THE SOVIET BLOC FINANCIAL PROBLEM AS A SOURCE OF WESTERN INFLUENCE

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP85T00176R001300110002-9
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 17
• Document Creation Date: December 20, 2016
• Document Release Date: March 26, 2007
• Sequence Number: 2
• Publication Date: April 1, 1982
• Content Type: REPORT

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Directorate of Secret
Intelligence NOFORN
The Soviet Bloc Financial
Problem as a Source of
Western Influence (u)
National Intelligence Council
Memorandum
tv1! F lar!? C
Secret
NIC M 82-10004
April 1982
spy 157
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Directorate of Secret
Intelligence
The Soviet Bloc Financial
Problem as a Source of
Western Influence (v)
National Intelligence Council Memorandum
Information available as of 8 April 1982 has been
used in the preparation of this report.
This memorandum was coordinated within the Na-
tional Intelligence Council and the Directorate of
Intelligence. Comments are welcome and may be
addressed to the author, Maurice
Intelligence Officer for Economics
(u)
Secret
NIC M 82-10004
April 1982
STA
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Secret
The Soviet Bloc Financial
Problem as a Source of
Western Influence (U)
Key Judgments The USSR and Eastern Europe are encountering serious hard currency
problems caused by systemic deficiencies, accumulated hard currency debt,
weak Western markets, and the Polish crisis. Private sources of long-term
credit to the Bloc have largely dried up. Poland and Romania are unable to
meet their hard currency obligations and most of the East European
countries will be forced to curtail imports. The USSR still has substantial
short-term flexibility but its long-term hard currency earnings' prospects
are poor.
These problems give the West an unusual opportunity to influence Soviet
Bloc developments, although there exists little direct leverage on these
countries' policies. The main instruments of influence are the volume and
terms of new government-guaranteed credits and the rescheduling of
existing obligations. These actions can affect the Soviet Bloc's ability to
finance hard currency imports both directly and through their impact on
the willingness of private bankers to lend at their own risk.
Western financial restrictions would further curtail the USSR's ability to
pay for hard currency imports in the 1980s and would thereby increase
Moscow's difficulty in coping with worsening economic problems, includ-
ing an already massive and rising defense burden. Hard currency shortages
might force Moscow to weigh financial costs more carefully before
embarking on foreign assistance programs or adventures. Such restrictions,
however, would not force Soviet concessions in important areas of foreign
or defense policies, such as Afghanistan. They could influence indirectly
the evolution of Soviet policies, although the Soviet reaction might be
either aggressive or accommodating.
With respect to Eastern Europe, Western financial instruments-notably
the handling of Polish and Romanian rescheduling-can be used as sticks
or carrots. A strongly restrictive policy could trigger widespread debt
default, which would hurt the East European economies, force the Soviet
Bloc economies closer together, increase the burden on Moscow of
supporting its empire, and also create risks for the stability of the
international banking system. On the other hand, a liberal Western
financial policy would allow Hungary, and to a lesser extent Poland, some
flexibility in the choice of economic and social policies, and Romania some
limited independence in foreign policy. By the same token, Moscow's
economic burden would be somewhat relieved.
iii Secret
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The West's ability to use what potential influence its financial instruments
provide is substantially restricted, however, by differences between the
United States and our West European allies as to the role and importance
of trade with the East. The Europeans view this trade as providing jobs at a
time of severe unemployment and as creating mutual interdependencies
that will tend to limit Soviet adventurism and provide bargaining chips
with Eastern Europe. The European governments, like the private bankers,
are concerned about excessive financial exposure to Soviet Bloc countries
but are not willing to severely restrict trade with these countries.
Nevertheless, the common ground which exists may be sufficient to support
an informal agreement now that has the effect of limiting the volume of
new government-guaranteed credits and of tightening their terms. Such an
agreement would not significantly reduce the USSR's import capacity. It
could, however, prevent a possible increase in imports by: (1) giving a
negative political signal to private lenders, thereby strengthening their
reluctance to make long-term loans to the USSR; and (2) heading off
possible attempts by West European governments to compensate for
reduced private credits through larger or longer term government-
guaranteed lending.
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The Soviet Bloc Financial
Problem as a Source of
Western Influence (U)
Trends in East-West Economic Relations
Political detente in the 1970s helped to stimulate a
massive increase in the volume of East-West trade-
more than a threefold increase for the USSR and
about a doubling for Eastern Europe. Trade with the
West also grew as a share of most Eastern countries'
total trade, with the most dramatic increase occurring
for the USSR. The importance of trade with the West
to the Eastern Bloc economies is greater than its share
in their GNP would suggest (3 to 7 percent in Eastern
Europe and less than 2 percent in the USSR). These
countries all rely on the West for critical imports of
food, steel, and high-quality equipment.
Gross Hard Debt Service
Currency Debt Ratio
(million US $)
The expansion of East-West trade was aided by
formal and informal encouragement by Western gov-
ernments, including a loosening of export controls,
and a massive expansion of credit. In the early 1970s,
most of the Western credit was in the form of
government-guaranteed loans for machinery and
equipment sales. As trade surged, however, and con-
tacts multiplied, the USSR and the East European
countries entered private Western financial markets
on a much larger scale than before. For example, the
USSR and several East European countries adjusted
to the unexpected drop in foreign exchange earnings
during the 1975 recession by borrowing on a large
scale in the Eurodollar market. Encouraged by the
detente atmosphere, the Communist countries' excel-
lent payments record, the belief that Communist
governments had the power to undertake any econom-
ic adjustment that financial circumstances might
require, and the assumption that the USSR would
play the role of lender of last resort for Eastern
Europe, Western banks competed with each other for
loans to the Eastern Bloc. By the end of 1980 Eastern
Bloc hard currency debt exceeded $80 billion (com-
pared with only $8 billion in 1971), or nearly $100
billion if the debt of the CEMA banks is included.
Hungarian debt ranges between $8 billion and $15
billion. The Soviet hard currency debt surged from
less than $2 billion in 1971 to over $10 billion in the
mid-1970s, leveled off in the late 1970s at about $18
billion as Moscow irestricted its hard currency im-
ports, and then began to rise again to over $19 billion
(see table 1).
The Soviet Bloc Hard Currency Problem. A funda-
mental reassessment of the risk of lending to Soviet
Bloc countries has curtailed those countries' access to
Western private credit and made some of the remain-
ing credit flows vulnerable to new negative develop-
ments. The Soviet hard currency position has wors-
ened greatly in recent months and long-term prospects
are poor. Most East European countries either cannot
meet their hard currency obligations or must make
severe economic adjustments to do so.
Poland has incurred the largest debt, about $25
billion. The other East European countries have been
more cautious, but Romanian, East German, and
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The severe deterioration of the Soviet and European
hard currency positions has been due to the following
factors:
? Increasingly evident systemic deficiencies, resulting
in declining growth of productivity and poor export
performance.
? The logical implications of the rapid accumulation
of hard currency debt in past years-a process
which obviously could not continue unless hard
currency earnings were also growing rapidly, which
they are not.
? In the Soviet case, and to a lesser extent in the East
European countries, events outside their control
(Western recession, bad crops, lower oil and gold
prices, high interest rates).
? The Polish political crisis and economic collapse and
its fallout.
? The general worsening of East-West relations, espe-
cially in the past year.
These factors led to a fundamental reassessment of
the risk of lending to Soviet Bloc countries, which in
turn has curtailed those countries' access to Western
private credit and made some of the remaining credit
flows vulnerable to new negative developments. In the
past few months, the possibility that Western govern-
ments might restrict or discourage credit to Eastern
Europe has created added uncertainty in financial
markets and has further discouraged bank lending.
The Soviet Problem. The Soviet hard currency posi-
tion has worsened greatly in the last 12 months
because of falling oil prices, bad crops, weak markets
for other exports, and aid to Poland, and probably will
remain difficult in the foreseeable future. Last year,
Moscow drew its hard currency assets to dangerously
low levels and has since had to sell large amounts of
gold, expand its short-term borrowing, and cut non-
food imports. With large gold reserves (worth some
$17 billion at a gold price of $300 an ounce) and small
fixed debt obligations (equal to less than 10 percent of
export earnings), Moscow has substantial flexibility to
deal with its foreign exchange problems in the short
run. Longer term prospects for increasing hard cur-
rency earnings, however, are poor.
The chances are that the volume of Soviet hard
currency exports will stagnate or decline during the
coming decade. Specifically:
? The volume of Soviet crude oil exports has been
declining for three years and, with domestic oil
production likely to be at best constant and at worst
in steady decline, it will be extremely difficult to
prevent a further drop, and eventually perhaps a
complete cessation, of oil exports for hard currency.
? Gas exports will continue to increase, but not on a
large scale until the Yamal pipeline can be complet-
ed-which will probably not be before the latter
part of the decade. Even then the increase in gas
exports will probably less than offset the decline in
oil exports.
? Arms exports for hard currency appear to have
leveled off for lack of large new clients. Even
current large customers, such as Libya, may have to
pare purchases if oil export revenues continue to
decline.
? Other Soviet exports (wood, metals, manufactures)
are likely to stagnate because of supply limitations
and Soviet inability to adapt to Western market
needs.
Without the Yamal pipeline a sizable decline in
exports would be inevitable, even if Moscow redirect-
ed some of the gas to its own and Eastern Europe's
use in order to free some oil for export to the West.
With the pipeline and some good luck in oil develop-
ment, the volume of hard currency exports may be
held about constant.
Moscow's main hope for sizable increases in hard
currency earnings would be another large jump in the
prices of oil, gas, and gold-in the case of oil, an event
that appears unlikely in the next two or three years,
but increasingly likely during the second half of the
1980s.
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If Soviet hard currency earnings are stable or declin-
ing in the long term, Moscow will need to greatly
increase its new borrowing from the West to avoid a
decline-even more to achieve an increase in its hard
currency import capacity. But, unless the new credits
were on very easy terms, with long maturities, the
Soviet debt service ratio would reach dangerous pro-
portions within only a few years. For example, with
average maturity of new credits (other than for Ya-
mal) of five years, and continuation of recent interest
rates, hard currency borrowings sufficient to raise
import capacity by 3 percent a year would push up
debt service ratios to between 25 and 50 percent by
1985 and over 70 percent or more by 1990.
The East European Problem. East European coun-
tries' hard currency problem is far more severe than
the USSR's. Their gold and foreign exchange assets
are minimal and their debt service obligations are
enormous. Leaving aside Poland, which is in a class
by itself, East Germany has a debt service ratio above
60 percent, and the rest, except Czechoslovakia, are
all above 30 percent. These ratios put the East
European countries in the same class as Brazil,
Mexico, and Chile, countries with far more flexible
economies and generally rapidly increasing export
earnings.
Although Poland's 1981 private debt rescheduling
agreement finally has been signed, Warsaw has next
to no chance of generating a large trade surplus or
obtaining enough debt relief and credits to cover a
1982 debt service burden of $10 billion. None of the
possible outcomes to Poland's financial mess is likely
to improve the prospects for borrowing by other East
European countries.
Romania also is in de facto default-a problem
which, like Poland's, has hurt other East European
countries' ability to borrow. Bucharest's effort to
reschedule its debt with banks is off to a smoother
start, but several obstacles must be overcome to
conclude an agreement. Even with debt relief, Bucha-
rest would face a large financial gap. After sharp
import cuts in 1981, there is less scope for adjustment
without damage to the already strained domestic
economy. Reserves are low and Romania is reluctant
to draw from its gold stock perhaps because some of it
has been used as collateral for loans. Large, additional
cuts in imports would set in motion an economic
decline, such as has occurred in Poland.
East Germany and Hungary have multibillion-dollar
borrowing needs this year, and they are virtually shut
out of Western capital markets. Banks have been
reducing their medium- and long-term exposure for
the past year, and, in recent weeks, some West
European banks have reduced their short-term lines of
credit. Even if the cutbacks are modest, East Ger-
many, Hungary, and Yugoslavia will face serious
problems in 1982, but they might be able to get
through by recourse to government-guaranteed loans,
supplier financing, reserve drawdowns, and sharp
import cuts.
Even if existing debt were rolled over, the East
European economies would at best limp along with
little or no economic growth for the next several years.
It is important to keep in mind that Western credits
played an important role in financing a large increase
in investment in nearly all East European countries
during the 1970s, and that this investment was an
important factor in sustaining tolerable, if generally
slow, growth rates. This important prop for inefficient
economies has disappeared.
The Potential For Leverage and Influence on the
Soviet Bloc
The Soviet Bloc's hard currency problems coupled
with deteriorating economic performance throughout
the Bloc present the West with an opportunity to exert
a degree of influence over the USSR and its Warsaw
Pact allies. Soviet Bloc dependence on Western cred-
its for food, equipment, and technology gives the West
the opportunity to use credits as an instrument of
influence.
A reduction in the availability of Western credits to
the Soviet Bloc would at least temporarily affect the
Bloc's capacity to import Western goods. For Mos-
cow, declining hard currency imports would pose
serious problems. In the 1980s slower economic
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growth will present the Soviet leadership with increas-
ingly tough and politically painful choices in resource
allocation and economic management. Annual incre-
ments to national output will be too small to simulta-
neously meet mounting investment requirements,
maintain growth in defense spending at the rates of
the past, and raise the standard of living. Simply
stated, something will have to give. The Soviet need
for Western goods and technology will therefore
increase greatly. Imports can relieve some economic
problems by raising the technological level of key
Soviet industries and by reducing shortages of grain
and such important industrial materials as steel.
Western equipment and know-how will be particular-
ly important to raising productivity in the critical
machine-building and energy industries. The Soviets
must continue importing large amounts of agricultur-
al products and will probably expand their purchases
of steel and some other industrial materials.
The main Western government policy instruments
affecting the flow of capital to Soviet Bloc countries
are: the volume and terms of government-guaranteed
Soviet Bloc Dependency on Western
Government-Backed Credits in 1981
credits; interest rate subsidies; rescheduling of past
government-guaranteed credits; and pressure on pri-
vate banks. Moreover, any official financial actions
would surely have an indirect effect on the willingness
of the private sector to lend at their own risk to the
Soviet Bloc. Credits financed or guaranteed by West-
ern governments make up about one-third of the
Soviet Bloc's total hard currency debt-with Poland,
the USSR, and East Germany having relied the most
on such credits (see table 2).
The Direct Levers. Western governments have at their
option a number of direct measures to influence the
flow of capital to the USSR and/or its Warsaw Pact
allies.
To illustrate the direct impact of some such measures:
? A 3-percent increase in interest rates charged on the
new government-guaranteed credits-roughly the
recent increase in OECD Consensus rates for the
Soviet
Bloc
USSR
Poland
Romania
East
Germany
Hungary
Czecho-
slovakia
Bulgaria
Government-backed debt
29,225
8,500
13,500
As a percent of total debt
33
41
52
Flows
Gross hard currency borrowing
40,324
5,600
10,000
4,274
6,600
4,310
1,930
910
Gross borrowing from
government-backed credits
9,715
2,300
5,750
360
700
100
265
140
As a percent of gross
borrowing
24
41
58
Net change in stock of
government-backed debt
+300
+3,100
This table is Secret.
Secret
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USSR-provided at the 1981 annual level would
gradually increase interest payments for the USSR
by about $60 million a year, assuming a five-year
repayment schedule and no grace period in repay-
ments. The cumulative effect of such a policy over a
10-year period, for example, would result in a total
increase of interest payments of some $1.5 billion
for the USSR and $2-2.5 billion for the Soviet Bloc,
excluding Poland. It should be noted, however, the
aggregate numbers still pale in face of an East Bloc
financing requirement of hundreds of billions of
dollars for all of the 1980s.
At the extreme, a moratorium on new government-
guaranteed credits to Soviet Bloc countries (exclud-
ing credits for the Yamal pipeline) would reduce the
net flow of Western capital by amounts equal to 5 to
6 percent of the 1981 level of hard currency imports.
The effects would take some three to five years to be
fully felt as the government-guaranteed credits un-
der existing commitments were drawn down.
Western creditors could also declare Poland in
default of its obligations as a result of the initiatives
of either private banks or Western governments, but
formal default would not of itself have much impact
on Poland's capacity to import from the West. It
would cause substantial but short-lived disruptions
of Polish exports, thereby reducing earnings. Polish
default could have severe repercussions for other
East European countries, and for Western banks.
Private bankers' willingness to lend to other East
European countries would be even further weak-
ened. Not only Romania, but also Hungary and
East Germany could be forced into debt reschedul-
ing or, failing this, into de facto default.
The Indirect Impact. The greatest potential effects of
Western government credit restrictions are of an
indirect nature. They would come from the political
signal restrictions on government-guaranteed credits
would convey to private lenders. It is highly unlikely
that Western banks would be willing to resume
unguaranteed long- and medium-term lending if
Western governments were imposing politically moti-
vated limits on government-guaranteed credits. Short-
term lending might also contract, depending partly on
the creditworthiness of the individual countries. To
some extent, this effect has already been felt by the
Bloc.
As things now stand, no Soviet Bloc country has
received any mid- or long-term unguaranteed bank
credit for almost a year. Shorter term credit is
available (except to Poland and Romania) but on less
favorable terms than in the past. To date, credit
restrictions have come entirely from the private sec-
tor, and not from any specific Western government
action. The current discussion over credit restrictions
has contributed to an atmosphere of uncertainty for
the private banking community, however.
Pressure on the USSR could also be exerted via
Eastern Europe. Soviet trade with Eastern Europe
helps to knit the Soviet empire together. All the East
European countries, except Romania, depend on the
USSR for one-third or more of their trade (see table
3), including the bulk of supplies of oil, gas, and other
critical commodities. But Moscow pays a high price
for this close relationship. By denying East European
countries the possibility of developing economies and
economic systems that could be reoriented mainly
toward the West, Moscow has little choice but to
provide some direct and indirect forms of aid. The
direct aid is in the form of credits on bilateral
account. The indirect aid takes the form of delivery of
undervalued Soviet raw materials and foods in return
for overvalued East European manufactured goods.
Many of the commodities the USSR exports to
Eastern Europe are also sold on the world market,
generally at higher prices. The most important Soviet
export-oil-is sold to Eastern Europe far below
world market prices. Most of the East European
exports can be sold on world markets only at severe
discounts, if at all, but the Soviets pay world market
prices for them.
Before the Polish crisis and its negative impact on
Soviet Bloc creditworthiness, Moscow had planned to
reduce its price subsidies on oil exports to Eastern
Europe, thereby forcing painful economic adjustments
in those countries. The Bloc hard currency crisis
reopens the issue of Soviet support.
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USSR
42.3
31.9
25.8
Poland
33.1
22.4
34.2
10.3
East Germany
35.5
24.5
24.3
15.7
Romania
20.7
19.1
34.5
25.7
Czechoslovakia
34.4
26.9
22.2
16.5
Hungary
36.6
26.6
23.7
13.1
Bulgaria
50.0
16.5
16.9
16.6
USSR
42.9
35.4
21.7
Poland
34.6
20.4
33.8
11.2
East Germany
35.1
23.6
30.8
10.5
16.5
15.7
30.8
37.0
36.3
28.9
24.0
10.8
35.5
23.9
30.3
10.3
58.4
17.3
17.7
6.6
A worsening of the East European hard currency and
economic situation is bound to impose additional
burdens on the USSR. Moscow simply cannot afford
to let the East European countries go begging to the
West by themselves, or alternatively to let their
economies deteriorate to the point that serious politi-
cal consequences could follow. Additional Soviet as-
sistance to Eastern Europe may or may not take the
form of hard currency, but, even if it did not, there
would be indirectly an unfavorable impact on the
Soviet hard currency position. By the same token, an
improvement in the East European economic situation
would make it easier for Moscow to reduce some of its
economic burden of empire.
The Limitations of Leverage and Influence on the
USSR This is not to say the West could force the
Soviet Union to reverse basic policies through the use
of credit levers. Although Moscow could make good
use of increased imports from the West to help relieve
its serious and growing economic problems and West-
ern aid to Eastern Europe would serve to reduce the
Soviets' burden, Western credit policy used either in a
negative or positive fashion would provide little direct
leverage on the USSR. It would be difficult to find
any specific linkages between Western credit policies
and Soviet military and foreign policies. The East-
West interface is simply not broad enough to permit
policy quid pro quos which might be feasible given
the nature and limited scope of the economic restric-
tions and at the same time do not engage central
issues of national power and prestige. On these central
issues there is little chance that Western economic
pressure on the USSR would induce Moscow to
become more accommodating. For example, the
threat of Western credit restrictions, or a promise to
lift them once they have been imposed, could not
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induce Moscow to withdraw from Afghanistan, or
allow Poland to slip out of the Soviet power orbit, or
concede significant military advantages to the West.
Moreover, the Soviet economic problems are predomi-
nantly homegrown, and cannot be greatly worsened
by Western actions.
On the other side, Western economic pressure could
provide hardline Soviet leaders with an excuse for
economic problems, a justification for continuing dy-
namic military growth at the expense of the Soviet
consumer, and a political rationale for assuming a
more aggressive stance in foreign areas to show
defiance of Western actions. There also exists a slight
possibility that a sharp curtailment of Western credits
could provoke Moscow to declare a moratorium on the
repayment of the Bloc's $80 billion worth of debt to
the West.
Within these limits, there remains the possibility that
sustained Western economic pressure could influence
Soviet policy choices. Restrictions on government-
guaranteed credits, coupled with the likely negative
reaction of private lenders, would increase the cost to
the USSR of both civilian and military programs and
thereby exacerbate the worsening economic trends. It
is reasonable to expect that the negative impact would
fall particularly hard on Soviet programs requiring
large foreign exchange expenditures, such as foreign
aid to or other involvements in Third World countries.
Moscow might then give greater weight to cost con-
siderations in their policy decisions concerning such
programs. Eventually, growing economic stringencies
could lead to major changes in Soviet policies and
priorities, although we see no sign that such changes
are in the offing.
Leverage and Influence on Eastern Europe. Western
economic leverage directed toward East European
countries is potentially larger than that on the USSR
because of their far greater dependence on economic
relations with the West (table 4), and their lesser
concern with national power and prestige. But West-
ern leverage on Eastern Europe is also severely limit-
ed by the present threat of Soviet military control and
the self-interest of Communist leadership and elites in
protecting the existing political system. Leverage,
Soviet Bloc Imports From the Developed West
Total Imports
USSR
Poland
Czechoslovakia
Hungary
Bulgaria
24.0
35.3
0.7
1.7
26.0
33.7
2.4
3.9
40.0
33.3
3.6
3.4
24.8
24.0
3.1
3.3
27.1
30.3
5.0
7.4
19.3
17.7
3.7
4.2
This table is Unclassified.
moreover, is a two-way street. For example, West
Germany for decades has traded economic conces-
sions to East Germany in return for limited rights of
travel and access, and to Poland in return for the
repatriation of ethnic Germans.
Potential Western leverage or influence in Eastern
Europe varies from country to country. It is small in
Czechoslovakia and Bulgaria, both countries with a
relatively small hard currency debt, close economic
ties with the USSR and hardline political leaderships.
Although West German economic leverage has been
employed on East Germany, that country's central
role in sustaining the USSR's East European empire
and military position in central Europe leaves room
for little political flexibility in relations with the West.
The possibilities for Western leverage and influence
are greatest in Poland, Romania, and Hungary. It
should be noted, however, that realizing this influence
requires use of both carrot and stick, for under present
circumstances positive Western government actions
will be necessary to avoid a further curtailment of
Western trade with these countries.
The potential for Western political influence in Po-
land has been greatly reduced by the imposition of
martial law and the political dynamics that this
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critical step set in motion. The present Polish leader-
ship is unwilling to share power in any meaningful
way with the workers' movement, and the Soviets
probably would not allow them to do so. This means
that Western actions can affect only those aspects of
the Polish scene that are considered politically safe by
both Warsaw and Moscow. There remains consider-
able uncertainty, however, as to how Poland can
rebuild a workable, if not efficient economy, and a
tolerable form of political control. Although the ex-
igencies of martial law give the hardline elements in
the Polish party a clear advantage for the present,
competing political factions will push for diverse
solutions, and there will be considerable uncertainty
as to what will work, what is politically safe internal-
ly, and what will be acceptable to Moscow.
These uncertainties provide the West not so much
with direct leverage on the Polish Government, as
with a potential for indirectly influencing in a small
way Polish internal policies. So long as formal default,
and the consequent legal scramble for Polish assets,
can be avoided, reformist elements in Poland can hold
out the hope of some new Western assistance in the
future. Even more, a rescheduling by Western govern-
ments of Poland's 1982 official debt obligations,
and/or acceptance of Poland as an IMF member,
would provide clear signals of support for Polish
policies if these were seen by the West as moving in
the right direction. By the same token, formal default
would probably foreclose these options and would
leave Poland no alternative but to seek even greater
Soviet support and economic integration into the
Soviet Bloc. Although Moscow might welcome these
added restraints on the restive Poles which would
come with a formal Polish default, it would be very
unhappy at the prospect of adding to what it regards
as an already excessive level of economic assistance.
The degree of Western influence on Poland should not
be exaggerated. Western actions cannot affect Po-
land's foreign policies in any significant way, its
military position in the Warsaw Pact, or its funda-
mental political system. Even the politically accept-
able scope of economic reform would be far less in
Poland at this stage than in Hungary. Hungary was
able to undertake a substantial economic decentral-
ization, but only years after Radar had established a
stable political base. By contrast, Poland could expect
any substantial decentralization of economic author-
ity to quickly become highly politicized, and to pre-
sent a major threat to the party's monopoly of politi-
cal power.-
In Romania, as in Poland, the main Western policy
issue is whether or not to reschedule debt service
obligations, and on what terms. A successful resched-
uling will not eliminate Romania's hard currency
problems, which are deep-seated, nor prevent a drastic
slowdown in economic growth. But it could give
Romania some options other than a substantial redi-
rection of its trade from the West toward the Soviet
Bloc. In recent years, some 60 percent of Romania's
foreign trade has been with non-Communist countries
and less than 20 percent with the USSR. Should
Romania be forced to make such a shift, the limited
freedom of action Bucharest has been able to exercise
in its foreign policy will almost certainly be greatly
curtailed. These expressions of Romanian independ-
ence from Moscow, although on largely peripheral
issues, have been useful to the West. On the other
hand, accommodating Romania's economic needs
would involve substantial economic costs to the
USSR.
Hungary has developed broad economic linkages with
the West as well as the CEMA countries and created
a unique amalgam of central planning with elements
of market economy without in any way threatening
the Communist Party's monopoly of political power or
the country's attachment to Moscow in foreign policy.
There are few indications that Moscow has opposed
Budapest's relatively liberal economic policies or
would welcome an opportunity to reverse them. Nev-
ertheless, lack of access to Western credits could force
a sharp curtailment of Hungarian trade with the West
and consequently greater economic dependence on
Moscow. Hungary depends little on government-guar-
anteed credits, but a great deal on medium-term
private credits, and these are highly vulnerable to
changes in market psychology. Membership in the
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IMF would provide both an important new source of
hard currency and a boost to market confidence in
Hungary.
West European Persctflves and Interests
The differences of perspective and interests between
the United States and its European allies concerning
economic relations with the East make it difficult to
find common ground on which to base joint financial
restrictions aimed at the East and thus limits our
ability to exercise that leverage which exists.
The broadest agreement among the allies is in the
private sector. Bankers throughout the West are
concerned about their financial exposure to Soviet
Bloc countries and would like to reduce it. They
consider themselves particularly overexposed in East-
ern Europe but also have become increasingly aware
of the extent of the USSR's long-term hard currency
problem. Moreover, they see the severe worsening of
East-West relations in the past two years or so as
substantially increasing the political risk involved in
any long-term lending to the Bloc.
To some degree the reduction in the East Bloc's
creditworthiness in the private sector is reflected in
the attitudes of Western governments. As mentioned
before, Western governments do not want to be
saddled with the heavy budgetary costs that would be
entailed in a large-scale bailout of private bank
exposure under government guarantees. Moreover,
most Western governments probably agree that they
have excessively encouraged credit to the Bloc in the
past and would prefer to reduce or eliminate the
subsidy element in this lending in the future.
This common ground becomes severely limited, how-
ever, by the following considerations:
Trade with the East is still viewed by the Europeans
as promoting their economic, political, and strategic
interests. West Europeans view this trade as provid-
ing jobs at a time of severe unemployment and as
creating mutual interdependencies which will tend
to limit Soviet adventurism and provide bargaining
chips with Eastern Europe.
They give little weight to the argument that East-
West trade buttresses Soviet military power because
of its small size in the overall Soviet economy and
the long-established priority given to the Soviet
military.
They are even more reluctant to reduce trade with
Eastern Europe than with the USSR because of
their greater bargaining power with the East Euro-
pean countries, the close bilateral economic, histori-
cal and cultural ties with a number of them, and the
belief (or rationalization) that Western influence
can spread through Eastern Europe and eventually
to the USSR.
More precisely, East-West trade plays a small role in
the West European economies but is important to
certain industries. Even for West Germany, which
accounts for about one-fourth of OECD exports to the
Soviet Bloc, sales to the East amount to only about 6
percent of total exports and directly provide jobs for
about 1 percent of the labor force. The relative
importance of trade with the Soviet Bloc increased
sharply in the mid-1970s, but has since been declin-
ing, and is now nearly back to what it was in 1970 (see
table 5).
Nevertheless, the West European countries consider
their trade with the East to be important for both
economic and political reasons:
Although a small part of total trade, trade with the
Soviet Bloc is one of the most important sources of
export earnings from outside the European Commu-
nity. In the case of West Germany and France,
exports to the Bloc about equal those to the United
States and are far larger than exports to Japan.
? About one-half of West European exports to the
Soviet Bloc and the USSR consist of machinery and
steel. The Soviet Bloc, especially the USSR, is an
important market for West European steel and for
some types of machinery. For example, it accounts
for about 15 percent of West German and 12
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Soviet Bloc Share of Western Exports 1970-80
West Germany
5.6
5.6
6.5
7.1
7.7
8.8
7.6
7.1
6.9
6.5
6.3
France
3.6
3.6
3.7
3.7
3.6
5.0
4.9
4.4
3.8
4.1
4.2
United Kingdom
3.1
2.6
2.7
2.5
2.6
2.9
2.6
2.5
2.6
2.3
2.3
Italy
5.3
4.9
4.2
4.4
5.4
6.2
5.3
5.0
4.3
3.7
3.5
Japan
2.3
2.2
2.6
2.2
3.0
3.9
4.2
3.3
3.3
3.2
2.8
percent of Italian steel exports. Some West Europe-
an plants are almost exclusively dependent on the
Soviet Bloc market.
? During the current Western economic recession,
there are few alternative markets for exports to the
Soviet Bloc. The United States and Western Europe
are giving priority to fighting inflation. Many less
developed countries, faced with a massive debt
burden and depressed prices for their primary prod-
uct exports, are forced to curtail imports. Falling oil
revenues are greatly slowing growth of the OPEC
market. Consequently, any source of increased or
sustained demand is important to the West Europe-
ans. Moreover, the steel industry is in secular
decline, so that orders from the Soviet Bloc are
important in cushioning the needed adjustment in
employment and plant capacity.
? Perhaps most important, the Europeans see their
political and security interests best served by in-
creasing economic contacts with Eastern Europe
and the Soviet Union to promote political and
economic stability there and to establish a web of
interdependence between East and West. For West
Germany, moreover, ties with the East are vitally
important in keeping alive the ideal of German
reunification and maintaining a high level of person-
al contacts between West and East Germans.
Although some groups within the West European
countries-such as certain conservative political par-
ties and the military establishments-are sympathetic
to the view that Western exports to the East Bloc have
at least indirectly supported Soviet military efforts,
these particular groups generally have had little say in
trade and credit matters. European business interests
and trade officials have consistently promoted in-
creased trade with the East as has most of the foreign
policy establishment.
For all these reasons the West Europeans look favor-
ably on trade with the East and are reluctant to
restrict this trade except where its specific contribu-
tion to Soviet military strength can be demonstrated.
Among our major allies, West Germany and France
have the strongest economic and political stake in
economic relations with the Soviet Bloc. Italy too has
substantial ties with the Bloc. UK interest is substan-
tially less, however, and Japan's is smaller than that
of any West European country.
The major West European countries have used gov-
ernment-guaranteed credits as an important means of
increasing exports to the Soviet Bloc. These credits
are particularly important in financing exports to the
USSR because a large proportion of those exports are
for major projects, such as gas pipelines and chemical
plants, which require long-term credit financing.
About 30 percent of exports to the USSR, including
the bulk of exports of machinery and steel from the
major West European countries have been financed
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by government-guaranteed credits. At least for the
next few years, the Western governments will face a
dilemma. They are loath to increase an already large
budgetary exposure to bank credits which are seen as
increasingly risky for both economic and political
reasons. On the other hand, they are under pressure at
least to maintain exports to the Bloc by providing
increased credits under government guarantees to
offset the decline in Soviet Bloc access to the private
credit market.
For all these reasons it is highly unlikely that our
European allies will accept any restrictions on govern-
ment credits to the USSR or to Eastern Europe which
would have the effect of forcing sizable reductions of
East-West trade. They may be willing to accept some
sort of de facto ceiling on credits or on debt exposure
and some further reduction in interest subsidies, but
any such agreement is likely to be informal and
flexibly applied.
The European governments are extremely concerned
with preventing a spread of the Polish financial crisis
to the rest of Eastern Europe. They would very much
like to see Poland's and Romania's 1982 debt service
obligations rescheduled and generally would like both
Hungary and Poland to join the IMF. In addition, the
West Germans want to avoid any public discussion of
East Germany's precarious financial position, for fear
that they will have to confront much more openly and
dramatically the inconsistencies between economic
actions designed to maximize contacts with East
Germany and West Germany's key role in the West-
ern alliance and the European Community.
The strong West European views on protecting their
economic ties with Eastern Europe give the United
States some potential leverage with its allies, since
these may be willing to trade off some moderate
restrictions on credits to the USSR in return for some
US cooperation on Polish and Romanian rescheduling
and Polish and Hungarian IMF membership.
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