are three basic options, none of which would entail additional budgetary outlays. In each case, the size of the overall package is predicated on the assumption that the US would contribute 20 percent of the total, an amount consistent with the US share of total Yugoslav hard-currency debt. The options are as follows:

— Medium-term Credits Option. The total package would be $875 million. On the U.S. side, the main components would most likely be CCC guarantees ($150 million) and the Economic Support Fund ($25 million). There are, of course, competing claims on ESF monies and the opportunity costs of providing such funds to Yugoslavia will have to be considered. There is also a $90 million dollar EXIM line of credit earmarked for earthquake assistance in Montenegro. However, it is highly unlikely that these funds would be disbursed in the short run. Moreover, the disbursements would be linked to imports for specific projects, which would not have been initiated in the absence of EXIM financing. Thus, such lending would not reduce the “financing gap”.

The primary advantage of medium-term assistance is that it avoids saddling Yugoslavia with more short-term debt, thus putting the country in a better financial position as it enters 1984. In addition, we understand from banking sources that medium-term official assistance might have a more powerful catalytic effect on private lending than would a short-term “bailout” arrangement.

— Short-Term “Bridge” Finance Option. This would be a loan backed by Yugoslav gold (if they can do so) of about $750 million through the BIS with payment due in less than one year. The US portion would be $150 million, provided by the Treasury’s Exchange Stabilization Fund. It would be quick-disbursing, but it would not be large enough to ensure the GOY against rescheduling or be seen as a “bail-out” of private banks. Yet, it reduces the probability of rescheduling and minimizes the negative bilateral political fallout should a rescheduling prove necessary. Moreover, because the financing would be general balance of payments support, the financing gap would be reduced by the full amount of the assistance. The chief disadvantage of a BIS option is that the bridging loan implies the existence of a future source of funds from which the Exchange Stabilization Fund (and its equivalent in other countries) would be repaid at maturity.

— Combination Package Option. A blend would combine a $300 million BIS participation (a lower level than option two with the US share about $60 million) with the entire $875 million medium-term package from option one (US share about $175 million), for a total of $1.175 billion. Due to its larger size and medium-term component, this option would be more likely to bring along the private banks and thus to reduce the probability of rescheduling. By staggering the timing of the short and medium-term components, the BIS element could be bridged directly to a medium-term package and the issue of gold collateral could be avoided. The advantages of this approach are that it would provide quick-hitting balance of payments support with a firm bridge. The main disadvantage is that it would be hard to orchestrate. This alternative also combines some of the disadvantages of options one and two. Yugoslav drawings on the CCC portion may proceed slowly, and the extent to which the CCC guarantees would reduce the funding gap is not clear. Moreover, despite the link to medium-term assistance, money is “fungible”, and there is a risk of non-repayment.

Any given financing option could also be combined with a stretch-out of EXIM maturities on uncompleted projects, when requested by the Yugoslavs and justified on the basis of project-by-project needs. We could add the savings to the Yugoslavs, generated by such a stretch-out, directly to the US share of an overall package, levering upward the allied contribution. Alternatively, the stretch-out could serve to fend off possible allied pressure to raise the US share of the financing package above the 20–25 percent level. We have had indications that the private banks may also be willing to refinance on loans for selected major projects, outside of the context of a general rescheduling. With the stretch-out, we would be in a position to suggest that the banks take “comparable” action.

VII. Recommendation

That, on the basis of its long-standing policy of support for the independence, territorial integrity and national unity of Yugoslavia, the U.S. Government pursue a strategy in coming months consisting of political, economic and military elements intended to: a) protect and further our bilateral relationship and interests during a time of Yugoslav economic difficulty; and in particular, b) assist Yugoslavia in maintaining its economic viability and its ability to resist pressures from the Soviet Union and the Warsaw Pact.

In implementing this strategy, the U.S. Government will seek to reinforce the U.S.-Yugoslav consultative dialogue, which has become an important underpinning of our bilateral relationship, through continued high-level visits and discussions. The U.S. Government will also seek to expedite further progress in various fields of cooperation important to U.S. long-term interests in Yugoslavia, especially in the area of sales of U.S. military equipment.

To deal with the immediate economic and financial crisis facing Yugoslavia, the U.S. Government will complete on an urgent basis a contingency financial assistance package for Yugoslavia. This package, which would commit the U.S. Government up to $235 million, based on 20% of the total multilateral package, will be drawn from a variety of sources, including CCC guarantees and, as feasible, the Economic Support Fund (both in the category of medium-term assistance), as well as U.S. participation through the BIS for a short-term loan bridged to a larger governmental package. The U.S. contribution to a BIS loan would be provided by the Treasury’s Exchange Stabilization Fund. In addition, the U.S. Government would be receptive to Yugoslav requests for a stretch-out of EXIM maturities on uncompleted projects, on a project-by-project basis.

The U.S. Government will seek, in consultation with other friendly countries, to work out a sufficiently large total assistance package to help Yugoslavia solve its financial difficulties without a general rescheduling. If other countries are willing to participate in a significant multilateral effort, the U.S. package will go forward as one of its components. Financial assistance should not be for a “bail-out” of Yugoslavia. Appropriate conditionality should be affixed to any multilateral Western assistance so as to encourage the Yugoslavs (through such international organs as the IMF or BIS) to proceed with needed domestic fiscal and economic reforms. If efforts are not successful to arrange a multilateral assistance package, the U.S. will continue to evaluate on their merits specific GOY requests for trade-related financing. Should a general Yugoslav rescheduling prove unavoidable, the U.S. Government will cooperate fully with other official creditors and the Yugoslavs in seeking a mutually acceptable agreement.

1. Source: Reagan Library, Robert H. Lilac Files, Arms Transfer: Country File, AT: Yugoslavia [11/17/1982] (2). Confidential. The memorandum was sent to Donald Gregg (OVP), Michael Wheeler (NSC), Raymond Lett (Agriculture), Thomas Cormack (CIA), Helen Robbins (Commerce), John Stanford (Defense), William H. Draper (EXIM Bank), Charles Siegman (Federal Reserve), Alton Keel (OMB), David Pickford (Treasury), and Dennis Whitfield (USTR).
2. The undated discussion paper is ibid.
3. See Document 203.
4. Alvin Adams signed for Bremer above Bremer’s typed signature.
5. Secret; Sensitive.
6. Secret; Sensitive.
7. See Document 18.
8. See Document 191.
9. Secret; Sensitive.
10. See Document 198.
11. An unknown hand placed checkmarks above “F–5G2” and “PW1120” and wrote beneath the paragraph, “Should go. PW1120 refused once—I called Lantos and Rudd. We support—”
12. Attached but not printed.
13. Not found attached.