EASTERN EUROPE'S EXPERIENCE WITH THE IMF

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP86S00588R000300300002-2
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 32
• Document Creation Date: December 22, 2016
• Document Release Date: August 26, 2010
• Sequence Number: 2
• Publication Date: September 1, 1985
• Content Type: REPORT

Directorate of
Intelligence
Eastern Europe's
Experience With the IMF
EUR 85-10158
September 1985
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Directorate of Confidential
Intelligence
Eastern Europe's
Experience With the IMF
This paper was prepared by
the Office of European Analysis. It
was coordinated with the Office of Global Issues
and the Office of Soviet Analysis. Comments and
queries are welcome and may be directed to the
Chief, East-West Regional Economics Branch, East
European Division, Office of European Analysis,
Confidential
EUR 85-10158
September 1985
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Eastern Europe's
Experience With the IMF
Key Judgments The International Monetary Fund (IMF) shepherded Yugoslavia, Roma-
Information available nia, and Hungary through the worst of their debt crises in the early 1980s.
as of l August 1985 The East European members rank among the leading borrowers from the
was used in this report.
Fund, and IMF credits gave these countries breathing room to improve
payments performance. The IMF, however, has had difficulty adapting its
policy guidance to Communist economic systems. Fund programs have not
produced the adjustment needed for these countries to achieve sustained
economic growth without payments problems.
The IMF's inability to attack the root causes of the payments problems
predates the region's recent crisis. Staff assessments during the 1970s
pointed out flaws in these economies that hurt trade performance. Yet the
IMF programs designed to correct balance-of-payments difficulties fo-
cused largely on controlling monetary growth and investment and failed to
prod the regimes to attack systemic weaknesses.
Since the failure of large standby programs given to Romania and
Yugoslavia in 1981, IMF programs have tried to correct inefficiencies in
resource allocation that, the Fund believes, are behind poor export
competitiveness and sluggish growth. Expanded performance criteria have
tried to give greater weight to market incentives-similar to Fund
recommendations for market economies and most Third World debtors.
East European policymakers, however, managed instead to produce trade
surpluses by tightening controls on investment and consumption, foreign
exchange allocation, and imports. Although such controls did correct
payments deficits, we believe the associated distortions have frustrated the
IMF's overriding goal of balanced, sustainable growth.
In our opinion, the changes needed to achieve the Fund's goal presume a
basic economic reform that none of the regimes seems prepared to
implement. The IMF faces the dilemma of either better adapting its policy
prescriptions to the political and economic institutions in these countries or
insisting that the regimes carry out systemic change so that market
instruments will work. The latter option, however, violates the Fund's
charter, which stipulates neutrality on the institutional arrangements of its
members and the Fund's contention that the impetus for systemic change
must come from the member. Moreover, the major reforms required could
involve serious political risks for the leaderships of these countries.
iii Confidential
EUR 85-10158
September 1985
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Although not demanding systemic reform, the IMF's recent programs have
challenged political control of resource allocation and have tried to force
the governments to put economic efficiency ahead of other priorities. The
slight improvement in the three countries' financial positions in the last
year has reduced the willingness of these regimes to accept tough Fund
prescriptions:
? Romania not only terminated its standby program ahead of schedule in
early 1984, but also denounced IMF meddling and reversed many of the
changes made at the Fund's insistence.
? Mounting criticism of the IMF won Yugoslavia some easing of IMF
conditions; Belgrade is pressing for termination of close IMF supervision
after 1985.
? Even Hungary shied away from the thoroughgoing reforms that the Fund
anticipated and chose to forgo a new standby arrangement this year.
The most complicated challenge facing the IMF in Eastern Europe is the
prospective membership of Poland. While most groups in the regime
appear eager for membership as a way to win new credits and a better
credit rating, they seem unready to accept the Fund's conditions:
? The Fund almost certainly will push Poland to improve debt repayment
capacity by curbing consumption, investment, and government spending
to a much greater extent than Warsaw would like. The leadership's
reluctance to acquiesce would stem in part from the almost certain
opposition of much of the population to sweeping new austerity programs.
? Even most regime supporters of membership seem unwilling to consider
basic changes. Regime opponents of the IMF fear diluting the centralism
and greater discipline they believe is necessary for economic recovery.
in Poland.
? The USSR may also complicate IMF dealings with Warsaw. Despite
misgivings about closer Polish involvement with the West, Moscow
apparently approves Polish membership if borrowing from the IMF can
reduce Soviet economic support to Warsaw without risking extensive
economic reforms or political liberalization. Nonetheless, Moscow pre-
sumably has advised Warsaw on the guidelines for negotiations with the
IMF and would intervene if developments seemed to threaten its interests
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Even if agreement is reached, Warsaw's resistance to austerity and basic
reforms, as well as the IMF's problems in coming to grips with centrally
planned economies, will probably result in a program that is inadequate-
if not irrelevant-to Poland's needs. The Poles might try to avoid full
implementation, leaving the IMF and Western governments to decide how
tough they wanted to be in enforcing compliance.
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Key Judgments
Early Relations Between Eastern Europe and the IMF
1
The IMF and the Debt Crisis
4
New Program Conditions
5
Yugoslavia
6
Romania
8
Hungary
9
Has the Fund Made a Difference?
11
Yugoslavia
13
Hungary
14
The Problem of Reform
14
Waning Influence
15
Yugoslavia
15
Hungary
16
Poland: The Looming Challenge
16
Credits and Conditionality
17
Tables
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Eastern Europe's
Experience With the IMF
The financial problems and economic malaise of
Eastern Europe have prompted discussion-in both
East and West-about whether the International
Monetary Fund (IMF) can help the region correct its
economic weaknesses. Improvements in the financial
position of the East European member countries
under IMF programs in 1983-84 suggest to some
observers that the Fund can make a difference.
Others, however, question the linkage between these
gains and IMF policy guidance and doubt the Fund's
ability to correct the region's basic economic prob-
lems.
Early Relations Between Eastern Europe and the IMF
The feasibility of East European countries joining the
IMF has been debated since the establishment of the
Fund in the 1940s. Western critics argued that gov-
ernment monopolization of foreign trade in centrally
planned economies conflicts with the Fund's objec-
tives of promoting the growth of world trade and
eliminating payments restrictions. The East Euro-
peans had reservations about joining an organization
controlled by developed capitalist countries. They
were concerned that the Fund would insist on policies
that conflicted with their economic and political
institutions. Moreover, the East European regimes
were reluctant to provide economic data required by
The IMF's effectiveness in dealing with East Euro-
pean economies assumes particular importance with
the prospective entry of Poland into the Fund. Poland
will prove a difficult challenge, given the magnitude
of its problems and the differing expectations held in
the West and Warsaw about the IMF's role. Western
creditors and some Poles are looking to the Fund to
enforce basic economic reforms-a role that the IMF
may be ill equipped to perform. While Polish financial
officials are counting on IMF credits, important
segments of Polish opinion-ranging from former
Solidarity leaders to regime hardliners-oppose IMF-
mandated austerity.
This paper will assess the IMF's performance in
dealing with East European economic and financial
problems. It begins with a brief look at initial prob-
lems between the Fund and the socialist states, and
then examines the Fund's failure to forestall financial
crises in Yugoslavia and Romania. The paper will
next review the IMF's role in helping its East Euro-
pean members deal with their debt problems in
1982-84, with emphasis on whether tougher standby
programs have produced lasting improvement. The
discussion of future IMF-East European relations
focuses particularly on the problems posed by Poland.
the Fund's Articles of Agreement.
Despite these differences, Czechoslovakia, Poland,
and Yugoslavia became founding members. Although
an active participant in the organizational talks, the
Soviet Union chose not to join. Problems soon arose
with the Fund's two Soviet Bloc members: Poland
withdrew in 1950, arguing that the Fund had become
an instrument of US policy. The withdrawal appar-
ently resulted from Warsaw's failure to supply eco-
nomic data required for credits from the World Bank,
the Fund's sister organization. Czechoslovakia with-
drew in 1955 after the Fund declared it ineligible to
draw credits. Prague had refused to supply informa-
tion justifying sweeping monetary reforms initiated in
1953.
The IMF, nonetheless, remained willing to accept the
East Europeans and rejected accusations that it was
overly supportive of market economic theories. The
Fund contended that, while members are expected to
achieve certain goals, it is strictly neutral on their
institutional arrangements, with its policies paying
"due regard to the domestic social and political
objectives, the economic priorities, and the circum-
stances of members." The IMF argued that it could
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Although the Soviet Union gave no formal reason for
its refusal to join the IMF, the discussions at Bretton
Woods highlighted several basic objections to Fund
procedures:
? Displeasure with the distribution of voting power.
? A desire to pay a lower gold subscription.
? The right to alter its trade and exchange rate
practices independently of Fund approval.
? A refusal to release certain economic information,
especially balance-of-payments statistics and gold
reserves.
Some of these issues eventually were resolved, but
Moscow failed to proceed with membership when the
time arose.
While these objections no doubt played a part, politi-
cal motivations were probably at the heart of Mos-
cow's rejection of Fund membership. Attendees at
Bretton Woods were entitled to become founding
members of the Fund no later than 31 December
1945, a date by which East-West relations were
already chilling. The Soviets decided that the Fund
was merely a front for the United States and its allies
and would use its powers to promote Western poli-
cies.
has probably reinforced Soviet misgivings. Soviet
propaganda regularly denounces the Fund as a tool
used by Western banks and governments to exploit
debt-troubled developing countries. During the past
year Soviet media have criticized sharply the role of
"international financial institutions" in seeking to
solve Eastern Europe's debt crisis.
Why, then, do the Soviets tolerate Hungarian and,
prospectively, Polish membership? As early as the
mid-1970s, Hungary and Poland began exploring
IMF membership, but-unlike the Romanians-
these regimes did not ignore Moscow's opposition.
The USSR finally gave the green light in 1981
probably because it perceived the region's growing
financial difficulties and did not want to shoulder the
burden. Moscow presumably could swallow its objec-
tions as long as the West was willing to pump several
billion dollars into the region and the regimes did not
consent to extensive changes in policy. Moscow prob-
ably realizes by now that IMF membership does not
threaten Communist rule. Romania's 12-year mem-
bership has in no way diluted Ceausescu's near
Stalinist control of the economy. Hungary's reform
movement-while probably abetted by Fund guid-
ance-was initiated well before it joined the Fund
Moscow's basic view of the Fund has probably not
changed much in the intervening years. Indeed, the
Fund's recent tougher approach on lending conditions
better promote international monetary cooperation
and world financial stability by allowing all countries
to become members.
A Hands-Off Policy
The conditions attached to IMF loans to Yugoslavia
during the 1960s and 1970s and to Romania, which
joined the Fund in 1972, did not address the root
causes of external imbalance. Most of the borrowings
were reserve and first credit tranche drawings that
impose minimal conditions on economic policy (see
table 1 in appendix). Belgrade and Bucharest also
and has not weakened the party's control.
borrowed from the compensatory financing and oil
financing facilities. These borrowings entailed limited
conditions because they were to cover supposedly
temporary financial gaps caused by developments
beyond government control-OPEC oil price hikes,
Western recession, poor weather, and even earth-
quakes. Where the IMF saw the need for adjustment
of the domestic economy, it focused almost exclusively
on measures aimed at restraining investment and
imports. Little attention was given to changing the
mechanisms by which resources are allocated within
these economies.
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IMF Adjustment Programs
IMF adjustment programs for Eastern Europe have
followed the format typical for any Fund member.
The IMF sets conditions for the use of its credits to
help ensure.that the country overcomes its balance-
of-payments problems within a reasonable period of
time and can sustain financial equilibrium without
continued reliance on the Fund. At least until recent-
ly, the Fund focused almost entirely on fiscal, mone-
tary, and exchange rate measures aimed at balancing
domestic demand with available resources.
The starting point for the development of an adjust-
ment program is an estimate of how large an im-
provement in a country's current account is required
and over what period of time. This estimate depends
on an assessment of the likely inflow of foreign
capital. Once the Fund has established a current
account target, it considers the level of domestic
demand that can be sustained while bringing about
the necessary improvement in foreign trade perfor-
mance. Domestic expenditures must be reduced in
order to lower demand for imports and to free up
more production for export. A Fund adjustment
program aims to cut purchasing power primarily by..
? Controls on wages to lower real household income
and consumption.
? Controls on aggregate credit to lower investment.
? Increases in taxes and reduction in government
spending both to reduce government demand direct-
ly and to reduce government pressure on credit
markets.
? Decreases in the rate of growth of the money supply
to control inflation.
These expenditure-reducing policies are usually ac-
companied by substantial devaluation of the domestic
currency to encourage exports and discourage im-
ports.
The Fund has begun to pay somewhat greater atten-
tion to "supply-side" policies in recent years because
its traditional demand-oriented approach seemed to
have an excessively depressive effect on economic
growth. Fund programs have focused increasingly on
measures to improve resource allocation and produc-
tivity, especially by encouraging greater reliance on
price mechanisms. The IMF has tried to promote
greater efficiency by recommending liberalization of
trade and payments practices and by pressing for the
elimination of subsidies and controls on prices.
The Fund's policy advice is contained in the program
negotiated with the country seeking access to Fund
lending. The first section of the program contains the
so-called performance criteria. These criteria always
include commitments that prohibit the borrower
from:
? Imposing or intensifying restrictions on payments.
? Introducing or modifying multiple currency
practices.
? Concluding bilateral payments agreements that are
inconsistent with the Fund's articles.
? Imposing or intensifying import restrictions.
In addition, the programs contain "quantitative"
performance criteria that typically set targets for:
? Domestic lending by the banking system.
? Gross convertible currency reserves.
? Short-term foreign debt.
? Trade or current account balances.
These targets have to be met-either on a quarterly,
semiannual, or annual basis-in order for the mem-
ber to maintain access to IMF credits.
The second section of the program contains the letter
of intent drawn up by the borrowing country, usually
with the advice of Fund staffers. The letter reiterates
the quantitative targets to be met over the duration of
the program and outlines the policies the country
plans to adopt to achieve the targets. These policy
understandings may involve fiscal reform, investment
reform, price liberalization, and incomes policies.
Unlike the quantitative performance targets, however,
compliance with policy understandings is generally
not binding on the borrower.
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Yugoslavia's borrowing put Belgrade among the top
users of IMF credits during the 1960s and early 1970s
(see table 2 in appendix). Fund lending-particularly
several small standby loans-helped reassure Western
bankers when payments imbalances arose, in part as a
result of the implementation of major decentralizing
reforms. Belgrade's financial problems, however, were
seen as only temporary disequilibriums that could be
corrected by controls on domestic demand.
The IMF began to give more attention in the late
1970s to institutional weaknesses as a cause of Yugos-
lavia's growing payments deficits. The Fund's recom-
mendations, however, continued to focus on limiting
the expansion of credit, which the IMF saw as the
basic cause of Yugoslavia's excessively high rate of
investment and worsening inflation. The programs did
not address the systemic causes of balance-of-
payments problems:
? The highly decentralized political and economic
system that allowed regional authorities to pursue
policies of autarkic development resulting in irratio-
nal and redundant investment, subsidization of inef-
ficient enterprises, and protection of local
monopolies.
demonstrate its independence from Moscow. Romania
also was interested in the financial benefits to support
its growing trade with the West, although it drew few
credits in the first years of membership (see table 3 in
appendix). Two standby credits drawn in 1975 and
1977 were second tranche loans not subject to tough
conditions. The performance criteria focused merely
on domestic credit and external payment indicators.
As the first Soviet Bloc member since the 1950s,
Romania received kid-glove treatment. The Fund
allowed Bucharest to skip much of the data submis-
sion required of members and did not even insist on
the statistics typically demanded when a country
applies for IMF credits. The standby programs did
nothing to correct the regime's overly ambitious in-
dustrialization program, which was making the coun-
try increasingly dependent on imported materials and
energy, weakening agriculture, and undermining
trade performance.
? The lack of a capital market to ensure efficient
allocation of investment and foreign exchange.
? Limited control by central authorities over govern-
ment spending and taxation.
? The wage-price spiral embedded in the worker self-
management system.
Since the Fund would not question a member's politi-
cal and economic institutions, staff assessments at this
time did little more than urge better policy coordina-
tion between Belgrade and the republics. Moreover,
the IMF's leverage on Yugoslav economic policy was
limited because the growth of Western official and
commercial lending had reduced Belgrade's need for
Fund loans in the late 1970s.
Romania is an even clearer example of the IMF's
failure to attack the root causes of payments prob-
lems. Bucharest joined the Fund largely to
The IMF assumed greater importance in Eastern
Europe with the onset of financial crisis in the early
1980s. Poland's slide toward insolvency, as well as
deteriorating East-West relations, prompted Western
bankers to take an increasingly hard look at East
European creditworthiness. The rapid buildup of debt
by Yugoslavia and Romania in the late 1970s put
these countries in a particularly poor light. The
bankers responded with an increasingly rapid with-
drawal of credit.
The IMF tried to offset the loss of bank lending in
hopes of giving Yugoslavia and Romania time to
improve their trade performance and regain the confi-
dence of Western bankers. Yugoslavia was granted
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one-year standby loans in 1979 and 1980 and a
compensatory financing credit in 1980. Romania also
received a compensatory financing loan in 1979. Both
Belgrade and Bucharest adopted austerity programs,
including sharp reductions in imports, but they could
not improve their trade and current account balances
enough to counter the loss of capital inflows-even
with the IMF credits. As the financial position of both
countries deteriorated, the Fund moved to larger and
longer term programs. In early 1981 Yugoslavia and
Romania were granted three-year standby facilities
(see table 4 in appendix).
Although these credits were upper tranche drawings,
the IMF did not impose significantly tougher perfor-
mance criteria. The Fund continued to focus mainly
on controlling monetary growth through limits on
domestic credit and foreign borrowing, as well as on
targets for the trade balance, current account balance,
and international reserves.
The programs quickly proved inadequate to avert
financial crisis. The Fund had overestimated both the
amount of likely bank lending to both countries and
the improvement in current account performance the
IMF programs would produce. In Romania's case,
bankers were not reassured by the Fund's standby
program and continued to withdraw short-term credit
lines. By late 1981, Romania was trapped in a serious
liquidity crisis and found unpaid obligations mount-
ing. With arrears a violation of the IMF charter, the
Fund suspended drawings under the standby only a
few months into the program.
The Fund realized that its efforts would not restore
Romania's financial health. Bucharest's relations with
foreign creditors had sunk so low that bankers were
unlikely to resume normal lending soon. The IMF
persuaded Bucharest that rescheduling was the only
solution-a difficult task given the regime's fear of
being labeled a "second Poland." The IMF's advice
and expertise proved invaluable in concluding agree-
ments with Western banks and governments, especial-
ly given the inexperienced and incompetent Romanian
negotiators.
Yugoslavia's standby program proved nearly as unsat-
isfactory as Romania's. Continuing current account
deficits and missed payments by some Yugoslav banks
in early 1982 led to a precipitous decline in Western
bank lending. At the Fund's prodding, Belgrade
attempted to recentralize control over foreign ex-
change to manage its dwindling reserves, but by the
end of the year Yugoslavia's reserves had fallen to less
than a month's worth of imports, and arrears were
building.
In response to Belgrade's alarming financial position,
the IMF pressed Western governments and banks to
adopt a financial rescue plan. The Fund's role in
assembling the package and providing its seal of
approval was critical in gaining both Yugoslav accep-
tance of tougher performance criteria in 1983 and a
commitment by creditors to reschedule maturing
loans and extend new credits
The debt crisis helped push Hungary to join the IMF.
Budapest applied to the Fund in late 1981, when its
payments position was weakening due to poor export
performance and rising interest payments on its debt.
By the time of its entry in May 1982, Budapest had
survived-with help from Western central banks and
the Bank for International Settlements (BIS)-the
worst of a severe liquidity crisis brought on by the
sudden withdrawal of over $1 billion in short-term
credits by Western, CEMA, and OPEC banks.
Hungary immediately sought IMF assistance because
the BIS loan required the adoption of an IMF standby
program, and because Fund support was essential to
restoring Budapest's standing with commercial banks.
Hungary drew its reserve tranche and received a
compensatory financing credit as well as a 13-month
standby arrangement in December 1982 (see table 5
in appendix).
New Program Conditions
The East European debt crisis took the Fund by
surprise because it failed to anticipate the loss of
confidence in the region by bankers, following
Poland's financial collapse. Reschedulings for Roma-
nia and Yugoslavia coming on the heels of large,
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multiyear standby arrangements left the Fund open to
criticism. Bankers-who to some extent made the
Fund a scapegoat for their own mistakes-denounced
"soft" IMF programs for Eastern Europe, arguing
that the Fund's policies reflected glaring misunder-
standings of the region's economic systems.
The Fund reacted to the failure of its Romanian and
Yugoslav programs by taking a closer look at planned
economies, and it developed some new thoughts on
adjustment and conditionality:
? The Fund concluded that performance criteria fo-
cusing on fiscal policies pay few dividends in East
European adjustment programs. These regimes do
not use deficit financing, and tax policies play little
role in the control of consumption or investment.
Nonetheless, the Fund recognized the need to re-
duce central budget subsidies to both consumers and
enterprises in order to rationalize prices and force
greater financial discipline.
? The Fund continued to believe that monetary policy
can promote adjustment by controlling credit ex-
pansion and the tendency of socialist economies to
invest at extremely high rates.
? The Fund acknowledged, however, that reliance on
monetary policy alone cannot correct problems of
inefficient resource allocation in these economies.
While controls on domestic credit and foreign bor-
rowing can reduce the overall amount of investment,
they do not ensure that economically efficient pro-
jects are protected at the expense of undesirable
ones. The lack of rational pricing for capital, foreign
exchange, labor, and goods means that the estab-
lished pattern of resource allocation will persist even
with reduced inputs. With no movement toward
greater efficiency, constraints on demand to im-
prove the balance of payments simply lower output.
Standby programs over the past two to three years
have begun to reflect the Fund's judgment that
performance criteria must address microeconomic dis-
tortions as well as demand restraint. The more recent
East European programs have called for:
? Reducing price subsidies and lifting price controls.
? Raising artificially low interest rates.
? Adjusting exchange rates to balance the supply and
demand for foreign exchange and to enhance export
competitiveness.
? Reducing trade restrictions that protect domestic
industries from import competition and prevent the
sale of exportable goods to foreign markets.
? Increasing wage differentials to reflect productivity
and enterprise profitability.
The Fund also has begun to press for tougher finan-
cial discipline on enterprises through reductions in
price, credit, and budget subsidies and enforcement of
bankruptcy laws. As long as enterprises can contin-
ually operate at a loss and default on obligations to
domestic creditors, rational prices will not promote
improved resource allocation.
The shift in focus of IMF programs has coincided
with growing tensions between the Fund and the
debtor countries. To some extent, the gradual im-
provement in the financial positions of these countries
since 1982 has reduced their tolerance of Fund guid-
ance. But the reasons for complaints about IMF
meddling are more deep seated. The Fund's growing
interest in correcting systemic weaknesses threatens
the power of political leaderships to control allocation
of resources and gives primacy to economic efficiency
over the traditional sociopolitical concerns of East
European governments.
Yugoslavia
The IMF's new approach to Eastern Europe is most
evident in its programs for Yugoslavia. The Fund
toughened its stance in the final year of the 1981-83
standby agreement. In addition to controlling domes-
tic demand through tighter limits on credit and
government spending, the performance criteria called
for monthly devaluations of the dinar and price hikes
in transportation, housing, and energy. The large
cutback in domestic demand and import rationing
produced a significant gain in trade and current
account performance, but output declined (see
figure 1). Some of this downturn was unavoidable, but
it also reflected the inflexibility and ineffectiveness of
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Figure 1
Yugoslavia: Economic Indicators, 1980-84
imports
Hard currency
exports
Current account
balance
1
-12 1980 81 82 83 84
Private
consumption
Gross fixed
investment
mechanisms for resource allocation, particularly for
moving capital and foreign exchange to export sectors.
Because of the shortcomings in 1983 performance, the
1984 standby program moved harder against distor-
tions in the Yugoslav economy. Performance criteria
were expanded to include:
? A lifting of the general price freeze with at least
55 percent of producer prices to be market deter-
mined and higher prices for those items still under
federal control.
? Monthly adjustments in nominal exchange rates to
achieve effective real devaluation between the dinar
and the currencies of Yugoslavia's main Western
trading partners.
? Quarterly increases in interest rates to achieve
positive real interest rates by April 1985.
? Limits on wage hikes, with harsher terms applying
to workers in unprofitable enterprises.
? Limits on support payments to insolvent enterprises.
Yugoslavia's success in restoring economic growth in
1984 and increasing its current account surplus
through export growth led the IMF to conclude that
this program had finally put Belgrade's adjustment
effort on the right track.
The Fund's decision to target distortions in the Yugo-
slav economy provoked a deterioration in relations
with Belgrade. As long as adjustment programs had
centered on monetary policy, the Fund's prescriptions
were consistent with Yugoslavia's traditional use of
credit controls to regain balance. But once the Fund
began pushing for greater use of market forces, it was
challenging the decisionmaking prerogatives of Yugo-
slav politicians and the regime's priorities.
The debate between Belgrade and the Fund has
centered on the impact of the recent criteria on
inflation, enterprise solvency, and output. Yugoslav
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critics contend that freeing prices, devaluing the
dinar, and raising interest rates are responsible for
Yugoslavia's inflationary spiral. Increases in the con-
sumer price index have risen from 30 percent in 1982
to more than 70 percent in early 1985. The Fund's
view is that the costs of a temporary acceleration in
inflation due to the program's conditions are more
than offset by the long-run benefits from improved
resource allocation and better incentives for export.
The high inflation rate reflects impediments caused
by fragmented markets that limit the economy's
responsiveness to changing prices. The IMF acknowl-
edges that a solution to these basic problems must
address sensitive social and political issues, but insists
that structural changes must be made if the economy
is to regain growth with external balance and ease
inflationary pressures. Gains in exports and improved
trade balances have been small comfort, however, to
Yugoslav politicians who are more concerned about
growing dissatisfaction at home over their failure to
reduce inflation and protect household incomes.F_
Yugoslav critics of the IMF have argued that reduc-
ing the subsidies to enterprises provided by negative
real interest rates would weaken the already precari-
ous solvency of many enterprises. This would produce
substantial losses in output and employment and
widen economic disparities between the relatively
prosperous North and the poorly developed South.
The Fund countered that the costs in lost output from
reduced investment would be minimized if interest
rates allocated capital to projects offering the highest
return. Administrative controls on credit can reduce
investment to promote stabilization, but regional
powers can still protect pet projects and squander
resources on inefficient ventures. By trying to use
interest rates to ration credit and enforce financial
discipline on enterprises, the IMF has challenged
Yugoslavia's priority system for investment decisions
and threatened to suppress the use of political criteria
in allocating resources among competing projects and
regions.
Belgrade's objections paid off in some easing and
simplifying of performance criteria in the 1985-86
program. Even though the intent of the new program,
is to deal more with supply
problems than demand restraint, the performance
criteria have returned largely to fixing macroeconom-
ic targets rather than influencing microeconomic deci-
sions. For the most part, the current criteria resemble
those of earlier programs, which emphasized limits on
public-sector expenditures, monetary growth, and for-
eign borrowing. Even these criteria have been loos-
ened to allow for some growth in investment, which
the Fund believes is necessary to upgrade the aging
capital stock. Criteria in the 1984 program on price
liberalization, subsidies, and wage hikes in unprofit-
able enterprises have become less binding policy
understandings; only the achievement of positive real
interest rates has remained a specific target. Apart
from Yugoslav demands for a simpler program, the
easing of conditions reflects the Fund's judgment that
Yugoslav policies have begun to shift resources to-
ward more efficient uses-and particularly toward
export sectors. Specific criteria are no longer needed,
provided Belgrade keeps to the policy understandings.
Nonetheless, the IMF has made it clear that it will
monitor closely Yugoslavia's compliance.
Romania
The IMF began pressing the Romanians harder than
before for policy changes when it reinstituted the
suspended 1981 standby arrangement in late 1982.
The Fund demanded price increases and exchange
rate adjustments, including increased energy prices,
the gradual merging of the commercial and noncom-
mercial exchange rates, and the pegging of the leu to
a basket of Western currencies. In the letter of intent
Bucharest also stated that it would conduct four
detailed studies on further changes in prices and
exchange rates, and on future policies regarding
interest rates and investment policy.
Romania achieved an impressive improvement in its
hard currency current account in 1982-83, but the
gain was based on a sharp curtailment of imports
which depressed economic growth (see figure 2). Con-
cerned over this trend, the Fund pressed Bucharest for
additional policy action: further devaluations, in-
creases in interest rates to ensure the selection of
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Figure 2
Romania: Economic Indicators, 1980-84
Hard currency
exports
Hard currency
imports
Current account
balance
Gross fixed
investment a
Private b
consumption
-6 1980 81 82 83 84 -12 1980 81 82 83 84
aBecause of the large distortion in official indexes, we have less confidence in the estimates
for Romania than for the other countries.
b Romania has ceased publication of data needed for the calculation of consumption after 1983.
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efficient investment projects, and increases in crude
oil prices to reduce domestic consumption and to
stimulate production.
The Ceausescu regime, however, balked at the IMF
guidance and refused to conduct the studies stipulated
in the letter of intent. Bucharest had grown weary of
IMF involvement in economic decision making and,
with its external position improving, felt that compli-
ance with more demands was unjustified. The Fund,
with Bucharest's agreement, canceled the last year of
the standby arrangement in early 1984.
Romania's estrangement from the Fund deepened
following termination of the program. The regime
reversed earlier actions on devaluation and reduction
of multiple exchange rates. In the Fund's view, these
decisions-coupled with Bucharest's continued tight
controls over imports and exports-have undone the
regime's earlier small steps toward balanced adjust-
ment. In his speech to the Romanian Party Congress,
Ceausescu denounced the IMF and called on the
Fund to cease imposing political and economic condi-
tions as the basis for its lending.
Hungary
The IMF's dealings with Hungary have been more
placid than those with Yugoslavia and Romania, but
the Fund has taken an increasingly critical stance on
Budapest's efforts to correct systemic problems. Dur-
ing the honeymoon phase, the Fund accepted almost
uncritically the regime's adjustment policies and re-
form program. But the IMF began to look harder at
Budapest's management once it became clear that the
stabilization efforts were falling short of the mark and
the reform proposals promised more than they deliv-
ered.
The overriding priority in the IMF's first program for
Hungary was to help Budapest overcome its liquidity
crisis. The focus was on controlling demand to achieve
a large improvement in the current account rather
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Figure 3
Hungary: Economic Indicators, 1980-84
1
-6 1980 81 82 83 84
Hard currency
exports
Hard currency
imports
Trade balance
Current account
balance
1
-12 1980 81 82 83 84
than on correcting underlying economic weaknesses.
The Fund endorsed the regime's stabilization pro-
gram, which has been implemented since 1978, with
specific performance criteria aimed only at control-
ling the growth of the money supply and foreign debt.
Budapest pledged to place stricter controls on real
incomes and investment, higher interest rates, and a
more active exchange rate policy. Rather than estab-
lish specific criteria, the IMF merely monitored per-
formance against Budapest's own targets for reduc-
tion of expenditures. The regime stated that it would
pursue its program of economic reform. The Fund
welcomed this intention-but apparently had no input
into the specific measures-and merely noted that
Budapest should eventually deal with such distortions
as import controls and subsidies.
The 1983 program proved only a limited success (see
figure 3). The improvement in hard currency trade
and current account performance was less than antici-
pated largely because investment and consumption
did not decline as much as planned. Because of the
program's shortfall and the large debt repayments
facing Hungary, the Fund insisted on somewhat
tougher conditions in the 1984 program. The perfor-
mance criteria expanded controls over credit-in par-
ticular, lending to support state investments-and
over enterprise use of retained earnings. While the
thrust of the program remained demand restraint, the
Fund stressed that Budapest had to do more to
increase supply in order to restore economic growth.
The Fund applauded Budapest's commitment in the
letter of intent to reduce wage controls, increase wage
differentiation, free more prices, and cut subsidies;
nonetheless, the Fund urged the Hungarians to move
beyond these policy understandings in the areas of
wage determination, market-determined prices, and
banking reforms.
Budapest's financial and economic health improved in
1984. Economic growth resumed, and Budapest at
least maintained its current account surplus. Western
lender confidence revived sufficiently to produce a
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sizable inflow of loans and an increase in foreign
exchange reserves. The Fund declared that Hungary
was well enough off to forgo further support upon
completion of the 1984 program.
The IMF's explanation for not extending further
standby assistance masks friction with Budapest over
the stabilization and reform effort. With the worst of
the financial crisis over, the IMF contended that
further cuts in investment and income in the socialist
sector were no longer appropriate. The Fund noted
that the longer run problems from reduced investment
could be lessened by ensuring that scarce capital is
not wasted on inefficient projects. The appraisal
criticized the lack of rational pricing and of financial
responsibility of enterprises, which frustrated efforts
to improve efficiency. Sustaining the improved finan-
cial position and growth required new policy instru-
ments to manage demand, as well as a stronger role
for market forces to promote efficiency and productiv-
ity. The IMF urged the Hungarians to:
? Expand enterprise authority over the determination
of wages and prices.
? Intensify competition by reducing subsidies to loss-
making firms, eliminating most controls on imports,
and expanding the foreign trade rights of
enterprises.
? Introduce tax reforms which would provide better
control over rapid increases in consumption result-
ing from the buoyant growth of income in the
private sector.
? Improve incentives by widening wage differentials.
? Pursue a more flexible exchange rate policy.
While Budapest addressed some of these issues in the
reform program for 1985-90 approved by the Party
Central Committee in April 1984, the IMF's guid-
ance went beyond what the regime was willing to
implement.
The Hungarians asked for IMF financial support for
1985 and beyond to facilitate implementation of its
reform program. The Fund was sympathetic to the
need for standby assistance should adoption of new
reforms produce temporary disequilibrium in the
economy and external finances. The IMF, however,
faulted the Hungarian proposals for the slow pace of
implementation and excessive exceptions and loop-
holes that watered down the thrust of the reforms.
The Fund complained that the package of measures
planned for 1985 had been scaled back from earlier
discussions, and, as a result, there would be little
impetus toward greater efficiency, exports, and out-
put. Moreover, the Fund was unhappy with Buda-
pest's protection of consumption at the expense of
investment in its adjustment policies. The IMF called
upon the Hungarians to place tighter controls on the
growth of income in the booming private sector and to
adopt a more thorough program of reform, or do
without IMF credits. Buoyed by its strengthened
financial position, Budapest chose to do without the
IMF's support.
The financial positions of Yugoslavia, Hungary, and
Romania improved under IMF programs, in some
cases far more dramatically than even the Fund had
anticipated. Each of the countries moved its current
account balance from deficit to surplus. Romania and
Yugoslavia negotiated debt refinancing arrange-
ments, while Hungary restored its creditworthiness
sufficiently to resume large-scale borrowing from
Western banks. While important in repairing
creditor-debtor relations, the IMF's guidance does not
seem to have done much to ensure that these gains
will be long lived.
The IMF's major contribution to Eastern Europe has
been arranging reschedulings and new credit pack-
ages. Direct lending by the IMF and World Bank plus
new credits extended by commercial banks at the
IMF's insistence totaled nearly $6 billion in 1982-84.
The three East European countries rank among the
leading users of IMF credits although only Yugosla-
via has used more than half its credit limit with the
Fund (see table 6 in appendix). These loans covered
over half of the borrowing requirements for Yugosla-
via and Romania. Although IMF and World Bank
credits covered a smaller share of Hungary's financ-
ing requirements in 1982-84, Budapest could not have
raised the nearly $2 billion in Western bank loans
needed to avoid rescheduling without the Fund's seal
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Eastern Europe and the World Bank
The World Bank is a multilateral lending institution
whose long-term credits are to promote economic
development. While IMF lending and programs tradi-
tionally have focused on correcting short- to medium-
term payments problems, the World Bank has con-
centrated on lending to specific projects that are
designed to augment long-term capital inflows. Over
the years, however, the distinction between the World
Bank and the IMF has blurred. While the Fund's
goals have led it to delve increasingly into matters of
microeconomic efficiency-such as investment priori-
ties and pricing policies-the World Bank has
realized that it must deal with long-term balance-of-
payments problems that threaten economic develop-
ment. Thus, the Bank's mission has begun to overlap
with the Fund's to the point that the Bank now
extends "structural adjustment loans, " or credits
specifically designed to help countries with balance-
of-payments difficulties.
The three East European members of the World
Bank have made extensive use of its lending
programs:
? Yugoslavia has drawn on World Bank credits more
than the other two, and indeed has been one of the
largest users among the Bank's 144 members. It
has received 83 loans worth nearly $4 billion during
its 30 years of membership. At present, the Bank's
outstanding commitments to Yugoslavia account
for over 4 percent of the Bank's loans, placing
Belgrade among the top 10 borrowers. While the
vast majority of the loans have been project loans
for agriculture and export industries, Belgrade was
awarded a structural adjustment loan for
$275 million in 1983. Conditions for this loan
included tightening investment allocations, espe-
cially in energy, and undertaking jointly with the
IMF a study on improving foreign exchange alloca-
tion. In addition, Yugoslavia has made some use of
credits provided by the International Finance Cor-
poration (IFC), an arm of the World Bank whose
purpose is to promote development of the private
sector. Loans worth almost $360 million have been
offered to 18 different projects since Belgrade
joined this organization in 1970.
? Romania has received 33 project loans worth about
$2.2 billion since it joined in 1972. The projects
have covered transportation, agriculture, energy,
and export industries. Use of the Bank's resources
tapered off after 1982 as Bucharest sought to
reduce its hard currency debt. Romania, however,
has now decided to seek new borrowing from the
Bank and recently submitted several project
proposals.
? Hungary has already received seven project loans
worth $689 million since joining in July 1982.
Moreover, Budapest has taken advantage of the
Bank's promotion of cofinancing loans to obtain
additional commercial bank financing for the pro-
jects. Syndications for these projects have brought
in $1.3 billion, of which the World Bank has kicked
in an additional $118 million. In 1985 Hungary
joined the IFC and the International Development
Association (IDA), a World bank affiliate that
provides very-long-term, low-cost project loans to
the poorest developing countries. Hungary is look-
ing to the IFC to provide funding-potentially
through joint ventures with Western commercial
banks-to its private enterprise sector, particularly
in agriculture. Budapest is interested in using the
IDA as a vehicle to bid on projects in the Third
World.
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of approval. This financing enabled the three coun-
tries to avoid default and offered them breathing
room to achieve external balance without crippling
austerity-an opportunity Romania chose to ignore.
Even though IMF programs have given more scope to
market forces in Yugoslavia and Hungary, East Euro-
pean policymakers continue to allocate resources
largely through administrative measures. The East
Europeans responded to the need for trade surpluses
after 1981 by tightening direct controls on investment
and consumption, foreign exchange allocation, and
the level of imports. Hungary, Yugoslavia, and Roma-
nia negotiated programs with the Fund in order to
obtain credits, but the truly effective measures were
those that the regimes would have employed without
the Fund. The Fund's policy measures were neither
necessary nor sufficient to produce adjustment within
these economies. Moreover, the Fund does not seem to
have made much headway in correcting the inefficien-
cies and distortions of these systems.
Yugoslavia
The IMF apparently believes that its policy guidance
has produced the most change in Yugoslavia. The
improvement in hard currency trade and current
account balances coupled with revival of economic
growth in 1984 convinced the IMF that its program
had helped Yugoslavia achieve a "watershed." In the
IMF's view, its recommendations have started to
promote greater efficiency and to shift resources to
export sectors.
These gains, however, do not seem deeply rooted. The
major improvement has been a more realistic ex-
change rate that has helped boost Yugoslav exports. It
is unclear, however, whether growth in export indus-
tries reflects a movement of resources in response to
prices or administrative allocation of needed imports
to this sector. The interaction of supply and demand is
determining a greater share of prices, and movements
in interest rates and exchange rates are more fully
reflected in prices. Nonetheless, the persistent prob-
lem of inflation indicates that excessively fragmented
and protected markets are still preventing goods,
capital, labor, and foreign exchange from moving to
their most efficient uses. Moreover, the regime's bias
toward repressing inflation rather than dealing with
the underlying causes-as seen in the partial reimpo-
sition of controls in early 1985-continues to limit the
effectiveness of prices in allocating resources.
Yugoslavia has not made much progress in moving
capital and labor out of inefficient uses into more
productive sectors. The IMF's effort to restrict wage
hikes in money-losing firms in order to encourage
workers to move elsewhere has been undercut by
numerous loopholes and exceptions. The effort to
impose tighter financial discipline on enterprises by
reductions in subsidies and tougher application of
bankruptcy laws has been similarly weakened. Pro-
posed legislation on banking and foreign exchange
gives little reason to expect the establishment of
efficient, integrated capital markets. In the absence of
such markets, the authorities will continue to rely on
direct intervention and subsidies to allocate invest-
ment resources and foreign exchange. Without more
progress in removing the impediments to the move-
ment of inputs, the recent policy changes could be
short lived and the progress with adjustment reversed.
Romania
The policies advocated by the IMF were totally
irrelevant to economic decision making in Romania.
Romanian enterprises have little power over pricing,
their financial position, and investment, which means
that changes in real variables must come through
modifications in the central plan. There is little
evidence that plan provisions were adapted to the
IMF-mandated increases in domestic and export
prices. Through controls on profits and selective tax
relief for enterprises, Bucharest largely neutralized
the impact that the devaluations, increases in interest
rates, and hikes in energy prices could have had on
incentives for production, exports, and the efficient
use of inputs. The fiscal and monetary targets set by
the Fund had little effect on economic activity since
the financial plan was drawn up in conjunction with
the economic plan and was designed to accomodate
rather than influence the targets for production,
investment, and consumption.
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Bucharest improved its hard currency trade and
current account performance by imposing draconian
cuts in imports and diverting much domestic produc-
tion-particularly of food and energy-to exports.
This has cut living standards drastically and appar-
ently damaged the economy's growth potential.
Hungary
Budapest's failure to meet the minimal performance
criteria and policy understandings negotiated with the
Fund is strong evidence that the 1983-84 programs
did little to improve the efficiency and competitive-
ness of the Hungarian economy. Control over invest-
ment was achieved largely through licenses and credit
allocation rather than interest rates. As a result,
cutbacks have been general rather than selective,
slowing completion of all projects rather than elimi-
nating the least efficient. To control consumption, the
regime has imposed tight constraints on wages in the
socialist sector in preference to reductions in consum-
er subsidies and control over incomes in the private
sector. These policies seem to have distorted the
allocation of labor and to have caused losses in
productivity. Hungary's disappointing export perfor-
mance-despite repeated devaluations of the forint-
suggests that the response of enterprises to changing
prices remains weak.
The limited impact of the Fund's market-oriented
prescriptions reveals the fundamental dilemma facing
the IMF in Eastern Europe. The IMF must either
adapt its advice to the economic institutions in these
countries or insist that the countries carry out system-
ic change so that market instruments will work. While
administrative controls can be effective in meeting the
Fund's primary requirement of correcting payments
deficits, the associated inefficiencies can frustrate the
goal of sustainable growth. The changes needed to
deal with this problem, however, are long term and
affect the basic organization of these systems and how
they function. They go beyond the scope of IMF
adjustment programs and conflict with its commit-
ment to work within the member's institutions. F
The Fund, nonetheless, has tended to develop a
symbiotic relationship with supporters of reform with-
in the economic leaderships of Hungary and Yugosla-
via. The Fund, for its part, appeals to domestic reform
prosposals as a source of legitimacy for its policy
recommendations, while maintaining the official posi-
tion that it did not tell the government what to do, but
rather accepted a program proposed by the govern-
ment. The advocates of reform within the regimes, for
their part, appeal to the need to meet the Fund's
conditions in their effort to push forward desired
reforms. In Hungary, the Fund has worked closely
with reformist elements within the National Bank of
Hungary, and its staff assessments have urged gov-
ernment adoption of this group's program. In Yugo-
slavia, the Fund has linked its recommendations to
the Kraigher Commission report-adopted by the
Yugoslav government in late 1983-which came
down strongly for reforms establishing national capi-
tal and foreign exchange markets, market-determined
prices, and a reduction in ad hoc political intervention
in economic decision making.
The Fund, however, has been frustrated in its efforts
to get the regimes to move fast and effectively in
correcting systemic flaws. The regimes may accept
Fund guidance to deal with an immediate financial
crisis, but the major reforms needed to correct sys-
temic problems could involve serious political risks for
the leaderships in these countries. Decisions on basic
reform are made in the political arena where the
influence of the IMF and its regime allies appears
limited.
The Fund thus confronts the task of better adapting
its policy recommendations to the mechanisms by
which economic decisions are made.
adjustment programs must look more closely at plan
objectives, particularly at variables affecting invest-
ment, output, and, ultimately, foreign trade results.
Nonetheless, staff assessments of the East European
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market forces in resource allocation.
economies still show a strong bias toward the use of
Yugoslavia's payments position weakened.
The IMF's influence in Eastern Europe seemingly has
waned over the past year with termination of the
Romanian and Hungarian standby arrangements.
The possibility of Yugoslavia replacing its standby
with a less rigorous monitoring arrangement next year
suggests further diminution of the Fund's role. This
trend, however, could be quickly reversed. The exter-
nal payments performance of both Romania and
Hungary has been poorer than anticipated so far in
1985, and either or both regimes may request new
standby arrangements. Even if Belgrade succeeds in
ending standby supervision, the creditors probably
would be quick to demand renewed IMF guidance if
scheduling agreement.
Yugoslavia
In its negotiations for a multiyear rescheduling agree-
ment with Western banks, Belgrade has demanded
enhanced Article IV consultations in place of a
standby agreement after April 1986.' The regime sees
this as a way to respond to domestic criticism of IMF-
mandated austerity and to reduce the Fund's leverage
to demand changes in the economic system. Belgrade
has argued that its improving economic and financial
performance entitles it to the same, less rigorous Fund
oversight granted Mexico in its multiyear bank re-
Commercial bank creditors and the Yugoslavs have
reached general agreement on the form of such
monitoring: the IMF would conduct two-instead of
one-Article IV consultations annually, assessing per-
formance and-possibly-prospects. The banks and
the Yugoslavs also reached agreement on "trigger"
criteria that would precipitate consultations with the
banks on economic policy if performance fell short of
the targets. While the IMF is willing to do the
consultations, it is wary of becoming a tool of the
' Annual Article IV consultations are meetings with IMF staff that
primarily oversee exchange rate issues, but that more recently have
examined broader economic and financial problems. They do not
involve policy guidance.
private creditors and insisted that it would not agree
to any trigger mechanisms that would require the
Yugoslavs and the Fund to hold policy consultations.
The agreement in principle between Belgrade and the
banks does not ensure that the Yugoslavs have a way
out from IMF supervision. The Paris Club of official
creditors merely indicated that it will consider the
appropriate nature of future IMF surveillance at the
time of rescheduling 1986 debt. Since many Western
governments believe that Belgrade has done little to
correct its fundamental problems, the Paris Club may
continue to insist on explicit policy conditions in a
standby arrangement. If this were the case, the Fund
probably would demand more reductions in adminis-
trative controls over capital and foreign exchange in
favor of integrated markets, greater use of wage
incentives, and the liquidation of bankrupt enter-
prises. Belgrade would try hard to soften the IMF's
conditions but probably would agree in the end to a
new program.
Romania
Worsening financial problems could build pressure on
the Romanians to reinstitute a standby arrangement.
Poor hard currency trade performance in 1985 has led
to late payments to suppliers and to an emergency
short-term loan from a few major bank creditors.
Bucharest's ability to cover the large payments due on
its rescheduling agreements late this year seems in-
creasingly uncertain, and a group of banks are trying
to syndicate a medium-term credit to bolster the
country's cash reserves. The banks have not yet
insisted on a new IMF program, but if Bucharest's
situation deteriorates to the point of needing a re-
scheduling, private and official creditors presumably
would press for renewed IMF supervision.
A new round of negotiations with the Fund would
prove difficult. President Ceausescu would find re-
turning for help particularly galling, given his sharp
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criticism of the IMF. The Fund presumably would
demand that Bucharest first comply with the criteria
of the program terminated in 1984. The criticism in
the 1984 staff evaluation lays the basis for future
conditions. The report indicates that the Fund would:
? Require further devaluations of the leu.
? Mandate additional price hikes, especially for
energy.
? No longer tolerate incomplete, inconsistent, or un-
timely economic information.
? Seek the elimination of many restrictive trade and
payments practices.
But, even under pressure from creditors, Bucharest
might refuse to conclude a new agreement with the
Fund and would continue its costly effort to close
financial gaps with its own strapped resources.
Hungary
Budapest has hinted that it may reapproach the Fund
for a standby program and credits because of disap-
pointing hard currency trade performance this year.
Hungary has had success in raising loans from com-
mercial banks; however, Budapest may fear that the
decline in its payments surplus will tarnish its
creditworthiness unless it resubmits to IMF supervi-
sion. In contrast to Romania, Hungary remains on
good terms with the IMF and has left the door open
for resuming a standby relationship if conditions
warranted.
Even so, dealings between the IMF and Budapest
would probably entail more friction than in 1982-84.
The Fund almost certainly would require more re-
straint on consumption than the Hungarians have
allowed in their current plan. This could prove a sore
point for Budapest, which seems increasingly uneasy
about social tensions associated with even the modest
austerity imposed up to now. Moreover, the Fund
would press for faster movement on price and wage
deregulation, subsidy reduction, and wage differentia-
tion than Budapest seems prepared to accept. While
the IMF would insist on stricter conditions and more
attention to correcting problems with supply, the
Fund would probably be willing to make compromises
to strike a deal with Budapest. The IMF seems eager
to support Hungary because it sees Budapest as the
most promising example of a planned economy imple-
menting systemic change.
Poland: The Looming Challenge
The prospective membership of Poland will prove a
major headache for the IMF. Warsaw's application to
rejoin the Fund-submitted in November 1981-was
held in abeyance as one of the Western sanctions
imposed after the December 1981 declaration of
martial law. Preparations for Poland's entry resumed
in early 1985, following withdrawal of the US objec-
tion to Warsaw's membership. The IMF board, how-
ever, probably will not take a final vote until early
1986. While the regime appears eager for member-
ship in order to obtain new credits and an improved
credit rating, Polish leaders seem to have a poor
understanding of the requirements of membership.
Consequently, negotiations on standby arrangements
will be long and difficult.
The USI Embassies in Warsaw see
Polish support for IMF membership crossing party,
government, and church lines. There are major differ-
ences, however, in the way these groups perceive the
advantages of membership. The largest group of
supporters within the regime is that which sees mem-
bership as the means to improved standing with
Western banks and access to low-interest, long-term
credits. The objective of this group-centered in the
Finance Ministry-is to squeeze more money out of
the West. A smaller group within the regime hopes
that membership will be a catalyst for effective
reform and sees the Fund as the scapegoat on which
hard economic measures can be blamed. Finally,
those outside the regime favoring the IMF believe
that membership can help sustain economic links with
the West and act as a counterweight to Soviet efforts
to tie Poland more closely to CEMA.
By contrast, a small but vocal opposition to member-
ship has brought together some strange bedfellows.
On the one hand, some former Solidarity leaders
25X1
25X1
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oppose any step that might ease the economic pres-
sures that they hope will eventually force the Jaru-
zelski regime to resume a dialogue with the banned
labor union. This group also believes that workers
would shoulder most of the burden of IMF adjust-
ment through reduced subsidization of food and other
consumer goods. Joining in opposition to membership
are regime hardliners who believe an IMF agreement
will enable creditors to squeeze Poland for more debt
repayment and will dilute the centralism and greater
discipline they believe necessary for economic recov-
ery. Sources of the US Embassy in Warsaw indicated
that the hardliners pressed for a reassessment of
Poland's strategy for dealing with creditors and the
IMF earlier this year, but the pro-IMF faction appar-
ently retained the upper hand. Warsaw went ahead
with conclusion of a rescheduling agreement with
Western government creditors in July in hopes of
smoothing the path to Fund membership.
The USSR seems to be taking a wait-and-see attitude
about Warsaw's dealings with the IMF. Despite
repeated criticism of the Fund in Soviet media,
Moscow has remained quiet about the Polish bid for
readmission. The Soviets undoubtedly are wary about
Warsaw's developing closer contacts with the West,
but they apparently do not see the IMF as a serious
threat to their efforts to integrate Poland more closely
into CEMA. More important, Moscow probably is
counting on IMF lending to help reduce the cost of
Soviet economic support to Warsaw. Senior Soviet
officials have probably advised Warsaw on the guide-
lines for negotiations with the IMF, and Moscow has
kept its options open by avoiding a public position on
membership. The Soviets undoubtedly would step in if
they saw a need to influence Polish-IMF decisions,
but they seem unlikely to veto membership unless new
events in Poland threaten vital Soviet interests. F_
Credits and Conditionality
Poland presumably would seek to draw funds as soon
as possible after entry into the Fund. Although precise
amounts depend on the quota-which we estimate
will be about $900 million-Warsaw probably could
draw about $450 million with little difficulty (see
table 7 in appendix). This would include $225 million
from the reserve tranche (Warsaw's own money) and
$225 million from the first credit tranche, neither of
which requires strict conditions. Warsaw also may
seek a credit from the Fund's compensatory financing
facility, although it may be unable to demonstrate
much export shortfall according to IMF procedures.
We estimate that Warsaw's drawings from this facili-
ty are unlikey to exceed $100 million. These credit
tranche drawings and compensatory credits would
increase Warsaw's payment capacity by roughly
25 percent.
Polish financial officials apparently are counting on
more IMF and World Bank money. Warsaw's projec-
tion of $3 billion from the IMF during the first three
years of membership evidently assumes the establish-
ment of a standby arrangement. In addition, Warsaw
hopes to obtain about $1.5 billion from the World
Bank in its first two years of membership, an overly
optimistic projection.
Before releasing more than the first $450 million or
so, the IMF will require Warsaw to implement the
comprehensive stabilization program that the regime
so far has avoided. The IMF will demand slower
growth in consumption, investment, and government
expenditures in order to shift resources to the external
sector. Recommendations are likely to include reduc-
ing budget subsidies, hiking interest rates and prices,
and tying wage increases to productivity gains. In the
foreign sector, the Fund is likely to urge simpler trade
and foreign exchange systems.
Many obstacles may well prevent the conclusion of a
standby arrangement. Unlike its position in Yugosla-
via and Hungary, in Poland the IMF does not seem to
have many allies within the economic leadership
willing to push for major changes. Some Polish offi-
cials-particularly in the Ministry of Finance-have
argued that reform measures adopted in 1982 would
go far toward meeting IMF demands. In our view,
these reforms do little to ensure achievement of strict
performance criteria. The Fund probably will exam-
ine much more critically than Warsaw anticipates the
discrepancy in Polish reforms between theory and
practice. Although a few officials would like to use
the Fund as a scapegoat for imposing tough austerity
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measures, the regime probably would not accede to
IMF proposals if it felt social tensions would increase.
Since lifting martial law, Warsaw has backed off
from imposing austerity on consumers and has caved
in to industrial ministries wanting to accelerate in-
vestment. Warsaw's interest in a borrowing arrange-
ment probably would slacken if, as seems likely,
Western creditors insisted that IMF funds be used to
pay debt service rather than to buy more imports.
Moreover, the USSR will be watching closely and
would press Warsaw to reject measures that might
risk political instability or excessive economic decen-
tralization.
Even if an agreement is struck, the IMF probably will
not make much headway in correcting Poland's eco-
nomic problems, at least not very quickly. Warsaw's
resistance to austerity and basic reforms as well as the
IMF's problems in coming to grips with centrally
planned economies may produce a program that is
inadequate-if not irrelevant-to Poland's needs.
Warsaw might agree to policies to draw funds, but
fall short in adhering to the conditions. If perfor-
mance criteria are not met, the IMF and Western
governments will have to decide how tough they want
to be in enforcing compliance. Even with acceptable
compliance, the magnitude of Poland's economic and
financial problems ensure a lengthy period of IMF
supervision.
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Appendix
Table 1
Eastern Europe: Commonly Used
IMF Credit Facilities
Type of Credit Share of Conditions on Recipient
Quota a
(percent)
Reserve tranche 25 Demonstrate balance-of-pay-
ments need. Requests are al-
most never contested by the
Fund.
First tranche 25 Demonstrate balance-of-pay-
ments need and show the Fund
that reasonable efforts are be-
ing made to solve the problems.
Upper tranches 50 to 100 Demonstrate "substantial" jus-
tification of need and agree to
conditions worked out with the
Fund. Program duration is usu-
ally up to one year.
Standby 95 b Demonstrate serious balance-
of-payments needs over an ex-
tended period of time. These
facilities are made available for
up to three years subject to
strict conditions worked out
with the Fund, usually involv-
ing structural adjustments.
Compensatory 83 Demonstrate temporary export
financing facility shortfall due to circumstances
beyond the member's control.
a A member's quota is denominated in Special Drawing Rights (as
of June 1985 SDR=$0.997) and is determined by "the member's
economic characteristics relative to other members of comparable
size."
b Current annual limit on drawings. Under special circumstances,
the Fund can approve standby or extended arrangements in excess
of the limits.
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Table 2
Yugoslavia: Use of Fund Credit
Million SDRs
(except where noted)
Use of
Fund
Credit a
Reserve
Tranche
Compensa-
tory Financ-
ing Facility
Oil Facility b Credit
Tranche:
Ordinary
Credit
Tranche:
SFF+EAR c
Quota
Share of
Quota
(percent)
1979
1,036.4
125.7
138.5
340.7
431.5
1980
1,374.9
125.7
277.0
340.7
506.9
124.8
1981
1,928.9
125.7
277.0
340.7
787.6
398.0
1978
182.5
182.5
277
65.9
1979
346.0
138.5
136.7
67.6
277
124.9
1980
596.1
277.0
83.0
108.1
124.8
416
143.3
1981
1,075.5
277.0
8.3
392.2
398.0
416
258.6
1982
1,590.4
242.4
3.8
415.5
928.7
416
382.3
1984
1,985.9
17.3
0
406.3
1,562.3
613
324.0
1985 d
1,946.9
0
0
374.3
1,572.6
613
317.6
a Because of rounding, components may not add to total shown.
b Credits to members with oil-related balance-of-payments difficul-
ties. Discontinued granting new credits in 1976.
c Supplementary Financing Facility and Extended Arrangement.
d As of 30 June.
e Reported as of end of the year. Equals total drawings minus
repayments.
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Table 3
Romania: Use of Fund Credit
Million SDRs
(except where noted)
Use of Fund
Credit a
Reserve
Tranche
Compensatory
Financing
Facility
Credit
Tranche:
Ordinary
Credit Quota Share of
Tranche: Quota
EAR b (percent)
1979
437.9
47.5
183.8
206.6
1980
559.1
47.5
305.8
206.6
1981
904.9
83.8
474.5
293.4
53.2
1982
1,226.1
95.0
474.5
434.3
222.3
1983
1,449.0
134.0
474.5
517.9
322.6
1984
1,632.7
134.0
474.5
563.0
461.2
1985 c
1,632.7
134.0
474.5
563.0
461.2
Net drawings d
1984
955.7
157.4
337.1
461.2
523
182.6
1985,
884.2
105.9
323.8
454.5
523
169.1
a Because of rounding, components may not add to total shown.
b Extended arrangement.
c As of 30 June.
d Reported as of the end of the year. Equals total drawings minus
repurchases.
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Table 4
Eastern Europe:
IMF Standby Arrangements, 1979-85
Amount
(million
US $)
December 1982-
January 1984
532
January 1984-
January 1985
451
Romania
June 1981-June 1984
1,300
May 1979-May 1980
89
June 1980-June 1982
441
December 1983
May 1984-April 1985
370
300
Comments
Suspended from November
1981 to December 1982 be-
cause of arrearages to creditors;
canceled in January 1984 after
disbursement of $880 million.
Replaced by larger program in
January 1981 because of wors-
ening payments problems.
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Table 5
Hungary: Use of Fund Credit
Use of Fund
Reserve
Compensatory Credit
Credit
Quota
Share of
Credit a
Tranche
Financing
Facility
Tranche:
Ordinary
Tranche:
EAR b
Quota
(percent)
1983
628.4
81.4
72.0
248.7
229.3
1984
1,092.3
120.3
72.0
458.2
441.8
1985 c
1,092.3
120.3
72.0
458.2
441.8
1982
214.5
72.0
94.6
47.9
375
57.2
1983
547.0
72.0
245.7
229.3
531
103.1
1984
972.0
72.0
458.2
441.8
531
183.2
1985 c
972.0
72.0
458.2
441.8
531
183.2
a Because of rounding, components may not add to total shown.
b Extended arrangement.
As of 30 June.
d Reported as of end of the year. Equals total drawings minus
repurchases.
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Table 6
Leading Users of IMF Credit a
Amount
(million US $)
Share of Quota b
(percent)
India
3,903
177.3
Mexico
2,695
231.9
Yugoslavia
1,941
317.6
Argentina
1,627
146.6
Korea
1,496
324.3
Morocco
1,067
349.0
Hungary
969
183.2
Thailand
936
242.9
Romania
881
169.1
As of 30 June 1985.
b The limit on cumulative borrowings under standby and extended
financing arrangements is currently 450 percent of quota (net of
scheduled repayments and excluding borrowings under the compen-
satory financing facility, the buffer stock financing facility, and the
oil facilities).
Table 7
Estimated IMF Assistance to Poland a
Type of Credit
Share of
Quota
(percent)
Amount
(million
US $)
Reserve tranche
25
225
First credit
tranche
25
225
Compensatory
financing
facility b
11
100
Standby
50c
450
Conditions
for Poland
Demonstrate bal-
ance-of-payments
need.
Demonstrate bal-
ance-of-payments
need and show the
Fund that reasonable
efforts are being
made to solve the
problems.
Demonstrate a tem-
porary export short-
fall due to circum-
stances beyond the
member's control.
Adhere to relatively
strong IMF-mandat-
ed stabilization
program.
a Estimated assistance within the first 12-18 months of joining;
estimates based on assumed quota of $900 million. The exact quota
is determined by "the member's economic characteristics relative to
those of other members of comparable size."
b Although technically CFF drawings can be as high as 105 percent
of the member's quota, we believe that Poland will have great
difficulty qualifying for much more than 10 to 12 percent.
c The annual limit on drawings under standby arrangements can be
as much as 95 percent of quota, but the IMF is unlikely to approve
more than 50 percent of quota for Poland.
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