EASTERN EUROPE: BOOM MARKET FOR SYNDICATED LENDING

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CIA-RDP87B00342R000100200011-3
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RIPPUB
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S
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126
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December 22, 2016
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May 26, 2010
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11
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Publication Date: 
October 25, 1985
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REPORT
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Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 MEMORANDUM FOR: Here are copies of the material we sent to Commerce for Secretary Baldridge in prepara- tion for W. Friday NSC Meeting on the Garn Amendment. Date 10/31/85 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Eastern Europe: Boom Market for Syndicated Lending East European borrowing from Western banks has rebounded sharply this year. The region raised $2.8 billion in syndicated loans on increasingly favorable terms in the first 10 months of 1985-a sharp , turnaround from the early 1980s when bankers slashed lending to the East. Japanese and Arab banks have played a leading role in new lending, while the importance of US and West European banks has fallen. Lenders have become more in- clined toward Eastern Europe because of improved hard currency trade performance in the region over the past two years and a lack of comparably attractive investments elsewhere. Borrowers have taken advantage of favorable loan terms to restruc- ture debt, build reserves, and cover shortfalls in hard currency earnings this year Widening Circle of Borrowers The number of East European countries returning to the syndicated market has grown quickly this year, and many of the loans have been oversubscribed.' ? East Germany secured a $500 million loan in March; in June it obtained a consortium loan for $600 million. ? Hungary in June tapped Western banks for the bulk of an $800 million World Bank cofinanced loan and Japanese banks for an additional $400 million since January. ? Bulgaria borrowed $200 million in July and $120 million in October. ? Czechoslovakia borrowed $100 million from a Western bank consortium in July. ' Oversubscription occurs when participatin banks offer funds in excess of the original loan amount. ? Four commercial banks extended an $80 million bridge loan to Romania in May, and, most recently, a group of Romania's leading creditor banks agreed to try to syndicate a $167 million loan. Only Yugoslavia and Poland, which still require debt reschedulings, remain shut out of the syndicat- ed loan market Japanese and, to a lesser extent, Arab banks have played a prominent role in the upswing in new lending. Japanese banks, looking to diversify their loan portfolios, have taken the lead or jointly 25X1 managed 41 percent of the loans to Eastern Europe this year, as compared with 18 percent in 1979. According to West European bankers, increased competition from Japanese banks in the lending market has pushed down interest rates on loans to Eastern Europe. In contrast, US banks have man- aged 15 percent of this year's loans to the East, down from 20 percent in 1979. This parallels the decline in overall US exposure to Eastern Europe. Many US banks that have managed recent loans to the region have been mainly interested in earning the management fees and have tried to sell off their portions of the loans quickly to limit exposure. The lack of comparably attractive lending opportu- nities elsewhere largely explains the willingness, and, in some cases, even eagerness of Western banks to resume lending to Eastern Europe. The financial positions of East Germany, Hungary, Secret DI IEEW 85-043 25 October 1985 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret Eastern Europe: Selected Major Loans in 1985 East Germany March 1985 500 7 years at LIBOR plus 0.875 point Oversubscribed from $150 million. June 1985 600 8 years at LIBOR plus 0.75 on $520 million, US Prime plus 3/8 on $80 million Oversubscribed from $20 million. NA 200 NA Under discussion with European banks. Hungary January 1985 250 12 years at 11.2 percent fixed From Japanese banks, which have extended an additional $150 million in smaller loans. June 1985 800 8 to 12 years at LIBOR plus 0.75 World Bank cofinanced loan. Under discussion with First Chicago, Bankers Trust, Dai-Ichi Kangyo. Bulgaria July 1985 200 4 years at LIBOR plus 0.375, 3 years at LIBOR plus 0.5 Oversubscribed from $100 million. NA 125 4 years at LIBOR plus 0.25, 4 years at LIBOR plus 0.375 Under discussion with Deutsche Bank. 2 years at LIBOR plus 0.25, 6 years at LIBOR plus 0.375 Romania May 1985 80 5 months To cover payments on resched- uled debt. NA 167 2 years at LIBOR plus 1.25, 3 years at LIBOR plus 1.375 with US Prime option. Currently being subscribed; to cover payments on rescheduled debt. I Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret Management of Syndicated Loans to Eastern Europe, 1979 and 1985 Percent 1979 Bulgaria, and Czechoslovakia seem relatively more secure than those of many LDCs, especially in Latin America, where bankers feel overexposed. As a result, not only has the absolute amount of East- ern Europe's borrowing increased, but also its share of bank lending to countries outside the OECD- 13 percent so far this year, as compared with 6 percent in 1976 and 10.5 percent in 1979 Eastern Europe's hard currency trade surpluses in 1983-84 and some easing of East-West tensions have been the major factors encouraging bankers to look more favorably on the region. The East Euro- pean borrowers have also substantially cut their debt since 1980, and, except for Romania, they have avoided rescheduling. Having made deep cuts in their East European exposure in 1981-83, banks now feel they have elbowroom to respond to loan requests from the more creditworthy countries. Some bankers-particularly in Western Europe and Japan-believe East European imports from the West will rise with the launching of new five- year economic plans for 1986-90, and they want to reestablish ties to the better credit risks Western banks have been particularly receptive to loan requests from East Germany and Hungary for additional reasons. East Germany, besides running sizable trade surpluses, boasts the strongest record of economic growth in Eastern Europe since 1982. Banks also value the West German umbrella for East Berlin, which Bonn demonstrated by guaran- teeing two large West German bank loans during 25X1 East Germany's liquidity squeeze. Finally, banks have found East Berlin a lucrative loan market because of the regime's acceptance of relatively high interest rates-recent loans have carried high- er spreads over LIBOR than those for most other Bloc countries. The East Germans apparently pre- fer to have their loans oversubscribed at higher interest rates than to obtain the most favorable terms In Hungary's case, bankers are counting strongly on Budapest's reform program to improve the efficiency and competitiveness of the economy. Hungary's good relationship with the NF-which lent it nearly $1 billion in 1982-84-has added to 25X1 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret Syndicated Loans to Eastern Europe, 1978-85 Billion US S 7 1978 79 80 81 82 83 84 85 Jan-Oct banker confidence. Moreover, banks have been eager to participate in World Bank cofinancing loans because they believe that Bank involvement guarantees that the loans are exempt from resched- uling should Budapest run into repayment prob- lems. Japanese banks have been particularly at- tracted by the apparent security of these deals. In Romania's case, however, new lending has been less than voluntary. Recent loans have stemmed largely from the bankers' desire to avoid another round of reschedulings. Disappointing export per- formance earlier this year seriously reduced Ro- mania's foreign exchange reserves. Leading credi- tor banks concluded that Bucharest needed a major loan to cover large payments due in October under its rescheduling agreements. Reasons for Borrowings The East Europeans initially used the borrowings to repair some of the damage to their financial positions caused by the credit crunch. They took advantage of the longer maturities and lower inter- est rates to replace more expensive short-term debt accumulated in 1982-83. Borrowers also used the funds to boost reserves and build financial cushions against another cutback in lending to the region. East Germany and Czechoslovakia returned to the loan market to reestablish their credit ratings. For example, East Germany continued to raise new credits even though it had not drawn down all its previous borrowings and sought oversubscribed loans as proof of its financial strength. In contrast, the more recent borrowing initiatives by Hungary, Bulgaria, and Romania have resulted from short- falls in hard currency earnings caused by poor trade performance this year 25X1 The borrowing trend is likely to continue, at least in the short run. Even countries with no immediate plans to draw down the funds will probably contin- ue to exploit the continued shortage of lower risk LDC borrowers. In addition, some East European countries may plan more borrowings to finance an increase in Western imports as they enter the new cycle of five-year plans. Some countries may see the need to import more capital goods to redress import cutbacks in the early 1980s and meet modernization requirements resulting from Soviet pressure to improve the quality of exports to the 25X1 25X1 Still, an extended downturn in the region's econom- ic health or deterioration in East-West relations could reverse the trend. While this year's slump apparently has not alarmed banks, lenders-and even borrowers-may become reluctant if trade performance continues to slide. The current enthu- siasm among bankers for Eastern Europe may cool when it becomes apparent that these countries have done little to produce the sustained growth in exports needed to pay for more imports. Failures by Poland, Romania, and Yugoslavia to meet obliga- tions under rescheduling agreements might sour 25X1 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret some bankers on the entire region, but such a spillover seems much less likely than in 1981. A more serious threat to Eastern Europe's ability to obtain new loans might result from a reemergence of severe payments problems in the LDCs. Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R0001002000111--3JU,-r This c' C' nanipform,ation requested by David Wigg at NSC. It was prepared for his consideration in light of proposed legislation on financial controls for U.S. banks. The information was prepared by both of the Regional East-West a contribution from Branch, East European Division. Comments and questions are welcome and should be addressed to Chief Re ional East-West Branch F 30 August 1985 E U R A Office of European Analysis 2.5X1 25X1 25X1 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Syndicated Lending to Eastern Europe in 1585 Eastern Europe has undertaken in recent months a resurgence in borrowing from Western commercial banks. Syndicated credits to Bulgaria, Czechoslovakia, East Germany, and Hungary have totaled $2.6 billion so far in 1985--compared with just $3.2 billion in 1982-81--and have carried favorable terms. The principal borrowers have been East Germany, Hungary, Bulgaria, and Czechoslovakia, which have used the credits to improve debt maturity schedules and to rebuild hard currency reserves rather than to finance imports. The principal lenders have been Japanese and Arab banks, although West European and US banks have also participated. The surge in lending by bankers seems to be the result of high bank liquidity and a lack of better lending opportunities elsewhere instead of enthusiasm over East European economic performance and prospects. East Germany has borrowed $1.2 billion this year through two loans which were heavily oversubscribed at $600 million each. In March, three US banks and the Bank of Tokyo underwrote a loan for 7 years with 3 1/2 years grace, at 0.875 percent over LIBOR or 0.5 percent over US Prime. A second $600 million loan in June was led by the Arab Banking Corporation of Bahrain, the International Bank of Japan, and First Chicago. The loan was for 8 years, with rates of 0.75 percent over LIBOR on a $520 million tranche and 0.375 percent over US prime on an $80 million tranche. US bank participation was $50-60 million Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 and included First Chicago, Bankers Trust, Security Pacific, and the American Security Bank. Hungary also has received over $1 billion in new loans this year. Japanese banks have been particularly active in lending to Hungary. In June, Budapest concluded an $800 million loan package from the World Bank and commercial banks. The commercial half was managed by National Westminster, Arab Banking Corporation, the Bank of Tokyo, and a US bank. The credit is a multicurrency facility including an ECU tranche, and was underwritten at favorable rates. Bulgaria borrowed $200 million in the form of an oversubscribed club loan signed in July. The loan is being led by the UK's National Westminister Bank and the Moscow Narodny Bank. It is for seven years with four years grace at interest rates of 0.375 percent over LIBOR for the first four years and 0.5 percent over LIBOR for the remaining three years of the loan. Czechoslovakia has also received Western credits. In July Prague borrowed $100 million from a bank consortium led by Credit Commerciale de France. The loan was placed at 0.25 percent over LIBOR for the first two years and 0.375 percent over LIBOR for the following six years. Banks from West Germany, Austria, Japan, the US, and Finland are participating. Only Bankers Trust participated from the US. Romania received an $80 million club loan in May to help it meet a Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 25X1 25X1 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 repayment on previously rescheduled debt. The loan, which comes due in October, was arranged by Barclays Bank, Deutsche Bank, Union Bank of Switzerland, and a US bank. Bucharest hopes to raise a further $150 million this year in syndicated credits. Yugoslavia received $25 million in credits since January as part of a World Bank co-financed loan. Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 ULVLLH5bit'Iti) Share of U.S. Commercial Banks in Total BIS-Area Lending to Eastern Europe (millions of US $) Totala in Percentc Total Eastern Europe 1982 48,505 6,048 12.5 1983 44,835 5,384 12.0 1984 41,491 4,668 11.3 1985c 40,602 4,418 10.9 Bulgaria 1982 2,067 192 9.3 1983 1,757 128 7.3 1984 1,568 100 6.4 1985c 1,673 10.6 6.3 Czechoslovakia 1982 2,848 171 6.0 1983 2,733 157 5.7 1984 2,410 157 6.5 1985c 2,393 107 4.5 East Germany 1982 8,859 633 7.1 1983 8,373 485 5.8 1984 8,262 372 4.5 1985c 8,201 308 3.8 Hungary 1982 6,757 937 13.9 1983 7,026 904 12.9 1984 6,765 765 11.3 1985c 6,900 663 9.6 Poland 1982 13,910 1,513 10.9 1983 11,236 1,067 9.5 1984 9,003 693 7.7 1985c 8,826 6$7 7.8 Romania 1982 4,243 282 6.6 1983 3,888 211 5.4 1984 3,836 202 5.3 1985c 3,099 190 6.1 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 UNCLASSIFIED Yugoslavia 1982 9,821 2,320 23.6 1983 9,822 2,432 24.8 1984 9,647 2,379 24.7 1985c 9,510 2,357 24.8 a Assets of reporting BIS-area banks vis-a-vis Eastern Europe based on semiannual statistics of the Bank for International Settlements (BIS). b Assets of U.S. banks vis-a-vis Eastern Europe based on statistical releases of the Federal Financial Institutions Examination Council. c March 1985. Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 SUBJECT: Syndicated Lending to Eastern Europe in 19851 Original - David Wigg, NSC 1 - DDI 1 - D/EURA 1 - C/EURA/EE 1 - C/EURA/EE/EW 1 - DI/PES 2 - EURA/PO 4 - CPAS/IMC/CB 1 - NIO/Europe 1 - EURA/EE/EW/Chrono 1 - Author Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret Eastern Europe: Financial Situation and Outlook in 1983-84 Key Judgments Eastern Europe is recovering from its severe financial crisis. Last year the Information available region posted its second consecutive hard currency trade surplus and its as of 16 July 1984 first current account surplus in more than a decade. Bulgaria, Czechoslo- was used in this report. vakia, East Germany, and Romania cut their net hard currency debt by an average of 13 percent, and the region as a whole built up foreign exchange reserves by 22 percent. Much of the improvement stemmed from continued belt tightening. Imports declined for the third consecutive year, albeit not as dramatically as during the previous two years. Eastern Europe's financial position also was helped by loans from the IMF and the World Bank, rescheduling agreements with private and official creditors, and some revival of commercial lending for the more creditworthy countries. The pace of improvement seems to be quickening in 1984. Excluding Poland, Eastern Europe's financing requirements will decline by about 15 percent this year. Prospects for new credits seem better than at any time in the last four years. While most of the upswing in lending consists of short- term, trade-related credits, Hungary and East Germany have already raised medium-term syndications. East Germany also has received a large government-backed loan from West Germany for the second consecutive year. Yugoslavia has arranged refinancing with private and official creditors, and Romania probably will avoid a rescheduling for the first time in three years. Despite its recovery from the 1981-82 crisis, most of Eastern Europe still faces long-term trade and financial problems: ? Even with additional reschedulings, Poland almost certainly will be unable to close its financial gap, and the regime seems unwilling to impose the tough adjustment measures needed to restore creditworthi- ness. ? Yugoslavia's financing requirements are declining, but it will still need more debt relief in the next few years. ? The drastic import cuts imposed by ,Romania have drained the economy, and the possibility of a Romanian rescheduling in 1985 cannot be excluded. ? The financial recoveries of East Germany and Hungary seem more solid, but both countries must continue to cover large financing requirements. ? All of the countries of Eastern Europe will be additionally burdened by growing pressures from the Soviet Union to balance bilateral trade and provide Moscow with better quality goods. iii Secret EUR 84-10151 August 1984 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 25X1 A number of economic and political factors still weigh against Eastern Europe in the risk assessments of Western lenders. To resume economic growth and maintain external balance, Eastern Europe must do more to improve its export performance. Many creditors regard the sharp import reductions of the past few years as a short-run expedient with little impact on long-term creditworthiness. Many bankers, still skeptical that the East Europeans will do much to correct fundamental problems, will be examin- ing more closely than in the past the economic policy and performance of individual countries. Creditor confidence also could be undermined by further cooling in the East-West political climate or outbreaks of unrest. Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 acUret Contents Improvement Continues in 1984 Individual Country Performance 6 Hungary 9 Yugoslavia 10 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret Eastern Europe: Financial Situation and Outlook in 1983-84 Regional Overview Performance in 1983 Eastern Europe's financial position began to improve in 1983 following the severe difficulties of the previ- ous two years. The region posted a hard currency trade surplus of $4.4 billion, more than double the surplus of 1982 and a sharp reversal of the $3.7 billion deficit recorded in 1981 (see table 1). The region pared hard currency imports by about 4.7 percent last year, a much less severe cutback than the 15-percent reductions in both 1981 and 1982. The first increase in exports since 1980-due largely to resales of Middle Eastern oil-helped limit import reductions. The trade surplus, along with lower interest pay- ments, helped produce a $2.2 billion current account surplus for the region, compared with the $1.9 billion deficit of a year earlier. Current account surpluses helped most countries re- duce their net hard currency debt for the second consecutive year (see table 2).' Foreign exchange reserves grew by 22 percent regionwide, offsetting the precipitous drop that occurred in 1982 at the height of the credit crunch. Thus, Bulgaria, Czechoslovakia, East Germany, and Romania cut their net debt by an average of 13 percent. Net debt increased for the other three countries because of Poland's climbing interest arrearages to Western official creditors and some new credits received by Hungary and Yugosla- via. Eastern Europe's financial position was helped by support from international institutions and by gener- ally improved relations with Western creditors. Loans from the IMF and the World Bank encouraged Western bankers to provide nearly $500 million in syndicated loans to Hungary. A $400 million government-guaranteed bank loan from West Germa- ny helped revive lending to East Germany. East Germany and Hungary, which together had suffered a nearly $4 billion loss in bank credit lines between ' Some of the debt reduction was only nominal, reflecting the depreciation of the nondollar component of the debt against the dollar, and did not represent an acutal liquidation of obligations[ December 1981 and June 1983, according to BIS statistics, increased total borrowings by $500 million during the last half of 1983. In contrast with 1982, Romania quickly negotiated rescheduling agreements with Western banks and governments. Negotiations proved difficult for Poland and Yugoslavia, but both countries eventually obtained favorable rescheduling terms from Western banks. Yugoslavia also secured a package of new credits from the banks, Western governments, the IMF, and the World Bank.--] Improvements in Eastern Europe's hard currency balances were even more impressive given the eco- nomic pressures applied by the Soviet Union. The terms of trade continued to move in Moscow's favor last year, forcing the East Europeans to export a greater volume of goods to the Soviet Union just to maintain existing import volumes. In addition, Mos- cow apparently stepped up its pressure on some of its Warsaw Pact allies to improve their bilateral trade 25X1 balances after a decade of allowing them to run large deficits. Last year Eastern Europe's trade deficit with Moscow declined by $500 million, with the largest cuts made by East Germany, Poland, and Bulgaria. Improvement Continues in 1984 The momentum generated by Eastern Europe in 1983 appears to be carrying over to 1984. Excluding Po- land, Eastern Europe's financing requirements will drop an estimated 15 percent this year. The increase 25X1 in reserves and the reduction in short-term debt have improved the liquidity position of most countries. Debt service ratios have improved for all countries except Poland and Yugoslavia due to a decline in scheduled debt repayments (see table 3). F__7 25X1 Prospects for new borrowing seem better than at any time in the last four years. Eastern Europe's standing with bankers appears to be rising because of trade and current account surpluses. Hungary and East Germa- ny raised medium-term syndications in the first half of 1984 and may return to the market liter this year. Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret Table 1 Eastern Europe: Hard Currency Trade Total 33,896 38,830 37,387 36,438 37,404 39,975 Bulgaria 2,335 3,021 3,198 3,298 2,879 2,900 Czechoslovakia 3,734 4,597 4,691 4,357 4,142 4,275 East Germany 5,098 6,565 6,714 7,172 7,625 8,000 Hungary 4,063 4,911 4,877 4,876 4,847 5,000 Poland 6,350 7,506 4,971 4,974 5,402 6,200 Romania 5,522 6,574 7,216 6,235 6,238 6,600 Yugoslavia 6,794 5,656 5,720 5,526 6,271 7,000 Imports Total 45,556 47,302 41,065 34,695 33,047 35,550 Bulgaria 1,621 2,035 2,546 2,684 2,415 2,500 Czechoslovakia 4,117 4,590 4,432 3,842 3,371 3,500 East Germany 6,908 8,145 6,654 5,663 6,300 7,050 Hungary 4,230 4,632 4,417 4,111 3,970 4,100 Poland 8,038 8,488 5,404 4,616 4,317 4,900 Romania 6,623 8,091 7,012 4,710 4,605 4,800 Yugoslavia 14,019 11,321 10,600 9,069 8,069 8,700 Total -11,660 -8,472 -3,678 1,743 4,357 4,425 Bulgaria 714 986 652 614 464 400 Czechoslovakia -383 7 259 515 771 775 East Germany -1,810 -1,580 60 1,509 1,325 950 Hungary -167 279 460 765 877 900 Poland -1,688 -982 -433 358 1,085 1,300 Romania -1,101 -1,517 204 1,525 1,633 1,800 Yugoslavia -7,225 -5,665 -4,880 -3,543 -1,798 -1,700 Because of continuing unease about the financial guarantees. The East Europeans seem equally cau- outlook for many LDCs, bankers seem to be looking tious about new borrowing, with some regimes delib- for profitable opportunities to lend to those East erately planning to run current account surpluses to European countries that have weathered the debt reduce debts further. Most of the medium-term, 25X1 crisis, untied money secured this year will be in the form of IMF loans for Hungary and Yugoslavia; the complet- Bankers, nonetheless, remain cautious and are limit- ed or planned commercial syndications generally are ing most lending to short-term, trade-related credits tied to trade and project financing. Because the inflow carrying higher interest spreads than in the past. of credits probably will be small, we expect the region Private lenders are reluctant to increase exposure again to run a sizable trade surplus of roughly $4.4 significantly unless backed by Western government billion and a current account surplus of $3.4 billion. Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret Table 2 Eastern Europe: Gross and Net Hard Currency Debt at Yearend Gross debt 83,645 85,085 80,658 81,975 Commercial debt 61,658 59,050 53,031 48,041 Government-backed debt 18,688 21,152 21,133 26,380 IMF/IBRD/BIS 3,299 4,471 6,081 7,154 CEMA banks NA 412 413 400 Reserves b 10,054 9,838 8,239 10,065 Net debt 73,591 75,247 72,419 71,910 Bulgaria 3,536 3,065 2,757 2,463 Commercial debt 3,201 2,695 2,292 1,968 Government-backed debt 335 370 465 495 779 840 1,014 1,076 2,757 2,225 1,743 1,387 Gross debt 4,926 4,508 4,053 3,707 Commercial debt 4,066 3,703 3,118 2,732 Government-backed debt 860 805 935 975 Reserves b 1,256 1,105 742 985 Net debt 3,670 3,403 3,311 2,722 East Germany Gross debt 14,098 14,863 13,039 12,630 Commercial debt 11,253 11,583 9,489 8,510 Government-backed debt 2,845 3,280 3,550 4,120 Reserves b 2,506 2,596 2,321 3,597 Net debt 11,592 12,267 10,718 9,033 Hungary Gross debt 9,090 8,699 7,715 8,250 Commercial debt 8,790 8,334 6,955 6,940 Government-backed debt 300 365 525 740 IMF/IBRD/BIS 235 570 Reserves b 2,090 1,652 1,151 1,518 Net debt 7,000 7,047 6,564 6,732 Poland __ Gross debt 25,000 25,453 24,840 26,400 Commercial debt 14,900 14,188 13,660 10,900 Government-backed debt 10,100 11,265 11,180 15,500 Reserves b 650 775 1,045 1,150 Net debt 24,350 24,678 23,795 25,250 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret Table 2 Eastern Europe: Gross and Net Hard Currency Debt at Yearend (continued) 9,387 10,160 9,766 9,000 Commercial debt 6,537 6,167 5,409 4,900 Government-backed debt 1,670 1,845 1,428 900 IMF/IBRD/BIS 1,180 1,736 2,516 2,800 CEMA banks NA 412 413 400 Reserves b 300 345 370 250 Net debt 9,087 9,815 9,396 8,750 Yugoslavia 17,608 18,337 18,488 19,525 Commercial debt 12,911 12,380 12,108 12,091 Government-backed debt 2,578 3,222 3,050 3,650 IMF/IBRD 2,119 2,735 3,330 3,784 Reserves b 2,473 2,252 1,596 1,489 Net debt 15,135 15,812 16,892 18,036 e Preliminary estimate. b Excludes gold holdings. Changes in reserves shown may not equal those in the country balance-of-payments tables because of fluctua- tions in gold stocks and differing definitions of reserves. Trade turnover with the West-exports plus im- ports-will pick up for the first time since 1980. Economic recovery in the West will increase East European exports, which-coupled with moderately more financing-will allow most regimes to ease import curbs. Even so, hard currency trade is unlikely to increase at the double-digit pace common in the 1970s. Hard currency sales probably will increase by around 7 percent while import growth should ap- proach 8 percent. Long-Term Problems Despite its relatively quick recovery from the 1981-82 credit crunch, Eastern Europe still faces long-term trade and financial problems. The East Europeans cannot continue to rely on import restraints to achieve trade and current account surpluses; strong export gains are imperative if the region is to attain economic growth and external balance. The regimes, however, have done little to correct longstanding problems with competitiveness, and the sizable cuts in imports of Western capital goods are widening the technology gap between Eastern Europe and the developed West. Growing Soviet demands for more and better goods from Eastern Europe also may limit the region's ability to sell in hard currency markets. Financial problems in developing countries not only have hurt East European sales to those countries, but also have made the Third World a more aggressive competitor in developed country marketsr_~ Even with the recent debt reductions, debt service obligations will remain large for most countries, and increases in international interest rates will further burden current account performance. The reluctance of lenders to increase their medium- and long-term exposure will leave 4Eastern Europe vulnerable to rapid reductions in short-term credit lines as occurred in early 1982. The breathing space given by debt reschedulings for Poland, Romania, and Yugoslavia will expire in the next few years, forcing these countries to repay their obligations, refinance them with new loans, or negotiate new rescheduling terms. Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret Table 3 Eastern Europe: Selected Financial Indicators Proportion of Bank Loans With Less Bank Loans With Less Than One Year Maturity Reserves as a Share of Debt Maturing in One Year 1979a 1980 a 1981 a 1982a 1983 b 1979 a 1980 a 1981 a 1982 a 1983 c Eastern Europe 39.9 36.3 37.0 34.0 33.6 28.8 29.0 28.1 23.1 27.0 Bulgaria 41.1 36.3 48.1 51.7 52.8 31.0 53.5 59.4 90.1 123.2 Czechoslovakia 47.1 43.1 37.6 31.2 32.8 46.8 65.3 67.8 55.8 95.6 East Germany 42.7 38.6 42.6 39.0 38.8 46.7 45.2 42.3 48.2 68.6 Hungary 47.4 42.9 40.4 33.2 36.0 27.2 34.0 25.0 29.0 31.7 Poland 39.1 33.1 36.1 32.8 29.3 14.7 7.5 9.7 9.0 7.2 Romania 50.5 42.7 35.3 38.9 32.8 9.6 9.4 8.9 9.5 16.7 22.6 28.1 28.4 26.7 30.0 46.3 36.9 38.3 18.0 23.8 Undisbursed Bank Commitments as a Share of Outstanding Debt Debt Service Ratios d Eastern Europe 16.5 17.4 11.7 8.4 7.5 36.7 39.9 48.7 56.7 61.0 Bulgaria 8.4 16.7 24.5 15.5 18.3 33.7 32.5 33.9 26.9 22.1 Czechoslovakia 9.7 8.3 6.7 10.4 9.7 20.6 21.8 20.1 19.4 17.8 East Germany 16.5 15.2 16.2 13.3 11.1 44.6 43.9 51.6 53.2 45.9 5.2 8.4 4.6 7.2 5.5 33.1 30.9 32.7 33.0 30.7 24.6 23.9 11.8 4.8 4.3 86.0 97.1 174.6 f 214.6 f 245.7 f Romania 18.3 18.2 9.4 9.8 9.0 21.1 25.6 27.4 45.3 31.5 Yugoslavia 23.8 19.0 11.9 7.5 6.7 20.2 22.8 26.4 28.4 33.8 a At yearend. b At midyear. Preliminary estimate at yearend. d Repayments of medium- and long-term debt and interest pay- ments on gross debt as a share of current account earnings. Reserves held by the National Bank of Yugoslavia. Ratio computed on the basis of obligations owed which were much larger than amounts actually paid. The warming of relations between Western lenders and several East European countries will likely be limited. The debt crisis of 1981-82 has changed bankers' long-term thinking about Eastern Europe. The banks can no longer point to Eastern Europe's financial conservatism and unblemished payments record, and they have learned that they cannot trust in Soviet financial support as adequate protection for lending to the region. Instead,of making blanket judgments about the area's creditworthiness, bankers are likely to draw sharper distinctions among the countries on the basis of economic policy, perform- ance, and prospects. As a prerequisite for increased lending, bankers will likely look for evidence that the East Europeans are making structural changes to improve trade perform- ance. Many creditors regard sharp import reductions as a short-rua expedient with little positive impact on long-term creditworthiness. Some bankers consider the Western recession as only one factor in the disappointing export performance in recent years, and they remain skeptical that the East Europeans will or can do much to correct their fundamental problems. 25X1 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret Political developments, as in the past, could again influence borrowing prospects. Any further cooling in the East-West political climate or outbreaks of unrest or violence could undermine creditor confidence. Threats to political stability could result from popular reaction to the pinch of austerity measures or from struggles over succession. Political problems in any one country could spill over and poison lenders' attitudes about the whole region, even though some countries-such as Czechoslovakia and Bulgaria- may be judged creditworthy solely on economic terms. The following sections summarize the recent financial performance of the individual countries and discuss their longer term prospects. Poland Warsaw continued last year to pursue a policy of limited adjustment by running a trade surplus large enough to meet the minimum demands of its creditors but not so great as to strain the beleaguered economy and risk unrest. Warsaw ran a record trade surplus of $1.1 billion as exports jumped 9 percent and imports fell 6 percent. Nonetheless, this surplus, coupled with other service earnings of $400 million (net), fell far short of the $3.3 billion owed in interest (see table 4). As a result, Warsaw slipped even further behind in meeting its debt repayments. New credits and debt relief from banks covered little more than $2 billion of Warsaw's $15 billion financ- ing requirement, which included almost $7 billion in arrears from 1982. Credit availability continued to decline as lines extended before 1982 were nearly exhausted. Warsaw was able to draw only $565 million in new money-about half in trade credits from Libya and China-plus $338 million in trade credits available from the 1982 and 1983 bank re- scheduling agreements. Western banks agreed to re- schedule $1.2 billion in principal-95 percent of the payments due in 1983-until 1988-92. The banks agreed to relend 65 percent of the interest due on original loan contracts as short-term credits to finance imports for Warsaw's export industries Table 4 Poland: Financing Requirements and Sources, 1982-84 Financing requirements 10,788 14,592 15,805 Current account balance -3,039 -1,807 -760 Trade account balance 358 1,085 1,300 Exports 4,974 5,402 6,200 Interest c -3,799 -3,299 -2,560 Other net invisibles, 402 407 500 (excluding interest) Repayments of medium- 7,061 5,447 4,045 and long-term debt due Paris Club creditors 2,573 1,825 1,808 Banks 2,442 d 1,436 d 619 Other creditors 2,046 2,286 1,618 25X1 Repayments of short-term 110 263 0 debt due Arrearages from previous year 573 6,906 10,800 -5 -69 -200 3,882 2,103 7,900 1,670 903 600 a Preliminary. b Projection. c Amounts are for interest due rather than interest paid. Because Poland has not paid all interest due, the figures for interest and the current account deficits overstate the hard currency outflows. 25X1 d Includes principal payments deferred until the following year under the bank rescheduling agreements for 1981 and 1982. e Arrearages at the end of 1983 according to Polish data. The total is not consistent with the $12.5 billion total we compute from data and estimates of current account performance, obligations due, payments made, new credits and reschedulings. r Includes interest deferred until 1983 under the 1982 bank agreement. Poland's large financial gap resulted primarily from failure to conclude a debt rescheduling with the Paris Club. Western government creditors, who had sus- pended debt rescheduling talks in January 1982 fol- lowing Warsaw's imposition of martial law, agreed in 25X1 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret principle in mid-1983 to negotiate debt relief and sent a technical team to Poland. The opportunity for progress was lost in November, however, when Polish officials made their first appearance at the Paris Club in two years and asked for a comprehensive package including generous debt relief, new credits, and IMF membership. The creditors responded that IMF mem- bership and new credits were outside the scope of the Paris Club, and that further debt relief could not be provided until Poland met unpaid obligations under the 1981 rescheduling agreement. The trends of the past two years-some improvement in the current account, dwindling credit availability, and difficult rescheduling negotiations-are being repeated in 1984. Poland owes about $16 billion this year, two-thirds of which represents payments over- due from as long ago as 1981. The current account deficit could fall below $800 million as interest pay- ments drop to around $2.6 billion and if Warsaw achieves another record trade surplus as anticipated. Exports and imports are projected to increase by 20 percent and 14 percent, respectively. First-quarter statistics suggest that the projected $1.3 billion trade surplus is reachable. The likelihood of new credits remains slim. Polish officials hope for over $2 billion in new credits this year, but they have acknowledged that they received only $90 million in the first quarter. Warsaw is more likely to receive around $600-800 million this year, including new money coming out of rescheduling agreements. After three years of rescheduling, roughly three- fourths of Warsaw's debt to Western banks has now been rescheduled. About $600 million in principal is due this year, well below the levels of the past two years. This relatively small sum encouraged the banks to negotiate a multiyear rescheduling on the following terms: ? Rescheduling over 10 years of 95 percent of princi- pal payments due from 1984 through 1987, includ- ing a grace period of five years. ? An interest rate of 1.75 percentage points over LIBOR on rescheduled obligations. ? Payment in 1984 of the remaining 5 percent of principal, a 1-percent fee, and interest due this year The banks also agreed ti extend about $700 million in short-term credit facilities over the next two years. Embassy reporting indicates that $330 million will be new credits. Each bank will contribute an amount based on its exposure, with approximately $230 mil- lion to be made available this year. The remaining $370 million is an extension on repayment of trade credits from the 1982 agreement, which come due in 1985. The rescheduling was contingent on Poland paying off some $100 million in interest arrearages.[ 25X1 25X1 The accord was signed on 13 July. The scheduled signing was threatened at the last moment when the Poles insisted that all banks accept the new money portion of the agreement. They eventually agreed to less than 100-percent approval. 25X1 Progress with the Paris Club has been slowed by Warsaw's delays in meeting the creditors' conditions for resuming debt relief negotiations. Warsaw initially agreed to pay all creditors 20 percent of the arrear- ages under the 1981 Paris Club rescheduling agree- ment 25X1 as well as all of the unrescheduled debt due the United States in 1981. The money was due at the end of May, but many creditors have reported receiving only partial payments. In addition, Warsaw now maintains that it will pay only 20 percent of $34 million in unrescheduled principal and interest due under the 1981 bilateral agreement with the United States. In early July, the Polish delegation informed creditors that payments could not be met because of 25X1 lack of funds. The regime in Warsaw apparently has set aside a fixed amount for debt repayments, and this limit cannot be exceeded. The delegation repeated its request that new financing was needed to meet debt obligations. A working group of the Paris Club has scheduled its next meeting for September and only then if the payments problem has been resolved. Even if it eventually completes reschedulings with commercial banks and the Paris Club and obtains some new credits, Poland will still face a financial gap of nearly $8 billion this year. This includes $2.7 25X1 on all of the debt to be rescheduled. Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret Table 5 Romania: Financing Requirements and Sources, 1982-84 Romania In narrow financial terms, Romania's turnaround has been the greatest in Eastern Europe and one of the most dramatic among all problem debtors. Bucharest has run sizable surpluses in its hard currency accounts the past two years in contrast to the large deficits Financing requirements 3,820 1,998 710 Current account balance 655 902 1,000 Trade account balance 1,525 1,633 1,800 Exports 6,235 6,238 6,600 Imports -4,710 -4,605 -4,800 Net interest -917 -725 -730 Other services 47 -6 -70 Debt repayments 2,830 2,219 1,528 Medium-and long-term 2,081 1,263 1,190 Short-term 749 956 338 Net credits extended -502 -293 -182 Arrears from previous year 1,143 388 0 Financing sources 3,316 1,876 755 Credits 1,591 1,056 560 Medium- and long-term 334 586 220 Short-term 956 338 300 301 132 40 Debt relief 1,700 749 0 Change in reserves -25 -71 -195 Errors and omissions 116 122 -45 388 a Preliminary. b Projected. billion due Paris Club creditors in 1984 under original loan contracts and obligations owed to individual companies, LDCs, and CEMA banks. Moreover, Warsaw would be burdened with resuming payments to governments after two and a half years of self- imposed debt relief. Despite four years of debt reschedulings, Warsaw still faces unmanageable financing requirements in 1985 and beyond. Not only will further reschedulings be necessary, creditors almost certainly will have to renegotiate agreements already concluded.) recorded between 1977 and 1981. The current ac- count surplus climbed to over $900 million in 1983- up from $655 million a year earlier (see table 5). These gains stem almost entirely from tight import curbs that enabled Bucharest to run trade surpluses in both years exceeding $1.5 billion. The current account surplus in 1983 allowed Romania to reduce its net hard currency debt by nearly $650 million from the 1982 level of $9.4 billion. 25X Despite the improved current account, debt relief from Western banks and governments was needed again in 1983. Bucharest's rescheduling efforts pro- ceeded more smoothly than the 1982 negotiations. As early as February 1983, Romania and major Western banks had agreed on terms, albeit tougher than those of 1982: only 70 percent of some $900 million in principal payments to banks were rescheduled instead of the 80 percent in 1982, and short-term debt was not covered. The Paris Club agreed to reschedule 60 percerft of principal due in 1983 on medium- and long-term guaranteed credits. Romania so far has made good on its goal of avoiding a rescheduling this year. This is largely due to a projected hard currency trade surplus of $1.8 bil- lion-assuming growth of about 4 percent in both exports and imports-and lower debt service obliga- tions. But to keep current on meeting bank repay- ments_ Romania is squeezing foreign suppliers 25 25X Romania has delayed- payments on 25X imports and pressed suppliers to accept either coun- tertrade deals or discounted repayments in cash. Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret In addition, Romania must cope with the cancellation of the final drawings of its 1981 IMF standby ar- rangement (worth nearly $300 million). Romania and the Fund agreed to end the standby credit because Bucharest refused to raise energy prices further and complete some studies requested by the Fund. Ac- cording to press reports, the Romanians will not request a new standby arrangement. Romania's financial progress has been costly and may be short lived. The huge trade surpluses-primarily the result of a 42-percent drop in imports in 1981- 82-have drained the economy and damaged the outlook for genuine recovery. Investment fell over 10 percent in 1981-82, and the officially acknowledged drop in consumption in 1982 was the first decline since World War II. In addition, industrial production growth has averaged a little over 1 percent the last three years, which is the slowest growth in the postwar era. The breathing space associated with rescheduling ends in 1985 when Bucharest must begin to repay obligations rescheduled in 1981. Total repayments of medium- and long-term debt, including IMF repur- chases, are scheduled to climb to almost $1.7 billion. The Ceausescu regime most likely will respond to the pressure of covering its external obligations by con- tinuing to earn large trade surpluses rather than deal with underlying economic problems that hurt compet- itiveness and prevent sustainable and balanced growth. Hungary Hungary's financial position improved in 1983 even though Budapest failed to meet all its goals. The borrowing campaign fared reasonably well, bringing in roughly $1.3 billion in medium-term loans (see table 6). In addition to $352 million in IMF credits, Budapest obtained a $200 million three-year club loan from Western banks, $239 million in project credits from the World Bank, a $275 million commercial loan to cofinance World Bank projects, and increased trade credits. A surge in short-term borrowings late in the year helped boost gold and foreign exchange reserves by $600 million. The major disappointment was that the trade surplus reached only $877 million and the current account surplus only $297 million. Table 6 Hungary: Financing Requirements and Sources, 1982-84 Financing requirements 4,208 3,048 3,351 Exports 4,876 4,847 5,000 Imports 4,110 3,970 4,100 Net interest -976 -662 -580 Repayment of medium- and long-term debt 894 1,216 1,534 Repayment of short-term debt 2,849 1,764 2,123 Net credits extended -192 -65 -94 Repayment of BIS credit 210 300 0 Financing sources 4,244 3,151 3,251 Credits 3,663 3,751 3,240 Medium- and long-term 1,154 1,276 1,100 Short-term 1,764 2,123 1,700 235 352 440 510 0 0 a Preliminary. b Projected. 25X1 Overly buoyant domestic demand bears some of the blame, but depressed export prices and a substandard grain harvest also kept export gains well below the original goal. Unlike other East European countries, Hungary is again counting heavily on medium-term bank loans to cover much of its 1984 financing requirement. Buda- pest faces $1.5 billion in medium- and long-term debt repayments-up from $1.2 billion in 1983-and its IMF stabilization program calls for a reduction in short-term debt to limit vulnerability to the type of liquidity crisis that occurred in 1982. While total debt Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 repayments thus are $800 million more than last year, Budapest plans to increase its current account surplus to only $400 million. Hungary is obtaining some $440 million in standby credits from the IMF, but it will need more than $1 billion in medium- and long-term commercial financing to prevent erosion of its re- serves This year's borrowing campaign is off to a good start and should meet the $1.1 billion target. A $150 million bankers' acceptance was oversubscribed- eventually reaching $210 million-and an Arab con- sortium drummed up $50 million. The World Bank has approved another $200 million in project loans; commercial cofinancing loans for these projects will likely reach $450 million. Budapest may seek another syndication toward the end of the year to help offset any shortfall in the current account and to buttress foreign exchange reserves. Foreign exchange holdings dropped around $400 million in the first quarter of 1984 as Budapest reduced its short-term debt in compliance with the IMF program. Early indicators for trade and current account per- formance seem favorable. Despite the lifting of some import restrictions, the hard currency trade surplus increased to $213 million in the first quarter of 1984 from $150 million in the same period of last year. The current account was in balance in contrast to last year's first-quarter deficit, indicating that the goal of a $400 million surplus for the year remains attainable. The Hungarians, nonetheless, must record substantial increases in exports since they have removed more import restraints in accordance with their IMF stabi- lization program. Sustained export gains are uncer- tain because they depend significantly on the outcome of this year's harvest. The success of Hungary's foreign borrowing effort has led many observers to conclude that the country is close to financial recovery. Hungary's bankers exude increased confidence and insist that a debt reschedul- ing would only increase borrowing costs and yield little relief in managing medium- and long-term debt. This optimism, however, tends to obscure important challenges facing Hungary's economic and financial managers. Budapest must cover large debt repay- ments in the next two years, $1.5 billion in 1985 and $1.2 billion in 1986. Improvqments in the economy's efficiency and competitiveness are needed to increase the trade surplus. Budapest-with prodding from the IMF-is working out a new package of structural reforms to be introduced in 1986 for the purpose of improving trade performance. Hungary's experience shows, however, that the payoff from reform is not quick. Trade prospects also depend on the willingness of Hungary's CEMA trade partners, in particular the USSR, to allow Budapest to continue running large 25X1 surpluses in intra-CEMA hard currency trade. In recent years, Hungary has relied on these surpluses to offset deficits in trade with the developed West, and Budapest is concerned that the Soviets will not want to continue this practice. None of these problems foreshadow an imminent financial crisis, but Hunga- ry's position will remain vulnerable for the next several yearsF____1 25X1 Yugoslavia Belgrade's creditors recognized by early 1983 that the country could not meet its debt obligations. The IMF, which was shepherding Yugoslavia through the last 25X1 year of a three-year stabilization program, pressed Western governments and banks to adopt a rescue plan for 1983 that would refinance maturing medium- and long-term credits, halt the erosion of short-term debt, and ensure enough new credits to rebuild Yugo- slavia's depleted reserves. The IMF hoped-at least initially-that the refinancing package, coupled with improvement in Yugoslavia's current account, would produce a strong enough revival in commercial lend- ing so that Yugoslavia would not require more help in 1984. The plan eventually grew into a complicated package involving new credits and refinancing: ? Western governments pledged nearly $1.2 billion in export credits, financial loans, and rollovers of maturing officially backed loans. ? Western banks refinanced $1.0 billion in medium- term loans for six years with a three-year grace period, kept in place $900 million in short-term credits, and exteqded $600 million of new untied loans. ? Net funding from the IMF-involving the last drawings from the 1981 standby credits-and the 25X1 World Bank amounted to nearly $700 million. ? The Bank for International Settlements contributed $500 million in short-term bridge loans.F__1 25X1 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret Yugoslavia achieved a major improvement in its trade and current accounts in 1983 (see table 7). Belgrade cut its trade deficit from $3.5 billion in 1982 to $1.8 billion in 1983 as a result of an upturn in exports and sharp cuts in imports. The delayed disbursement of credits in the refinancing package contributed to the reduction in imports, but the improvement in trade performance also resulted from the large devaluation of the dinar demanded by the IMF and Yugoslavia's success in redirecting exports from CEMA to convert- ible currency markets. Because of the reduced trade deficit and a revival of tourism earnings, Yugoslavia moved its current account balance from a $1.6 billion deficit in 1982 to a $300 million surplus in 1983.F- Despite the 1983 refinancing package and improved current account, Yugoslavia is seeking more debt relief in 1984. Belgrade faces an estimated $3.6 billion financing requirement, including $2.7 billion in repayments on medium- and long-term debt. The IMF projects a current account surplus of only $500 million for this year, leaving a large amount of maturing loans to roll over. Belgrade is not yet able to resume normal borrowing on its own, and its official foreign exchange reserves, which dropped $55 million last year to under $1 billion, give little scope for helping to cover the financial gap. Indeed, in the IMF's view, the reserves need to be increased by $500 million while the Yugoslavs would like to increase them by over $800 million. Belgrade is making progress toward covering this year's financing requirement. First-quarter current account results indicate that the IMF's projection of a $500 million surplus for the year is attainable. Reso- lution of a dispute with the IMF over pricing policies has permitted renewed disbursement of this year's $400 million standby credit. More important, settle- ment of this problem paves the way for completion of refinancing packages linked to the new IMF program: ? Private bankers have agreed to refinance $1.3 bil- lion in debts falling due this year. ? Western governments are deferring about $800 million in maturing credits and carrying over nearly $400 million in unused credits from last year's package. Table 7 Yugoslavia: Financing Requirements and Sources, 1982-84 -1,692 -1,489 -1,550 1,970 1,976 1,650 Remittances, net Repayments of medium- and long-term debt Repayments of short-term debt 2,312 1,810 1,140 Net credits extended -177 - 157 -200 5,325 4,125 3,585 4,314 4,070 4,095 1,815 250 1,810 IMF, net IBRD 563 125 410 280 10 505 2,340 2,430 790 1,190 790 390 0 800 1.550 1,240 60 980 -1,012 -55 510 530 -94 0 a Preliminary. b Projected. Includes net change in outstanding supplier credits. 25X1 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret In addition, Belgrade is counting on over $500 million in World Bank loans and about $250 million in medium- and long-term loans from other sources. Finally, last year's refinancing agreement commits banks to maintain some $900 million in short-term credit lines. Yugoslavia almost certainly will require additional- albeit smaller-refinancing packages after 1984. Even with increasing current account surpluses, Yu- goslavia will have larger borrowing needs than it can cover in the market and will require additional debt relief. Repayments of medium- and long-term debt are around $2.5 billion annually in 1985-86. Yugoslavia and representatives of US commercial banks are already informally discussing Yugoslavia's future financial needs. Yugoslav officials told US bankers that they are interested in a multiyear re- scheduling program to include 1985 and 1986 com- mercial bank debt. Belgrade also has indicated to US bankers that it would like to avoid further Paris Club refinancings. But such a move could upset bankers who are con- cerned that all creditors should be treated equally. Some bankers still harbor ill feelings about the 1983 rescue package. They feel private banks were treated unfairly since they were required to put up new money, some of which was then used to pay off government creditors. The Yugoslavs apparently are approaching further debt relief with one eye on Latin American debtors, according to the Embassy. Belgrade is monitoring closely Latin America's efforts to obtain debt relief, and Yugoslav officials have stressed increasingly the common difficulties shared by Third World debtors. We do not believe Belgrade is interested in joining a debtors' cartel as it wishes to keep current on its financial obligations and eventually resume normal borrowing. But Belgrade would argue that its finan- cial record should entitle it to more favorable terms should this occur in Latin American reschedulings. t Financial recovery ultimately depends on Belgrade's ability to regain the confidence of Western bankers by attacking systemic problems that contribute to the imbalance between supply and demand and encourage reliance on Western imports. To date, Belgrade's administrative controls and the IMF's prescribed tight monetary policy have not slowed inflation. Bel- grade will have to work harder to restrain increases in wages, prices, and domestic credit and to improve efficiency and competitiveness through systemic re- form. This would involve abandoning policies that have given primacy to regional interests over integra- tive market forces. In addition, policies that misallo- cate investment resources have been used to protect jobs by shoring up money-losing enterprises and to subordinate efficiency to political objectives. An effi- cient national foreign exchange market also is needed to ensure that all producers pay the true cost of foreign exchange and that those best able to use foreign resources receive hard currency. Despite professions of good intentions from officials and some steps in the right direction, Belgrade's capacity to overhaul its economy remains suspect. Needed adjustment policies and structural reforms may impose a higher price than society is willing to pay. The population is already grumbling about fall- ing living standards, and resistance could intensify as consumption levels decline further. Differences among regions and nationalities further complicate the collective leadership's task of reaching a consensus on burden sharing policy. At the same time, a greater reliance on market forces challenges official ideology and threatens the prerogatives of powerful vested interests in the republics. Moreover, repeated disputes over the IMF stabilization program do little to inspire creditor confidenceF__1 East Germany East Germany's financial position strengthened con- siderably in 19834due to another current account surplus, increased short-term trade financing, and special financial credits from West Germany, as well as new government-backed trade loans from other Western countries. Although faced with total debt repayments of more than $4 billion, the East Germans Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret Table 8 East Germany: Financing Requirements and Sources, 19982-84 current account surplfis remained around the $1.3 billion level. The East Germans continued to maxi- mize cash receipts by reselling for hard currency oil, silver, and other commodities obtained through barter arrangements with LDCs and on clearing account 25X1 from West Germany.~~ Financing requirevem s 4,081 2,935 2,610 Current account balance 1,239 1,310 1,080 Trade account balance 1,509 1,325 950 Exports 7,172 7,625 8,000 Imports 5,663 6,300 7,050 Net interest -1,220 -865 -820 Other net imisibles 950 850 950 Repayments of medium- and long-term debt 3,000 2,790 2,300 Repayments of short-term debt 2,320 1,430 1,390 Financing sources 3,865 2,344 NA 1,460 1,390 NA -275 1,276 NA 216 566 NA a Preliminary. b Projected. c Includes net change in supplier credits. met their obligations, reduced their gross debt to Western banks by $400 million, and built up reserves by an estimated $1.3 billion to a record $3.6 billion (see table 8). In contrast to 1982, the regime was able both to run a current account surplus and increase imports from the West. East Germany's trade surplus fell slightly, to $1.3 billion, in 1983 as a result of an 11-percent increase in imports and only a 6-percent gain in exports? The 2 A persistent problem in analyzing East German trade perform- ance is the discrepancy between totals announced by East Berlin and by Western partners. East Germany, for example, reports that its exports to nonsocialist countries rose 24 percent in 1982 and imports rose 13 percent. OECD and intra-German trade data, however, show East German exports rising 4 percent and imports falling by 10 percent. This discrepancy may be explained by different statistical procedures, the lack of LDC partner data, and failure to count East German commodity resales in Western statistics. We use East German data to compute the overall trade balance, but rely on Western sources to estimate trends in exports As in 1982, East Germany pursued a differentiated trade policy between West Germany and the other OECD countries in order to make maximum use of available import financing and to build up a convert- ible currency surplus. Capitalizing on West German trade credit facilities, East Germany boosted imports from West Germany by more than 30 percent during the first half of 1983 over the same period of 1982 and increased its net short-term debt to West Germany by roughly $300 million. During the same period, the East Germans ran a $300 million surplus with the rest of the OECD. The pattern shifted in the second half of the year when more credits became available from other Western sources. East Berlin ran a $250 million surplus in intra-German trade through a slowdown in imports and a boost in exports and paid back most of the increase in indebtedness to West Germany. While moving into surplus with West Germany, the East Germans ran a surplus of only $60 million with the rest of the OECD. 25X1 In addition to trade financing, West Germany helped ease East Germany's liquidity problems by granting a $400 million government-guaranteed financial credit with a five-year maturity. Unlike other intra-German credits, this loan was in convertible currency and not tied to trade; thus, East Berlin could use the proceeds to cover debt service payments to non-German credi-25X1 tors. By demonstrating West Germany's financial umbrella, the loan apparently encouraged Western bankers to revive lending to East Berlin and helped improve the terms East Germany could obtain on new credits 25X1 Even though the likelihood of an East German re- scheduling has diminished, the country will face financial pressures over the next few years. Repay- ments of medium- and long-term debt in 1984-85 will fall from the 1982-83 level, but at more than $2 billion annually they will remain substantial. The Secret Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 East Germans must also roll over a large short-term debt. We expect smaller hard currency trade surplus- es than in the past two years because East Berlin seems intent on expanding imports. Increased hard currency service receipts from West Germany will Table 9 Czechoslovakia: Financing Requirements and Sources, 1982-84 help offset some of the impact of smaller trade surpluses on the current account. The East Germans have been actively seeking more trade financing and have been particularly anxious to raise additional medium-term credits-including syn- dicated loans-in order to refurbish their credit rating and to stretch out the maturity structure of their debt. East Germany's foreign trade bank succeeded in raising a $75 million credit in the Euromarkets in May. While not large, the credit represents East Germany's first medium-term untied loan since late 1981 and may open the door to more such lending. In late July, West German banks extended a new $330 million untied loan guaranteed by the West German Government. Given recent improvements in East Germany's finan- cial position, there is no pressing need for the new 1,365 664 590 Current account balance 195 581 605 Trade account balance 515 771 775 Exports 4,357 4,142 4,275 imports 3,842 3,371 3,500 Net interest -380 -260 -250 Other net invisibles 60 70 80 Repayments of medium- and long-term debt c 320 435 405 Repayments of short-term debt 1,240 810 790 Financing sources 1,468 607 NA Credits 1,105 850 NA Medium- and long-term 355 100 NA Short-term 750 750 NA Change in reserves -363 243 NA Net errors and omissions -103 -57 NA a Preliminary. West German money. But the loan demonstrates the b Projected. `Includes estimated net change in supplier credits. lla continuation of the West German financial umbre and reduces doubts held by many creditors. They remain wary about East Germany, especially because of the lack of basic economic and financial data. For example, much uncertainty surrounds East Germa- ny's recent reserve buildup. Some Western observers argue that the buildup has been funded by increased borrowing from outside the BIS area, and hence East German debt has not fallen as much as BIS statistics indicate. Lacking credible statistics on East Germa- ny's trade and current account performance and on future debt service, many bankers count on continued West German financial support to offset the informa- tion gap. East Berlin's decision to revive imports and to press Western bankers and governments for new loans shows that East German planners still see trade with the West as an important element of their economic strategy. The regime probably will hold to a more cautious borrowing strategy than in the late 1970s, but East Germany probably will be more aggressive than Bulgaria and Czechoslovakia in seeking new loans to increase imports. Nonetheless, East Germany can no longer rely on its strategy of the 1970s that attained rapid economic growth and improvements in living standards through large resource transfers from the West Czechoslovakia In 1983 Czechoslovakia maintained its cautious policy toward hard currency imports and reduced its net debt for the second consecutive year. The foreign 25X1 trade plan envisioned a modest increase in both hard currency exports and imports. But a 5-percent decline in sales prompted Prague to cut imports by nearly 9 percent in order to'meet its financial targets. These reductions resulted in trade and current account surpluses of $771 million and $581 million, respec- tively, both up from their 1982 levels (see table 9)F_1 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret Czechoslovakia seems to face few borrowing prob- lems, and its liquidity has improved. The Czechoslo- vaks used part of their current account surplus last year to add more than $240 million to reserves in Western banks. To demonstrate its increased cre- ditworthiness, Prague raised a $50 million medium- term club loan from Western banks in mid-1983. Prague's senior banker described the small credit as a "symbolic question of getting back on the Euromar- kets" after the 1981-82 credit squeeze. The Czecho- slovaks apparently balked at emulating Hungary's example of disclosing more information on their debt and balance of payments in return for a larger loan. There appears to be some uncertainty about the future direction of Czechoslovakia's financial policy. In early 1984, Prague announced that it plans to pay off its debt to Western banks. A senior banking official put Czechoslovakia's net debt to banks at $1.8 billion and said Prague intends to pay off $600 million annually, about equal to the decline shown in BIS statistics for 1983. This seemed to reflect the leader- ship's frequently voiced concern that external debt provides the West with a tool for political and eco- nomic leverage. A Czechoslovak banker, however, recently indicated that Prague now has scaled back its plan for debt reduction and will permit some increase in imports of Western capital goods. The regime may have softened its stance against foreign borrowing in response to criticism from both Western bankers and Czechoslovak planners about its reluctance to modernize industry through greater Western imports. Prague's long-held financial conservatism has contributed to the technological decline of Czechoslovakia's industry and the stagna- tion of the economy. Even with economic recovery in the West, inherent weaknesses undermine export per- formance, permitting little if any growth in real imports. Some Czechoslovak economists have been arguing that a judiciously planned pickup in invest- ment-using borrowed Western resources-could help modernize key industrial sectors and jolt the economy out of its doldrums. Although the leadership may now be giving more credence to these arguments, fear of the political consequences of reliance on Western credits will probably continue to dissuade the Husak regime from adopting an aggressive strategy on Western imports and borrowing. Bulgaria Sofia's relatively low debt and lack of dependence on the West paid off during Eastern Europe's credit crunch. Creditors seemed less anxious to reduce their exposure to Bulgaria than to the rest of Eastern Europe. Although bank claims dropped somewhat, the decline probably reflected Sofia's policies as much as banks' efforts to reduce exposure. Not only was the bank pullout less severe for Bulgaria, but also the country faced minimal financing requirements as its low debt and comfortable maturity structure resulted Bulgaria-along with Czechoslovakia-remains in 25X1 the strongest financial position of any East European country. Several consecutive years of current account surpluses have enabled Sofia to cut its gross debt to about $2.5 billion at the end of 1983 and to build up reserves of $1.1 billion, enough to cover over five months' worth of imports. Creditors continue to give high marks to Sofia's financial conservatism. Bulgaria's financial strength allows it a range of options in managing its hard currency accounts. It could maintain its policy of holding down imports and reducing its debt even further. Or Sofia could use the cushion provided by the conservatism of recent years to pursue an expansion of hard currency imports. 25X1 Some reports have suggested that Bulgaria was con- sidering the latter option as Sofia was interested in negotiating contracts for Western equipment and technology needed to modernize its industry. =7 25X1 Trade performance in 1983, however, shows that Sofia still chose to limit hard currency imports in order to maintain healthy trade and current account surpluses (see table 10). Imports from nonsocialist countries were down 10 percent from the 1982 level. The decision to reduce imports probably was driven by the 13-percent drop in exports to the West. Sales were off significantly to Iran, Iraq, and Libya, which rank among Sofia's largest hard currency trading partners. Bulgaria ended the year with a trade surplus of $464 million, down $150 million from a year earlier. The current account surplus was $624 million, compared to $669 million in 19821 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret Table 10 Bulgaria: Financing Requirements and Sources, 1982-84 Financing requirements 811 816 650 Current account balance 669 624 600 Trade account balance 614 464 400 Exports 3,298 2,879 2,900 Imports 2,684 2,415 2,500 Net interest -215 -130 -120 Other net invisibles 270 290 320 Repayments of medium- and long-term debt 640 510 490 Repayments of short-term debt c 840 930 760 Financing sources 996 1,083 NA Credits 1,170 1,145 NA Medium- and long-term 270 385 NA Short-term 900 760 NA Change in reserves 174 62 NA Net errors and omissions -185 -267 NA Preliminary. n Projected. Includes net change in outstanding supplier credits. Exports must recover if Bulgaria is to meet its plans for modest expansion of trade with the West. Sofia, however, cannot count on large export gains because Bulgaria is not very competitive in developed country markets and must rely on Third World customers who are struggling with debt problems. If it chose to do so, Sofia probably could finance a larger volume of imports because of its good standing with bankers. The regime, however, probably will keep a close eye on its balance-of-payments performance an will not allow a repetition of the comparatively large deficits that occurred in the mid-1970s. Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret East Germany's Economic Links to West Germany Key Judgments A unique bilateral economic relationship has allowed East Germany to Information available derive significant benefit from West Germany over the last 35 years as of 27 July 1984 despite their often bitterly adversarial political relations. Just as signifi- was used in this report. cantly, East Germany has been able to do so without becoming excessively dependent on its Western neighbor: ? During 1976-82 alone, the special relationship yielded an estimated net flow of resources to East Germany totaling over 12 billion West German marks (DM), (This was worth nearly $6 billion at then prevailing exchange rates.) ? In June 1983 Bonn decided to guarantee an untied DM 1-billion loan from West German banks. Another loan of similar proportions was approved in July 1984. The key for East Germany has been its ability to exploit special intra- German trade and financial mechanisms to obtain vital imports on credit and to obtain hard currency for purchases in other countries: ? Bilateral trade has been conducted since the early 1950s through a clearing account mechanism that allows East Germany to purchase West German goods without spending hard currency. ? Because of readily available West German credits, East Berlin has been able to run chronic bilateral trade deficits that, particularly during the 1970s, allowed it to support rapid economic growth and rising consumption. ? Since the normalization of relations in 1972, millions of West German visitors have provided significant hard currency revenues. Bonn has also paid East Berlin considerable sums of hard currency for services and for major construction projects improving the economic health of West Berlin. Although East Germany did not escape the economic malaise that gripped Eastern Europe by the early 1980s, the intra-German relationship helped East Berlin to weather its acute financial problems in 1982-83. East Germany used the clearing account to finance increased imports of West German goods as well as commodities obtained from third countries. At the same time, East Berlin not only boosted sales to other Western countries, but used the large special earnings on services to West Germany to cover hard currency obligations outside West Germany. Perhaps most important, Western lenders have seen Bonn's loans as creating a West German financial "umbrella" underwriting East Germany's creditworthi- ness. iii Secret EUR 84-10160 August 1984 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 25X1 25X1 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret Bonn has supported these special economic mechanisms more for political than commercial reasons, and has done so for most of this period without wresting major political concessions from East Berlin. All West German governments have felt responsibility for the well-being of the East German people, and most have justified a special relationship as keeping alive ties that could lead to eventual reunification We believe that East Germany will continue to be able to derive considerable economic benefit from its special relationship at relatively little cost. We expect Bonn will adhere fundamentally to its accommodat- ing line despite conflicting domestic pressures in West Germany that will impel it to seek more tangible political concessions for future assistance: ? Tourism, fees, and long-term agreements on services should provide East Berlin at least DM 2 billion annually over the next few years. ? The extensions of the loan guarantees serve as a precedent for Bonn providing special assistance on short notice. Although not economically dependent on the West German connection in any absolute sense, we believe East Germany will continue to regard the special relationship as vital to addressing its significant economic problems: ? East Germany's financial position, although improved significantly, remains vulnerable: its factories need modernization, and it must become more efficient in its use of oil and raw materials that Moscow is reluctant to continue providing on concessionary terms. East Germany's dealings with West Germany will be constrained, however, by the Soviet leash and its own fears of becoming too dependent on its neighbor. Secret iv Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret Special Earnings and Other Invisibles 10 B. West Germany: Deutsche Marks per US Dollar C. East Germany: Trade With West Germany F. East Germany: Hard Currency Balance of Payments and Debt 29 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sec. Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Figure 1 Intra-German Trade: Goods and Payments Flow M Financial flows accompanying sale of East German goods to the FRG Merchandise flow accompanying sale of West German goods to the GDR Financial flows accompanying sale of West German goods to Merchandise flow accompanying sale of East German goods to the GDR the FRG This diagram represents a conceptualization of intra-German trade. ? All clearing account flows are in Verrechnungseinheit (VE). In a typical transaction, an East German exporter delivers goods to a West German firm and is paid in East German marks (DME) by the East German State Bank. The FRG firm pays for the goods by delivery of West German marks (DM) to the Bundesbank. The two central banks settle the transactions in accounting units (VE) through the clearing account. In the case of an East German purchase, the payments flows are reversed. Secret Vi Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret East Germany's Economic Links to West Germany F_ Ties between the two Germanys have long included a special economic relationship that has provided East Germany substantial support, especially since the early 1970s. This paper attempts to analyze the various aspects of that special relationship-trade, credits, service transactions, payments for emigration, and transfers-and to assess the economic advantages East Germany has derived and the prospects for future benefits. The paper also provides a description of the legal and institutional framework governing trade and financial links between the two countries. The conclusions must remain tentative in some areas, however, because we have only limited information on the inner workings of the economic relationship. Both Bonn and East Berlin cloak many of their dealings in considerable secrecy. The First Quarter-Century Despite the severe disruption of economic ties during the late 1940s as a result of the occupation policies of the victorious allies, particularly the Soviets who forced partition, West Germany remained a relatively important trading partner for East Germany. In the early 1950s, West Germany was East Germany's largest nonsocialist partner but lagged Poland, Czechoslovakia, and Hungary as well as the USSR. This pattern reflected, of course, eastern Germany's traditional trade ties with the western part of Germa- ny as well as East Berlin's limited commercial rela- tions with other Western countries and its heavy dependence on trade with the USSR and its new East European allies.' Despite political tensions during the 1950s, both sides sought improved commercial relations. Although the Adenauer government refused to recognize East Ger- many as a separate country (and threatened to break ' By contrast, the FRG's greater size, more rapid growth, and marked reorientation toward the West consistently have made bilateral trade with East Germany comparatively less important to it. In terms of trade volume, the GDR is about as important to the relations with any country that did), it favored an expansion of commercial links. Moreover, West Ger- man business and labor wanted to boost exports as a way of fostering growth. For its part, East Germany needed capital equipment and spare parts unavailable in the East. Such motivations contributed to the conclusion in 1951 of the Inter-Zonal Trade Agree- ment (IZT), which established rules for bilateral commerce and facilitated trade during a period when the two countries' currencies were inconvertible and both countries were short of hard currency (see inset, "The Intra-German Trade and Finance Mechanism" and figure 1). The IZT established a clearing account mechanism and included a "swing" credit overdraft facility to cover short-term trade imbalances. These 25X1 arrangements reduced the need for East German firms to obtain bank financing for their trade with 25X1 West Germany. The 1957 Treaty of Rome, which established the European Economic Community, ex- plicitly protected the intra-German trade relationship by accepting Bonn's claim that this trade is "domes- tic" and by exempting East German exports to West Germany, but not to other members, from tariffs. By 1960 the value of West Germany's share in East Germany's overall trade had increased from less than 5 percent to about 11 percent, or to over 45 percent of East Germany's trade with the nonsocialist world.' The volume of trade continued to rise in the 1960s despite the Berlin Wall crisis and continuing East- West tensions (see figure 2). In the 1960s West German businessmen, becoming convinced that bilat- eral tensions were costing them contracts, increasingly pushed for an easing of trade restrictions. The West 25X1 German Government itself came to show greater interest in improving relations with East Germany, particularly after the Social Democrats became part of the ruling "Grand Coalition" in December 1966. Government steps to help stimulate trade included a ' See appendix A for a description of the data sources and problems associated with the analysis of intra-German economic relationsF_ Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Reflecting the unusual intra-German political rela- tionship, the two Germanys have established special mechanisms to handle bilateral trade. The legal basis of intra-German trade continues to be the September 1951 Interzonal Trade Agreement, or Berlin Agree- ment, that was established tofacilitate trade between the two Germanys. Modified several times, the Agreement requires that: ? Trade must eventually be balanced, although no payment schedule is stipulated. ? Trade is conducted in a special accounting unit, the Verrechnungseinheit (YE), which for practical pur- poses is equal to the West German mark (DM) but which cannot be converted into DM. ? Payments are made through clearing accounts of the note-issuing banks of each country. The banks currently operate three accounts-two for commod- ities and one for services. ? To maintain the flow of goods, each side is allowed to overdraw its clearing accounts up to a specified limit-the "swing" credit. Originally, any overdraft had to be settled once each year. The FRG waived its right to this requirement in 1968, and the swing subsequently has been, in effect, a permanent West German interest free credit to East Germany. gradual simplification of commercial regulations, re- laxation of some quotas, and cuts in tax rates. After months of negotiation, interrupted only briefly by the Warsaw Pact invasion of Czechoslovakia, the two sides signed a new trade agreement in December 1968. The agreement raised trade quotas and in- creased the level of the "swing" credit, and the West German Government waived its right to demand annual balancing of merchandise trade payments.[ 25X1 New Ties The economic relationship expanded further with the normalizing of political relations in the early 1970s. The new government of Chancellor Brandt sought improved relations with the GDR in order to increase ? A special "Account S" established in 1958 allows payment for goods and services in hard currency. East Germany has used the account rarely in recent years to make payments. East Berlin, however, has sought to have some of its receipts funneled through Account S, while generally using the clearing ac- count to run up its debt to the FRG. Medium- and long-term financing of West German capital goods exported to the GDR is handled by a special organization, the Gesellschalt zur Finanzier- ung von Industrieanlagen MbH (GeFi). Although under the administrative control of the corporation that finances East-West trade (Ausfuhrkredit-Gesell- schaft MbH, AKA), the GeFi is a legally independent institution. Similarly, West German export insurance is provided by the Deutsche Revisions and Treuhand, A.G. (Treuarbeit) instead of Hermes-Kreditversicher- ungs A.G. (Hermes), a private company which acts as agent for the FRG Government in providing credit insurance for exports to other countries. In contrast, East Berlin handles intra-German trade through its regular foreign trade institutions because it considers such transactions to be foreign commerce contacts between residents of the two countries, to improve links between the FRG and West Berlin, and to keep alive hopes for eventual German reunification. West Germany also offered to conduct relations on a more equal basis (implying the abandonment of its 25X1 longstanding claim to being the only legitimate Ger- man state) and held out the prospect of increased economic benefits.F__~ 25X1 East Berlin eventually responded to Bonn's overtures, but only after some prodding from Moscow and the replacement of hardline party leader Walter Ulbricht by Erich Honecker.3 The Honecker regime probably saw Bonn's offer of "equality" as a way to boost its Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret Figure 2 East Germany: Foreign Trade by Country Groups, 1960-82 Socialist Other nonsocialist West Germany 150 ---- 0 1960 61 62 63 64 65 66 67 68 Source: Statistisches Jahrbuch der Deuischen Demokratischen Republik (various years) legitimacy and international standing. While remain- ing wary of close economic ties because of fear that they would lead to an undesirable dependence on its rival and raise concern in Moscow, the Honecker regime also undoubtedly tried to exploit the advan- tages of economic cooperation-particularly in view of its ambitious plans for the 1970s. The economic consequences of this new special rela- tionship-especially after conclusion of the "Basic Treaty" in 1972-have been a steady increase in ' East German Premier Stoph met Chancellor Brandt twice in 1970. but relations remained relatively cool until 1971, when Erich Honecker replaced Ulbricht and the four occupying powers signed the Quadripartite Agreement clearing up longstanding East-West "Ierences over Berlin. Subsequently, the two sides signed major ftsr. agreements in 1971 and 1972 that opened the way for much z?Mndcd bilateral contacts. The "normalization" of bilateral politi- cr1 tetations-through the conclusion in December 1972 of the *06"c Treaty on Relations Between the Federal Republic of ~s>anr and the German Democratic Republic"-established the bilateral trade, chronic East German trade deficits (financed largely by readily available West German trade credits), and significant hard currency earnings for East Berlin from invisible transactions and direct payments by Bonn. West German Government esti- mates of the balance of payments between East and West Germany indicate that the relationship has yielded a net flow of resources to East Germany totaling some 12.4 billion West German marks (DM) over the period 1976 to 1982.? 25X1 ' In this paper we generally use West German Deutsche Marks (DM) because West German trade and financial data are our best source of information and valuation in DM provides a better indication of real resource transfers during a period of considerable fluctuation in the dollar-DM exchange rate. The estimated net gain to East Germany of DM 12.4 billion would equal nearly $6 billion converted at the average annual exchange rates prevailing in the Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Y ~ Commercial Advantages Is W,u Germ"Y -1+ subject to licensing and some restrictions, ~,, f A" German goods enjoy special access to West Gesrtaur markets. The intra-German trade clearing m, hanism_.--unique in East Germany's trade with ae*vloped Western countries-reduces the need for ,arranging commercial bank credits, a major advan- la a In times of tight credit. The clearing mechanism also eliminates the risk of exchange rate fluctuation, a problem when East Germany trades with third ' countries in dollar-denominated deals East German manufactured goods are not subject to West German tariffs. The GDR thus escapes duties which the EC estimates will average 7 percent when the current (Tokyo) round of tariff cuts is completed. Moreover, Bonn does not impose a value-added tax (currently 14 percent) on East German manufactures even though they are classified as "domestic" goods, thus giving West German importers special incentive to buy East German products. Bonn also exempts East German services and agricultural goods from other domestic taxes. On the other hand, Bonn charges a tax on sales to the GDR even though it does not tax "exports. " West German officials have ar- gued publicly that the purpose of the tax was to help reduce East Germany's chronic trade dcficits. The actual benefit to the GDR of such policies is difficult to calculate because the savings are shared by both purchasing and selling firms. West German consumers also benefit from lower prices. One West German critic of the special relationship nevertheless estimates, probably excessively, that in 1980 the FRG government lost DM I billion from the duty exemption, DM 100 million from the farm product exemption, and DM 300 million from the lack of VAT. 25X1 Intra-German Trade. Developments in bilateral trade since the early 1970s have been shaped by the two countries' competing political objectives, their desire to exploit the commercial opportunities offered by mutually advantageous trade, and the unique institu- tional arrangements that govern their trade. East Figure 3 East Germany: Trade and Debt With West Germany, 1970-83 - Exports --- Imports -Net debt Swing limit - Swing actually used 11 I I 1 1 1 1 I I 1 0 1970 71 72 73 74 75 76 77 78 79 80 81 82 83 Source: West German Government Statistics Germany used its commercial ties and special finan- cial arrangements with West Germany to boost im- ports, particularly of capital goods, chemicals, and nonferrous metals; to support its ambitious targets for economic growth; and to sustain increases in personal consumption. Despite its preferential access to West German markets (see inset, "East Germany's Com- mercial Advantages in West Germany"), the growth of East German exports-while impressive in some years-did not keep pace with imports, in part be- cause of the low quality of goods being offered. As a Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret Figure 4 East Germany: Terms of Trade With West Germany, 1970-82 1 1 1 1 1 1 1 1 1 1 I I 1 1970 71 72 73 74 75 76 77 78 79 80 81 82 Source: German Institute for Economic Research (West Berlin) result, in the decade ending in 1979, East Germany annually ran deficits in its trade with West Germa- ny-averaging about DM 400 million per annum (see figure 3 and appendix C).' East Germany returned to surplus in 1980-82, before the onset of its financial crisis, as the regime pushed exports harder and con- trolled imports better. ' East Germany ran the deficits despite significant surpluses in its trade with West Berlin. The GDR sells large quantities of goods to the city; much of the oil products it sells to the FRG go to West Berlin, and East Germany also provides the enclave significant quantities of raw materials. West German statistics show that, in 1982, nearly 31 percent of East German exports to the FRG went to West Berlin, whose population was only about 3 percent of West Germany's.0 East Germany's cumulative trade surplus with West Berlin totaled nearly DM 6 billion during the 1970s even as its overall deficit with the FRG during the period was DM 4.1 billion. The surpluses swelled further in 1980-82, reaching 1.72 billion DM in 1982. Without its commerce with West Berlin, East Germany's trade balance with West Germany in 1982 would have shifted from a DM 257-million surplus to a DM 1.46-billion deficit. Technically, West Berlin and East Berlin do not "belong" to the FRG or GDR. Unless otherwise noted in this paper, however, each country's statistics include "its" part of Berlin Despite the advantages of bilateral trade, we believe that the Honecker regime kept the size of these deficits under some control because neither it nor the Soviets wanted East Germany to become excessively dependent on West Germany. Another factor helping to moderate the size of bilateral trade deficits was the improvement in East Germany's terms of trade with West Germany (see figure 4). Scholars at the German Institute for Economic Research (DIW) estimate that East Germany's terms of trade improved by nearly 39 percentage points between 1970 and 1982, with par- ticularly large gains in 1973-74 and 1979-80-years of large oil price hikes. Their price series indicate that East Germany's worsening terms of trade in capital goods and farm products was more than offset by improvements in manufactured goods and, particular- ly, raw materials related to oil. The composition of intra-German trade has been similar to West Germany's trade with other East European countries. West Germany has continued to export technically advanced goods, according to West German statistics, while in recent years about three- fourths of its imports from East Germany consisted of raw materials, semifinished goods, and consumer 25X1 products. The share of investment items in East German sales fell in the early 1970s and in recent years has languished at about 10 percent (see figure 5 and appendix D). The East Germans have had little success in selling high-technology goods to the West and, in the manu- factures field, have concentrated on relatively simple machinery and consumer goods. Moreover, in the 25X1 view of knowledgeable Western observers, the East Germans have consistently exported rather poor-qual- ity goods and have suffered from marketing and service problems. In addition to oil products, East Germany exports large quantities of intermediate goods-such as steel and chemicals-which it can price competitively and which face less stringent quality standards. Knowledgeable West German com- mentators and government officials regularly have expressed dissatisfaction with the composition of bi- lateral trade and have pointed to the low technological level of East German goods as a major impediment to the further growth of intra-German commerce. 25X1 25X1 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Figure 5 East Germany/West Germany: Composition of Trade, 1970-82 Percent Raw materials/ producer goods ? Investment goods Foodstuffs West German Exports Consumer goods Mining products and energy 0 Other Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87BOO342ROO0100200011-3 Secret The lack of West German tariffs on East German goods provides East Berlin an opportunity to use West Germany as a channel for sending goods to other EC countries. the East Germans on occasion have: ? Falsely labeled East German products as West German or "German "for duty-free reexport to other EEC countries. ? Reassembled or repackaged Eastern Bloc and Asian goods for reexport to the FRG as East German products. ? Delivered components for assembly in West Germa- ny as West German goods. West Germany periodically has charged businessmen with violations of trade regulations and has obtained- convictions. The West German Government estimates, however, that such illegal transactions account for less than I percent of bilateral trade. Evidence available to us suggests that East Germany does not pursue an official policy of directing exports to other EC coun- tries through West Germany. (high-level East German directives about devej- 25X1 oping commerce, especially exports, with selected nonsocialist countries-including EC member 25X1 France fail to mention any efforts to route sales through the FRG. In fact, East Berlin repeatedly has sought to negotiate individually with other nonsocial- ist countries bilateral trade pacts, barter deals, offi- cial credits, and loan guarantees on terms that require payment of appropriate duties. If comparatively easy access to the West German market has skewed the distribution of East Germa- ny's trade with nonsocialist countries, it does not appear to have markedly increased East German trade with Western countries as a group. Neighboring and structurally similar Czechoslovakia, which con- ducted only 6.2 percent of its trade with West Germa-25X 1 ny versus East Germany's 8.6 percent in 1982, showed an overall trade with the West that was nearly identical to East Germany's, according to official statistics. Moreover, Hungary and Roma- nia-and Poland before its recent economic trou- bles-have had higher percentages of overall trade with the West. 25X1 Accompanying the rise in intra-German trade in the 1970s was an even faster growth of East German trade with other nonsocialist countries and LDCs. A slowdown in the growth of deliveries of Soviet raw materials threatened ambitious East German plans for upgrading domestic consumption and led East Germany to turn increasingly to nontraditional part- ners such as the United States and the LDCs to cover its import needs. The boom in East-West trade and the increased availability of Western credits in the early 1970s created opportunities for East Germany to increase trade with other Western countries. And, as hard currency deficits soared, East Germany tried to boost exports to these markets, sometimes using its special West German "window" (see inset, "Window to the West?"). As a result, although West Germany has remained East Germany's second-largest trading partner, East German statistics show the FRG's share of GDR trade with nonsocialist countries fell from about 36 percent in 1970 to less than 25 percent in 1981 before rising slightly in 1982 (see figure 2).6 25X1 Western partner country trade data, however, show a greater West German role in East Germany's trade with nonsocialist countries when calculated in hard currency terms. IMF, OECD, and West German data indicate that West Germany accounted for about 40 percent of such trade in the 1970s, ranging from as much as 46.0 percent in 1971 to as low as 37.7 percent in 1974. We believe that the discrepancy between the two series reflects valua- tion differences due to use of exchange rates that often do not correspond to current market rates, possibly differing concepts of attributing origins of foreign trade, and lack of accurate reporting by some LDCs. Vjestern countries' data attribute commerce to the country of purchase or sale, while the East Germans reportedly source trade with Western firms to the country of each firm's parent organization-sometimes multinational corporations based in third countries. Such practices probably also help account for significantly different Western and GDR figures on East Germa- ny's trade with Austria. East Berlin's presumably consistent meth- od of calculating GDR trade worldwide makes its figures useful for comparing East Germany's trade by region of on ,in even though they may understate West Germany's role in economic relations Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87BOO342ROO0100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret Importance of The "Swing" East Germany has long used the interest free "swing" credit extended by Bonn to finance its purchases from West Germany even when it ran trade surpluses. Created as part of the Frankfurt Agreement of 1949, the swing facility was raised in stages from DM 16 million in 1949 to DM 30 million in 1951 and to DM 200 million in 1960. In the period 1969-75, the swing was set at 25 percent of the previous year's bilateral trade before being raised to a flat DM 850 million in 1976. An impasse in late 1981 over terms for renew- ing the swing agreement-including West German efforts to link renewal of the swing to an East German reduction in the Zwangsumtausch (the mini- mum daily currency exchange requirement imposed on Western visitors to East Germany)-prompted the two sides to extend the swing on existing terms for 6 months. They eventually agreed in June 1982 to cut back the swing gradually from DM 850 million to DM 600 million by 1985. At current interest rates and utilization levels, the swing represents a savings to East Berlin of about DM 30-50 million annually- the amount East Berlin would have to pay to secure the same credit from commercial sources. As intra-German trade has grown, the swing has become a relatively less important means offlnancing trade. the value of the swing fell from 30 percent of overall trade in 1976 to 16 percent in 1982. Because trade is likely to grow and the credit limit is to fall through 1985, the swing will become an even less important instrument of bilateral trade. Financial Links. East Germany financed most of its trade deficits with West Germany during the 1970s by borrowing from FRG institutions and using the "swing credit," even though it was running large bilateral current account surpluses (see inset, "Impor- tance of the `Swing"'). In the years 1976-80, for example, movements in intra-German debt closely mirrored trends in the trade balance, with cumulative East German trade deficits totaling DM 1.3 billion compared with net capital inflows of DM 1.6 billion (see table 1). The positive services balance deriving from the "special relationship" had limited impact on the level of debt to West Germany because most of the earnings represented convertible currency receipts that East Berlin opted to spend outside the bilateral relationship. East Berlin's policy clearly has been to exploit the intra-German bilateral trade and financial mechanisms in order to maximize the financial re- sources available to cover hard currency purchases 25X1 Debt held by West German commercial and govern- ment sources roughly tripled during the decade before tapering off slightly in 1980-82 (see figure 3). We calculate that during the 1970s financing from West German domestic sourcescovered 62 percent of East Germany's accumulated deficit on bilateral trade, while credits from subsidiaries of West German banks in other countries may have provided an additional 10 percent.' Nonconvertible services ties and some con- vertible earnings payments through the so-called S hard currency account covered much of the rest. Much of this lending was extended by the West German Government. Official West German figures show that in 1982 government credits and guaranteed commercial loans comprised about 60 percent of the DM 4.6 billion in debt held by domestic West Ger- man sources-similar to the government's share in financing exports to other East European countries! We estimate that in 1982 West German institutions held only about 15 percent of East Berlin's hard currency debt, although West Germany accounted for about 25 percent of East Germany's trade with all nonsocialist countries.' The relatively low West Ger- man share of East German debt in part reflects the ' One West German banker claims FRG banks use offshore subsidiaries to raise most of the credits not covered by Bonn's loan guarantees and estimates that this is about 10 percent of all West German loans. (c NF) ' The DM 4.6-billion debt total reported for yearend 1982 is gross debt and does not take into account East Germany's claims on West Germany. Net debt, which subtracts from gross debt the amount of East German deposits in West German banks and East German billion at yearend 1982. West Germany's actual share of East German debt almost certainly is somewhat higher. Although we believe we have cap- tured most West German credits, we have probably not included all, for example, that some short-term supplier credits are not even reported to the West German Government. 25X1 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret Table 1 East Germany: Balance of Payments With West Germany Current account balance 728 d 852 d Trade Balance -392 a -448 a Imports (gross) 4,269 a 4,409 a Deductions b Services (net) 500 d 580 d 600 d 1,245 c 902 c 1,091 c 1,104 c Transfers (net) 620 d 720 d 740 d 741 b 859- 859 c 831 c Balance on capital account 190 d 390 d 710d 186 c 88 c -297 c 117c Swing credit -75 a 71 a -71 a 3 c 16 c -231 c -92- "S" account -5c -25c -21c 21C Balance on capital and current accounts 918 d 1,242 d a Public information. b The West German Government internally deducts transactions with third countries and certain payments from its publicly an- nounced import and export figures. c 1983 Bundesbank study. smaller trade deficit accumulated with West Germa- ny in the 1970s compared with deficits with the rest of the West, as well as West German regulations that prohibit domestic banks from extending untied loans to East Germany or financing GDR trade with other countries.' '0 Overseas subsidiaries of West German banks apparently have heeded this restriction; West German banks did not participate in large syndicated Eurocurrency loans to East Germany in the 1970s. In 1983, Bonn made an exception to the rules, allowing the overseas banks to underwrite a large untied loan guaranteed by the West Despite the comparatively small amount of West German lending, creditors' faith in a West German umbrella helped East Germany to obtain large credits from non-German bankers. Many Western bankers regarded Bonn as the unwritten guarantor of East German debt and pointed to the special intra-German economic ties to justify extending credits to East Germany even after financial prudence might have dictated greater caution. This banker largesse allowed Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Table 2 East Germany: Net Service Transactions and Transfers From West Germany 500, 580 e Lump-sum transit payments d 400 a 400- Transportation improvements r 46 a 99 a 24a 18a l0ah IOa I I a IIa Other (net) 12 a 30 e Transfers 620 c 720 e Minimum currency conversion d 230 a 230 a Intershop purchases d 650 a 750 a Genex (gift shops) 131 a -139- Visa payments (private) d Payments to West German Communist Party -50- a 1979 Bundesbank study. b 1983 Bundesbank study. c CIA estimate. d Signifies known payment in DM (hard currency). e Public information. r Signifies at least some payment in hard currency. s Signifies known payment in VE (clearing account). h Net. i Gross. East Germany to diversify its sources of imports by running chronic trade and current account deficits with other Western countries. The result was a build- up in the estimated net hard currency debt to a peak of $12.3 billion by yearend 1981. And, East Germa- ny's debt service ratio rose from 13 percent in 1970 to 59 percent in 1982-the second highest in Eastern Europe (see appendix F). Despite this heavy debt burden and the slowdown in Western bank lending to Eastern Europe in 1981-82, unconfirmed rumors that Bonn was providing direct financial aid helped main- tain some banker confidence in East Germany's cred- itworthiness. 1,340 a 1,986 b 1,761 b 1,950 b 1,935 b 600 c 1,245 b 902 b 1,091 b 1,104 b 400 a 400 a 525 e 525 e 525, 79- 566- 450, 350 e 200 e 24a 18a 506 506 50b I I a h Ilan 85ei 85ci 85ei 10a Ilab 22b 25b 25b 30 a -25a -25a -75b -130b -140b -79b -966 -121 b -361 b 1046 80b 97b 125b 71 e 239 c -139 = 210, 595 e 740 c 741 b 859 b 859 b 831 b 250- 250- 250 b 300 c 350 6 750 a 750, 750 e 750 e 750 e 145a 181ab 187b 1806 192b 62 b 62 6 52 b 47 b i Data covering those conventional invisibles accounts (as opposed to "special services" are not available for period before 1979). k This entry reportedly does not include West German humanitar- ian payments to East Germany, such as prisoner "ransoms" and payments for legal emigrants. We are uncertain about where the FRG Government accounts for such monies. Special Earnings and Other Invisibles. Since the early 1970s, there has been a fairly steady increase in East Germany's hard currency earnings from the provision of special services to West Berlin and West Germany." East German revenues from these non- trade sources increased after 1978 in particular, when the two sides signed a major package of agreements (worth over DM 7 billion through 1989) that provided for major construction projects and an increase in fees Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret The 1980 Exchange Requirement Increase In October 1980 the Honecker regime suddenly in- creased to DM 25 the amount of money each West German and other Western visitor must exchange daily for East German currency-the Zwangsum- tausch-and eliminated exemptions for children and pensioners. Previously, West Berliners were required to convert DM 6.50 while residents of the FRG had to exchange DM 13. The move created a crisis in intra- German relations. The regime argued publicly that the increase was needed to compensate for rising costs of subsidized goods and services provided visitors. But the timing of the hike-immediately after the rise of Solidarity in Poland-suggested that the main reason was to reduce the number of visitors from West Germany. The increase provided East Berlin a financial wind- fall. We believe that revenues remained constant in 1980, despite a drop in visitors, and then soared as the number of visitors returned to more normal levels. The US Embassy in East Berlin calculated that in 1980-81 a decline in revenues from visits of West Berliners-many of whom make casual day trips-was more than offset by increased revenue from visitors from the Federal Republic, many of whom take longer trips. A report by the West Berlin for the use of East German transportation facilities connecting West Berlin with West Germany (see appendix E). The flow of West German visitors to East Germany has been the most important source of earnings, totaling more than DM 1 billion annually throughout the period. Although Intershop purchases have remained fairly constant, East German hard currency earnings from currency conversion require- ments imposed on Western visitors have increased appreciably in recent years (see table 2 and inset, "The 1980 Exchange Requirement Increase").F--] With these special agreements, East Germany thus has exploited the accident of history that created the "island" of West Berlin, has taken advantage of Bonn's efforts to keep the door open for reunification by expanding ties between the two Germanys, and has exploited such "humanitarian" concerns as the desire Of West Germans to remain in contact with family Senat said that visits by West Berliners to the GDR and East Berlin increased by 300,000 in 1982 over 1981. The total number of visits of 1.82 million remained significantly below the pre-1980 level of about 3 million, but the higher exchange requirement generated increased revenues. Despite some uncer- tainty about the length of visits, we estimate that East Berlin now earns about DM 350 million annual- The Zwangsumtausch is a continuing source of intra- German friction, but East Berlin has shown little inclination to reduce the requirement greatly. The Kohl government made clear that it expected some action in the "humanitarian" area in response to its guarantee of the 5-year DM 1-billion loan from West German banks in July 1983. Last September East Berlin eliminated the exchange requirement for chil- dren under 14. Rather than rescind a lucrative source of hard currency earnings, the regime, in our view, is more likely to allow more East Germans to visit West Germany possibly by reducing the age at which East Germans may travel relatively easily to the FRG-or roll back the exchange requirement for certain groups such as pensioners. ning an overall deficit in recent years. and friends in the East.12 East Berlin has allowed increased contacts despite its concern that these would undermine its control of the populace and thwart its efforts to create a separate East German national identity. These special earnings have ac- counted for all of the rise in East Germany's invisibles surplus with West Germany, from DM 1.1 billion in 1976 to DM 1.9 billion in 1982 (see table 1), and have been the key factor in the tripling of the bilateral current account surplus during this period. On con- ventional services transactions, such as transportation and interest payments, East Germany has been run- " For West Germany, "humanitarian" issues refer to a variety of East German policies that separate the German people and limit the freedom of East Germans. These include restrictions on FRG residents' travel to the GDR and East German cohtrols on emigra- tion and on travel by East German residents to the FRG. The humanitarian issues are especially important to Bonn because it maintains that East Germans, as German nationals, hold West Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Table 3 East Germany: Total Hard Currency Balance of Payments and Debt Year Net Invisibles Excluding Interest Net Interest Trade Balance Current Account Balance Net Debt 1,876 2,592 1975 250 -192 -1,125 -1,067 3,548 1976 450 -305 -1,591 -1,446 5,309 1977 550 -376 -1,510 -1,336 6,159 1978 650 -607 -1,137 -1,094 7,548 1979 800 -848 -1,810 -1,858 9,776 1980 900 -910 -1,590 -1,600 11,592 1981 985 -1,534 60 -489 12,267 1982 950 -1,220 1,509 1,239 10,718 1983 b 850 -865 1,324 1,309 9,033 a Changes in current account balance do not translate into identical changes in net debt because of occasionally sizable errors and omissions entries. b Preliminary. Source: CIA estimate based on BIS, OECD, NATO, UN, and West German data. Our estimates show that East Berlin's earnings from the relationship with West Germany have more than offset its large net outflow in hard currency interest payments to other Western countries through 1978 and kept its net invisibles payments in only modest deficit through 1980. We compute that earnings from West Germany accounted for essentially all of the East German surplus on hard currency invisibles excluding interest payments, which increased from an estimated $56 million in 1970 to $950 million in 1982 (see table 3 and, for additional detail, appendix F)." Therefore, while other East European countries were borrowing increasingly in the late 1970s to cover their debt service requirements, East Germany until 1981 used its borrowings almost exclusively to import real goods and services. Moreover, these earnings helped sustain bankers' confidence that Bonn provided a financial "umbrella" for East Berlin and reinforced their willingness to lend to East Germany, delaying the need for East Berlin to eliminate its chronic trade deficits with the West. The West German Cushion in 1982-83 East Germany's special economic ties with West Germany continued to help East Berlin even when debt servicing requirements and increased bankers' anxieties finally forced a major trade adjustment. Beginning in 1982,`East Berlin increased its imports from West Germany to help compensate for a forced cutback in imports from other Western countries and in 1983 received a major, untied hard currency loan guaranteed by Bonn. It was able to increase purchases " For example, at their current exchange rates, we estimate that in 1982 invisibles earnings from the FRG (DM 1.9 billion) accounted for about $800 million of East Germany's overall $950 million surplus. Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret Figure 6 East Germany: Trade With West Germany, 1982-84 Million DM - Fast German exports -- East German imports 1,300 ___L_ I I I I I I 1 I 1,200 1 11 III IV I II III IV 1 1982 1983 1984 Source: Warenverker mit derDeutschen Demokratischen Republik and Berlin (Ost), (various issues) from West Germany abruptly by using the intra- German clearing account and taking advantage of readily available West German trade credits. For 1982 as a whole, imports from the FRG grew about 14 percent, according to West German data, while imports from other nonsocialist countries dropped by 30 percent.14 Such purchases were particularly large during the last quarter of 1982 and the first half of 1983. During this nine-month period, East Germany registered a trade deficit with West Germany of DM 902 million. according to West German statistics (see figure 6). Evidence of a West German financial umbrella and East Berlin's ability to shift to a hard currency surplus in trade with other Western countries made interna- tional bankers more willing to lend again to East Germany by mid-1983. As a result, East Germany We estimate that, despite the increase in imports from West Germany, shortages caused industrial disruptions and cut GNP growth from about 2 percent in 1981 to almost zero in 1982. For a then cut imports from West Germany, boosted ex- ports, and for 1983 as a whole managed to register a modest DM 69-million trade deficit with the FRG.15 East Berlin had increased trade-related borrowings from West Germany by about DM 700 million be- tween mid-1982 and mid-1983. It reduced this debt by about DM 500 million in late 1983 when lending from other sources began to revive, cutting net debt to DM 4.0 billion at yearend, according to the West German Government) East Germany was able to redirect trade toward West Germany because of its continued special access to West German markets and the clearing account. West German banks and trading companies financed not only increased sales of West German goods but also deliveries of commodities such as grain that were channeled into intra-German trade from other coun- tries. As a result, the composition of East German purchases from West Germany shifted noticeably in 1982-83 toward increased raw materials and semi- manufactured goods and relatively fewer investment goods (see appendix D).~ 25X1 The East Germans also used the intra-German clear- ing account to generate hard currency. East Berlin 25X1 bought some commodities, such as silver, on credit from West Germany and then exported them else- where for cash to help improve its financial position. West German officials estimate that such transac- tions netted $100 million in hard currency for East Germany in 1983 at the cost mainly of a rise in official, clearing account debt to West Germany. Bonn's decision in June 1983 to guarantee an untied DM 1-billion loan from West German bank subsidiar- ies in Luxembourg gave East Berlin a further finan.25X1 cial boost and, helped " OECD data mirror the West German statistics. In the third 25X1 quarter of 1983,ps East Germany's borrowing prospects in the West improved and its imports from the FRG began to fall, purchases from other Western countries rose by about 30 percent compared with year-earlier levels to help reduce its bilateral trade imbalance. As the GDR boosted exports to the FRG in the third quarter of 1983, deliveries to other Western countries fell 3.5 percent. F__1 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret restore Western banker confidence in East Germany's creditworthiness." The loan helped ease the threat of a liquidity crisis by covering about 12 percent of East Germany's 1983 financing requirement. It also pro- vided East Germany with less expensive intermediate- term money-1 percent over the London Interbank Offered Rate (LIBOR)-than we believe it had been able to find since 1980. The five-year credit improved the maturity structure of East Germany's debt; be- tween late 1981 and mid-1983, East Germany appar- ently had been able to arrange only two-year and shorter trade credits from commercial sources. The drop in Western lending and the expansion of intra-German economic relations left West Germany as the leading source of hard currency (or hard currency-equivalent) resources for East Germany-in contrast to the situation in the 1970s--(see figure 7). Current account earnings in intra-German transac- tions continued to grow while receipts from other Western partners fell. More important, the East Germans suffered a nearly DM 4-billion outflow on the capital account to other Western countries in 1982 and another DM 2.7 billion in 1983. The "jumbo" loan made by offshore bank subsidiaries and in- creased trade financing raised East Germany's debt to 16 The guarantee-secured by Bonn's ability to withhold regular lump-sum payments to East Berlin in the event of default-was extended without any explicit economic or political conditions. It was granted with the expectation, however, that East Germany eventually would reciprocate by making "humanitarian" conces- sions such as easing travel barriers. The government was widely criticized for having failed to secure a tangible quid pro quo (see cartoon).0 The loan was a surprise and was an apparent reversal of previously stated Christian Democratic Union (CDU) policy that economic benefits should be extended to the GDR only in return for political concessions. Moreover, Chancellor Kohl's Christian Social Union ally Franz Josef Strauss, long a recognized hawk on intra- German relations, publicly claimed major responsibility for arrang- ing the deal. Shortly after the loan was announced, Strauss visited three East European countries and conferred with Honecker in East Berlin; he since has portrayed himself as a leading proponent of better intra-German relations. Kohl and Strauss appear to have been motivated partly by a desire to prevent economic dislocations in East Germany, which they feared could lead to social instability and cause East Berlin to impose more rigid domestic controls and restrict ties with the West. They also apparently hoped the credit would help insulate intra- German ties from any deterioration in East-West relations after the deployment of US intermediate-range nuclear wea - ns in the fall of 1983. Figure 7 1' East Germany: Sources of Hard Currency Receipts, 1976-83 Exports lnvisibles Net borrowings 15 West Germany Other nonsocialist -5 1976 77 78 79 80 81 82 83 This figure represents sources of hard currency available for either financing imports or servicing debt, West German-controlled institutions by an estimated DM 1.2 billion in 1983. By buying on clearing account from West Germany, the East Germans were able to direct hard currency export receipts and West German invisibles payments toward paying off debt owed to other Western banks. The East Germans, in 25X1 effect, paid off creditors outside West Germany through borrowings from West German-controlled institutions. Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret Suddeut.sche Zeitung %fanv West Germans believe that Bonn gets little in return for its Prospects Recent history suggests that East Germany will con- tinue to enjoy considerable economic benefits from its special relationship with West Germany, so long as the latter remains willing to assume the costs in order to promote its political goals. The large umbrella that went up in 1982-83 indicates that the West Germans are willing to arrange assistance quickly and waive regulations when the need arises. Moreover, the aid was extended without political strings or explicit concessions from East Berlin, save the hope of "hu- manitarian" concessions somewhere down the road. In July 1984 the West German Government approved the guarantee of a second jumbo loan of DM 950 million in return for some relatively minor easing of antra-German travel restrictions, including a reduc- tion in the Zwangsumtausch for pensioners and in- creasing the length of visits allowed each year. The loan will help improve East Berlin's financial situation further by extending maturities and reducing interest expenses somewhat. We believe Bonn would step in again should it become concerned about the economic and political stability of East Germany.' We expect that the growth of intra-German com- merce will moderate as other Western bankers be- come more willing to extend trade credits. Moreover, to prevent excessive dependence, East Berlin will seek to maintain a reasonable balance in the bilateral trade relationship. In fact, it ran a DM 424-million surplus in the first quarter of 1984, continuing the trend begun in September 1983, and we expect East Berlin will register a surplus for the year. Trade deficits may emerge again for short periods, but East Berlin will seek to control their size and duration. We thus believe that East Germany will reduce the share of its bilateral trade financed with West German Govern- ment credits. At the same time, we think that East Germany may strike new industrial cooperation agreements with West German firms that bring it new technology and, in the long run, enhance its hard currency export earnings. Although they are traditionally reluctant to enter joint ventures with any Western firms, the East Germans early this year tentatively agreed to produce car engines for Volkswagen beginning in 1988. At the Leipzig Fair in March, the GDR announced a DM 300-million long-term deal calling for West German companies to roll East German slab steel. We believe East Berlin is willing to make more such commit- ments if the economic price is right and the political cost is low. The regime probably will move deliberate- ly, however, and the predictions of West German businessmen that industrial cooperation will increase substantially seem overoptimistic. East German earnings from services, fees, and tour- ism from West Germany will continue to provide an important economic cushion. According to our esti- mates, they will total at least DM 2 billion annually. We think East Berlin will have some success in increasing fees and service payments as agreements come up for renewal. Moreover, the apparent eager- ness of Bonn and East Berlin to continue economic discussions despite the chill in East-West relations could lead to agreements on new joint projects in the Last September, East Berlin announced relaxation of controls on emigration for purpose of marriage and elimination of the Zwang- samtausch for children under 14 years old. It also dismantled some c,f the automatic-firing devices along the GDR-FRG border. The reduced exchange requirement affects only about 5 percent of travel, however, and some West German commentators ca roves an inadequate response to the 1983 loan guarantee. Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 areas of water pollution control, rail electrification, and further improvements in the autobahns and bor- der-crossing points. The two sides also could resurrect negotiations on construction of a lignite-fired power plant to serve West Berlin or an electricity transmis- sion line from the FRG to the city. Bonn remains committed to securing humanitarian gains and, we believe, could persuade East Berlin to lower the exchange requirement for all visitors by offering a lump-sum annual payment. But, in our view, the East Germans will demand a payment that is higher than their present income from the exchange requirement; they probably would want at least DM 400 million yearly. East Germany may also want to strike a multiyear agreement to facilitate long-term planning. In 1982 the East Germans sought an exten- sion of the swing through 1985 explicitly to facilitate economic planning. Any improvement in bilateral political relations could stimulate more visits by West Germans and increase tourism revenue for East Ger- many. Moreover, East Berlin could realize additional earnings by again liberalizing its emigration policy and thus exploring Bonn's willingness to pay for the release of East German citizens. While considerable benefits accrue to East Germany from its "special relationship" with West Germany, they will not be enough to overcome the effects of other economic problems. East Berlin's debt remains high and some Western bankers remain skeptical of its creditworthiness. East Germany still needs to improve significantly its industrial efficiency and ex- port capabilities. Moreover, continuing difficult rela- tions with its CEMA partners, which account for almost two-thirds of East Germany's total trade, will present the regime with major challenges. These pressures will push East Berlin to continue to exploit its intra-German economic opportunities, but always within the constraints posed by the Soviet leash and by its own fear of becoming too dependent on West Germany. Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret Appendix A Intra-German Economic Data The reluctance of both East and West Germany to publish complete data and the existence of peculiar institutional arrangements combine with the normal problems of making international financial compari- sons to make analysis of intra-German economic West Germany's refusal to treat intra-German com- merce as foreign trade reflects its contention that the GDR is an integral part of the German nation. Bonn steadfastly refers to its exports (normally Au.Ffuhr) to East Germany as LieJerungen, or deliveries, and its imports (normally Eirtfuhr) as Bezuege, or purchases. It does not report intra-German trade figures to international organizations such as the United Na- tions and Organization for Economic Cooperation and Development (OECD) and does not report its banks' loans to East Germany to the Bank for International Settlements (BIS). Instead, its statistical office pub- lishes separate figures on bilateral trade and financial transactions. other hand, we are compelled to use the limited East German data when discussing the FRG's share of total GDR trade; no other source contains informa- tion on East German transactions with the entire 25X1 Debt and Credit Statistics 25X1 25X1 East Germany stubbornly refuses to release any debt or reserve figures, maintaining that such data are state secrets. When told by a Western banker recently that bankers needed more information upon which to make lending decisions, Foreign Trade Bank Presi- dent Polze reportedly replied, "There is only one piece of information that you need: that we will pay the money back." West Germany periodically reports net bilateral debt, but only occasionally gross debt. In keeping with its policy of considering intra-German debt "domestic," the Bundesbank-West Germany's central bank- holds its statistics very closely. Bonn itself probably does not know the extent of German-source credits; we believe West German suppliers provide trade credits that they, for their own reasons, do not report to Bonn. East Germany describes its transactions with West Germany as foreign commerce, a reflection of its insistence on being recognized as a sovereign state. It also refuses to include transactions with West Berlin as part of trade with the FRG, asserting that West Berlin is not part of West Germany. Trade Data West Germany publishes the better trade data. The Federal Statistical Office in Wiesbaden publishes monthly data broken down by commodity. East Ger- many, by contrast, reports only a few commodity categories, refuses to specify exports and imports, and publishes instead turnover figures, which are useless for most analytical purposes. East Berlin occasionally releases figures on hard currency trade with all nonsocialist countries, but only, we believe, when it thinks the numbers reflect well on the GDR. On the 25X1 25X1 International Trade and Finance Statistics The OECD provides the best Western data but they are incomplete. Fifteen to 20 percent of East Germa- ny's trade with nonsocialist countries in recent years has been with LDCs that do not belong to the OECD. BIS statistics also suffer from a lack of completeness. For example, the GDR has borrowed from Arab 25X1 sources that do not report to the BIS. In addition, West German-controlled institutions mask their lend- ing by operating through third countries such as Luxembourg. Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Special Payments The two Germanys maintain payment flows that both countries prefer to keep confidential. For example, the West Germans regularly "ransom" political prisoners for up to DM 100,000 or more each. East Berlin does not want publicly to be seen dealing in human trade, while Bonn fears that East German embarrassment over any publicity would halt the releases. We remain uncertain of the exact payments mechanism. The Currency Problem To make matters worse, intra-German economic transactions occur in several currencies and account- ing units, some of which are only tenuously related. West Germany reports bilateral trade in West Ger- man deutsche marks (DM), but most trade actually is conducted via a special accounting unit, the Verrech- nungseinheit (VE), which is equal in value to but not convertible into DM. East Germany, in turn, pegs its foreign trademark or Valuta Mark (VM)-an incon- vertible accounting unit similar to the USSR's trans- ferable ruble-to the VE. East Berlin ostensibly also negs its domestic mark (DME) to the VEJ in recent years has traded on unofficial West German currency markets at about one-fourth the value of the DM. In addition East German statistics on bilateral trade, probably for accounting reasons and a desire to minimize the appearance or dependence on Bonn, show levels of trade that are consistently lower than West German figures by about 10 percent. 25X1 25X1 Exchange Rates Since the deutsche mark/US dollar exchange rate has fluctuated widely in recent years, we use the DM as the currency unit of bilateral transactions in this paper. Use of the dollar or any other currency would distort trends in real resource flows. On the other hand, because OECD and BIS statistics are reported in dollars converted from national currencies at pre- vailing exchange rates-which similarly would be distorted if reconverted to DM-we use the dollar in our estimates of East Germany's trade and financial transactions with other nonsocialist countries and nonsocialist countries as a whole. Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret Appendix B West Germany: Deutsche Marks per US Dollar 1961 4.0 1962 4.0 1963 4.0 1964 4.0 1965 4.0 1966 4.0 1967 4.0 1968 4.0 4.0 1969 3.66 3.9433 1970 3.66 3.6600 1971 3.2225 3.4908 1972 3.2225 3.1886 1973 2.6690 2.6726 1974 2.4095 2.5878 1975 2.6223 2.4603 1976 2.3625 2.5180 1977 2.1050 2.3222 1978 1.8280 2.0086 1979 1.7315 1.8329 1980 1.9590 1.8177 1981 2.2548 2.2600 1982 2.3765 2.4266 1983 2.7238 2.5533 Source: International Financial Statistics, International Monetary Fund, various years. Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret Appendix C East Germany: Trade With West Germany Million current West German marks Percent Change Over Previous Year Percent Change Over Previous Year 1971 2,318.7 16.2 2,498.6 3.4 -179.9 1972 2,380.9 2.7 2,927.4 17.2 -546.5 1973 2,659.6 11.7 2,998.5 2.4 -338.9 1974 3,252.5 22.3 3,670.8 22.4 -418.3 1975 3,342.3 2.8 3,921.6 6.8 -579.3 1976 3,876.7 16.0 4,268.7 8.9 -392.0 1977 3,961.0 2.2 4,409.4 3.3 1978 3,899.9 -1.5 4,574.9 3.8 1979 4,588.9 17.7 4,719.6 3.2 Source: Warenverkehr mit der Deutschen Demokratischen Repub- lik and Berlin (Ost) 1983 (official West German statistics). (u) Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87BOO342ROO0100200011-3 secret Appendix D East Germany: Composition of Trade With West Germany Imports Exports 5,575,074 6,382,316 6,050,648 6,639,298 Products of farms, forests, fishing, and so forth 27,038 181,256 465,233 475,841 Farm and market garden produce 21,227 167,218 183,894 188,500 221 1,099 251,814 260,217 5,010 8,048 22,450 18,988 1,039,845 819,889 203,082 241,135 Raw materials and semifinished goods 2,009,118 2,754,224 3,181,158 3,366,402 Minerals 22,690 28,432 1,628,842 1,704,999 Chemical elements and isotopes 463 739 972 1,393 Stone and earth 38,529 40,452 113,985 125,846 Iron and steel 321,892 612,798 273,596 243,462 Nonferrous metals and semifinished metals 391,238 559,992 249,951 251,063 Foundry products 7,549 4,969 15,243 17,154 Drawn and cold rolled goods 59,706 70,952 28,108 29,840 Chemicals 981,800 1,290,295 704,813 778,793 Cut and worked timber 75,744 52,453 42,137 92,552 Wood pulp, paper, and boards 47,393 49,236 93,553 81,294 Rubber goods 62,114 43,906 29,958 40,006 Investment goods 1,426,347 1,282,810 607,836 694,424 Shaped steel 7,058 5,453 25,350 32,579 Constructional steel and rails 66,579 53,681 29,171 41,732 Mechanical engineering products and so forth 971,829 886,128 157,623 188,261 Road vehicles 37,595 37,898 24,023 24,245 Water craft 3,745 13,631 33,937 13,264 Aircraft and spacecraft 39 37 41 Electrical engineering products 214,384 176,637 192,601 228,187 Precision instruments, optical equipment, and clocks 47,647 33,103 4 43,238 49,173 Iron plate and metal goods 67,278 58,232 92,407 106,650 Office equipment, data processing, and so forth 10,110 17,988 7,636 9,712 Finished sections for construction engineering 83 59 1,813 580 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87BOO342ROO0100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 East Germany: Composition of Trade With West Germany (continued) 1981 523,024 1,343,205 1,589,782 Musical instruments, sports equipment, and so forth 17,133 14,727 61,070 71,127 Pottery, china, and so forth 4,060 Glass and glass goods 12,165 16,311 14,028 36,179 33,235 Printed goods 39,537 40,261 31,601 34,973 Plastic goods 52,061 49,997 46,944 61,338 Leather 39,611 67,933 4,471 5,316 Leather goods and shoes 46,745 37,399 43,739 49,817 186,633 235,675 385,804 450,968 44,177 32,650 303,930 403,264 Foodstuffs and so forth 533,228 745,978 213,902 229,840 Foodstuffs 508,525 718,537 Tobacco 24,703 27,441 Source: Warenverkehr mil der Deutschen Democratischen Re ub- lik and Berlin (Ost) 1982 (official West German statistics).? East Germany bought more raw materials and semimanufactured goods in 1982-83 mainly to meet the needs of current production. West German statistics show that East Germany boosted imports of iron and steel products 63 percent in 1983-to about DM I billion -after a 90-percent gain in 1982. Imports of foodstuffs rose 31 percent in 1983 after a 41-percent rise the year before. Growth in these imports slowed markedly in the second half of 1983 when overall imports declined as East Berlin returned to a more normal trading pattern. Imports of investment goods, on the other hand, fell slightly after a 10-percent drop in 1982. East Germany's best export gains, though modest, were in investment and consumer OECD commodity trade data for 1982 show that East German purchases of foodstuffs from non-German sources declined by $340 million-over 47 percent. Imports of manufactured goods declined by about one-third, paced by a 46-percent decline in chemicals and a 63-percent drop in transportation goods. The composition of East German exports to OECD, on the other hand, showed little change in 1982 from 1981, similar to the relatively small change in East German exports to West Germany.F__1 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret Appendix E East Germany's Special Earnings East Berlin derives considerable hard currency earn- ings from special arrangements with Bonn affecting the city of Berlin and relations between West German and East German citizens. Construction Most of the lucrative construction agreements signed with Bonn and the West Berlin government have involved improvements in West Berlin's infrastructure and upgrading of the city's transportation links to the Federal Republic (see table E-1 and map). Bonn has paid East Berlin to: ? Expand and upgrade the autobahns between the FRG and West Berlin. ? Improve border-crossing points. ? Electrify rail links to the city. ? Reopen the Teltow Canal in Berlin and repair canals linking West Berlin with the FRG. ? Improve the Berlin area transportation network. The value of construction projects in the period 1979- 83 exceeded DM 1.5 billion. We estimate that East German receipts from these projects (see item "Trans- portation Improvements" in table 2) totaled more than DM 500 million in 1979, but fell thereafter as major projects were completed In 1983 the two sides reached several new agree- ments. In May East Berlin signed a contract with the West German firm Ruhrgas AG to build a spur line off the Siberia-Western Europe natural gas pipeline to deliver gas to West Berlin. In September, Bonn agreed to finance construction of a plant to purify water entering a river that flows from the southern GDR into Bavaria. Late in the year East Berlin also agreed in principle to install a fiber-optic telecom- munications link to West Berlin. The governments have at various times discussed several other projects, including the construction of additional power-gener- ating facilities for West Berlin and further improve- ments in transportation links between West Berlin and West Germany. Services For more than a decade East Berlin has received periodically increasing annual lump-sum payments- over DM 300 million in 1983-for services it provides West Germany, such as postal delivery, removal of sewage from West Berlin, disposal of solid wastes for the city of Hamburg, and hauling trains to and from West Berlin. Last November, Bonn agreed to raise its annual payment for post and telecommunications services from the DM 85 million it had paid since 1971 to DM 200 million in the period 1983-90. Beginning in 1984 the East German state railroad will receive small annual payments for the use of some of its West Berlin facilities that were transferred to the operational control of a West Berlin Senat authority. The payment will total DM 3.4 million this year but may vary slightly in the future. The agreement ceding control to the West Berlin government also relieved East Berlin of operating losses which Fees East Berlin collects substantial travel-related fees from both the West German Government and West German citizens. Since the 1971 Transit Agreement, Bonn has made lump-sum annual payments-current- ly DM 525 million-for the use of road, rail, and inland water routes to and from West Berlin." 1e The original surd was DM 235 million. It rose to DM 400 million in the period 1976-78 and, as part of the 1978 package of agreements, to DM 525 million yearly for the period 1979-89.F- Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87BOO342ROO0100200011-3 Table E-1 East Germany: Selected Joint Construction Projects With West Germany and West Berlin Project Cost (Million DM) Status Hamburg-Berlin Autobahn 1,200 Completed Warta-Herle- shausen Auto- bahn Undeter- mined Under negotiation Berlin-Hof Auto- bahn 500-1,500 Under negotia- tion Helmstedt Auto- bahn Undeter- mined On hold Spandau Lock expansion (Ber- lin) 30 Completed Teltow Canal re- opening (Berlin) 70 Completed Havel and Mit- telland Canal im- provements NA Completed Power plant Undeter- mined On hold Natural gas pipe- line 230 Under construc- tion Electricity trans- mission line 150-200 On hold Fiber optic tele- phone lines to West Berlin 15-20 Under negotia- tion Crossing point in Berlin Under construc- tion Electrification of rail lines Undeter- mined On hold Pollution control on Elbe, and Werra Rivers At least sev- eral hundred million Under negotia- tion Roeden River water purifica- tion plant 60-80 Agreed upon Ongoing Comments Fees Project involved expansion of some existing road near Berlin and new construction on the autobahn link. Part of 1978 package. Highway improvements. Highway improvements. Transit fees Agreement signed 30 November 1977. Expansion bene- fits FRG and GDR shippers. Transit fees 38 kilometers through West Berlin shortens barge trans- port time for shippers by one to two days. Canal had been closed since 1945. Reopening agreement signed November 1978. Transit fees Canals link the FRG with West Berlin and, ultimately, Poland via the Oder-Spree Canal. Improvements wid- ened and deepened the canals, increasing capacity and reducing costs. Part of 1978 agreement package. 9 million VE an- Contract signed March 1983. Spur gasline to provide nually. Soviet gas to West Berlin. Contract signed with Ruhrgas AG. Transit fees to begin upon completion in October 1985. Transmission and Project designed to transmit electricity from the Federal right-of-way fees. Republic to West Berlin. Agreement in principle signed as part of November 1983 post and telegraph agreement. East Berlin agreed to keep open Staaken crossing point _ until completion of the new border-crossing point. Long under tentative negotiation. East German industry dumps heavy metals into the Elbe. Potash mining pollutes the Werra with salts. Bonn and West German states apparently near agreement on sharing the costs. Signed agreement i October 1983. Eighteen million DM committed by FRG and Bavarian governments for 1984. Project scheduled for completion in 1987 at Son- neberg, East Germany. Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87BOO342ROO0100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret Figure 8 East Germany's Joint Projects With West Germany Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Emigration Payments Bonn has paid large sums annually to secure the exit from East Germany of emigration applicants. In recent years, East Berlin has allowed between 1,000 and 1,500 East German political prisoners and some 8,000 to 10,000 other people to emigrate annually. The number of legal emigrants increased substantial- ly in late 1983 to nearly 1,000 per month and then rose sharply again in early 1984 as East Berlin suddenly expedited exit visa applications; some 25,000 left in the first four months of 1984 before the regime slowed the exodus in May. We believe Bonn on average pays about DM 50,000 in "ransom" per prisoner and at least DM 5,000-sometimes much more-for each of those legally emigrating to the FRG.19 The two governments arrange deals through "private" intermediaries who also receive compensa- tion from West Germany. We estimate that this program normally has netted East Berlin DM 150- 200 million annually Transfers From Individuals After East Berlin agreed to ease travel restrictions in the 1972 Traffic Treaty, the number of West German visitors swelled from 2.62 million in 1971 to 7.10 million in 1973. An important source of tourist reve- nues-worth about DM 350 million in 1982 accord- ing to our estimates-is the Zwangsumtausch, or requirement that Western visitors buy a minimum amount of East German marks (DME) for each day they are in the GDR; the money cannot be converted back into hard currency when the visitor leaves the country. We believe that revenue from the exchange requirement has continued to rise even though the number of visitors from West Germany dropped sharply in 1980 when the regime increased the daily requirement to DM 25 (see inset, "The 1980 Ex- The regime capitalized further bn the increase in Western visitors by establishing in 1973 and then expanding a series of retail stores (called Intershops) that sell luxury and imported goods only for hard currency. The West German Government confiden- tially estimated that West Germans spent some DM 750 million in the shops in 1978. We believe the sum was about the same in 1982, when higher prices on goods offset a decline in visitors after 1980. West Germans, in addition, often give their East German relatives and friends consumer goods and currency, including East German marks they are forced to buy upon entering the GDR. Gifts of consumer goods unavailable in the East and hard currency spendable in Intershops provide East Ger- mans with much appreciated income supplements that soften the impact of shortages in the GDR. East Germany's tight restrictions on travel by its citizens to West Germany has preserved its hard currency windfall from tourism. Apparently con- cerned that many East Germans would never return home if allowed to travel to West Germany, the regime restricts travel to the FRG largely to individ- uals faced with such "urgent family needs" as the grave illness or death of a relative, and to retirees who it calculates are less likely to defect and whose loss would not reduce the work force but would cut change Requirement Increase").20 " East Berlin charges different rates for prisoners based partly upon an individual's education. Physicians, for example, reportedly are "worth" up to DM 150,000. Twelve people who won release to West Germany as legal emigrants after entering the FRG Perma- nent Representation Mission in East Berlin this January cost Bonn DM 94,000 each, according to West German officials. The GDR apparently insisted on the higher payment because of the publicity '0 West German statistics suggest that the number o visits is highly sensitive to the level of exchange requirement. The number of visits fell in 1974 after the requirement was raised, but rebounded strongly after it was reduced for most people and was eliminated entirely for pensioners. Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 25X1 25X1 1 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 East Germany: Hard Currency Balance of Payments and Debt -293 -197 -383 -689 -299 -268 -483 -774 -1,019 -1,067 -1,446 -1,068 -1,125 -1,591 Exports 1,261 1,368 1,642 2,230 3,014 3,062 3,643 1 560 1636 2,125 3,004 4,082 4,187 5,234 Imports Net invisibles, excluding interest 56 132 175 220 260 250 450 550 650 607 Net interest -50 -61 -75 -135 -211 -192 -305 -376 3 Capital account balance 298 211 146 528 1,000 2,052 1,668 1,289 ~.~~9__. 418 352 354 858 1,367 2,520 1,376 2,156 2.863 i ngs Draw 120 141 208 276 367 468 708 867 1,113 Repayments Errors and omissions -5 -1 359 42 303 111 -53 224 295 - 'ILA Changes in reserves 22 Gross debt 1,197 1,408 1,554 2,136 3,136 5,188 6,118 7,145 8.89.1__., tk 1116 4 497 553 609 626 Reserves 190 203 325 260 Net debt 1,007 1,205 1,229 1,876 Of which: West Germany 460 500 550 675 170 202 283 411 Debt service ratio (percent) c 13 15 _. 17-- 18 Gross annual financing 413 338 591 965 requirements (repayments on medium- and long-term debt plus current account deficit) d Net resource transfer 248 150 71 447 a 1981 East German trade data are especially inconsistent with partner country data. For this reason the 1981-82 trade and current account estimates should be regarded as very tentative. b Preliminary. Repayments of medium- and long-term debt plus net interest as a share of exports. d Difference between drawings and debt service. Source: CIA estimates based on official East German partner country trade and BIS data. 495 4,485 5,1143 o, i'+u . . Icc 641 703 544 1,640 809 2,592 3,548 5,309 578 660 1,013 1,243 1 720 ~~ ... 19 22 28 35 41 1,386 1,535 2,154 2,203 2.207 L 3.550 4,1: 2.321 3,5( 10.718 9,0: Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Million US 3 fetcept where not, 1,239 1,30' 1,509 1,32. 5.663 6,30 950 85 -1.730 - 60 STS 1.270 2,19 3,000 2,79 216 56 _-275 1,2- 13.039 12,6. Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret Eastern Europe: Facing Up to the Debt Crisis Summary Most of Eastern Europe has withstood the severe credit crunch that began Information available in 1980, but the region remains financially vulnerable. The peak of the as of I September 1983 crisis occurred in the first part of 1982, when it seemed that several was used in this report. countries were on the brink of default. The regimes responded by imposing austerity, mostly in the form of severe import reductions. With the incipient economic recovery in the West and signs of some easing in creditors' attitudes, the worst of the crisis is probably over. Some countries may yet have to reschedule their debts, however, and most will continue to look to the West for financial assistance. For the longer run, all will need to rely more on their own resources, which will increase pressure for more sys- temic solutions to economic problems. The adjustment process almost certainly will increase the risk of internal instability and will present. problems and opportunities for the USSR and the West. The Credit Crunch. While Western bankers showed some unease about Eastern Europe as early as 1980, the credit crunch intensified the following year when Poland's inability to service its debts gave bankers second thoughts about continuing to lend to other East European countries. Banks initially refused to provide more medium-term loans. As a result, the East Europeans had to resort to more official financing, activate undisbursed credit lines, seek costly short-term borrowing, and draw down their reserves. By yearend, all the East European countries faced liquidity problems. The crunch thus hit Eastern Europe well before Latin America and other developing countries. The squeeze grew particularly severe in the first half of 1982. The imposition of martial law in Poland and difficult rescheduling talks with Poland and Romania led bankers to withdraw short-term credits from the entire region in addition to refusing to roll over maturing medium-term loans. For the year as a whole, Western banks reduced their short-term ex- posure by 30 percent and rolled over only $3.6 billion of $9.1 billion in ma- turing medium- and long-term obligations. Western government-backed credits did not offset the loss of private loans; the region as a whole contracted new government-backed lbans in roughly the same amount that it owed in repayments. Adjusting to the Credit Squeeze. Lack of credits and inability to expand exports because of Western recession forced the East Europeans to slash imports by 30 percent in 1981-82. Planners focused the cuts on those items that would have the least immediate impact on their economies and Secret EUR 83-10216 September 1983 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret populations. Purchases of capital equipment were generally denied because the loss of these items would not jeopardize current production. For political reasons, most regimes have been cautious about reducing pur- chases of consumer goods and foodstuffs although last year's good harvest permitted cutbacks in grain imports. Despite attempts at insulation, the reduction in Western imports has been a key factor in the decline of GNP which fell by 0.5 percent annually in 1980-82 for the six CEMA countries compared with an annual average growth of 2.5 percent in 1976-79. For Yugoslavia, growth slowed from a peak of 7.0 percent in 1979 to only 0.3 percent last year. The East European countries reacted to their financial problems in varying ways. Poland, after Western governments refused to reschedule its 1982 debt or extend new credits, secured de facto debt relief simply by not making repayments. Warsaw was able to negotiate debt relief from commercial banks, and Western bankers report that Warsaw met the repayment schedule. Altogether, Poland managed to cover less than half of its $11 billion financing requirement last year. The need to deal with the resulting arrearages continues to delay and complicate Warsaw's economic recovery. Doubts about Bucharest's creditworthiness brought the credit crunch to Romania in early 1981. After arrears reached $1.1 billion at the end of the year, Bucharest gained breathing room through agreements with Western banks and governments to reschedule 1981 arrears and principal payments due in 1982. By mid-1982 there were signs that Bucharest was addressing its financial problems. By the end of the year, it had cut imports by one- third, enough to earn a current account surplus of $655 million, but was still left with arrears of nearly $400 million. The import cuts intensified shortages of food, gasoline, and other consumer goods. Data presented to the IMF show that consumption fell for the first time since World War II and that the rate of growth of industrial production fell to a new low. The problems of Poland and Romania had a spillover impact on Hungary, East Germany, and Yugoslavia-countries also dependent on new credits to meet debt obligations. In Hungary, the withdrawal of $1.3 billion in short-term credits by Western, OPEC, and CEMA banks and inability to roll over medium-term credits brought Budapest to the brink of a liquidity crisis in early 1982. The Hungarians parlayed their good relations with the West and reputation as sound managers into enough emergency support from Western governments, the Bank for International Settlements (BIS), Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 and the International Monetary Fund (IMF) to avert rescheduling. After temporizing for some months, Budapest imposed import controls and tougher austerity on consumers. Hungary consequently was able to slash its current account deficit by more than $600 million and stabilize its financial position. East Germany, despite suffering the region's largest cutback in credits- $1.9 billion, was the only heavily indebted country in the region that did not require debt relief or emergency loans in 1982. The East Germans apparently managed last year's credit crunch through tough adjustment measures and skillful cash management. Trade adjustments offset more than 80 percent of the cutback in bank credits, but the measures exacted a stiff price from the domestic economy. We estimate that GNP growth fell from 2.4 percent in 1981 to 0.5 percent last year. Yugoslavia did not suffer as severe a reduction in Western bank lending as Hungary or East Germany, but the impact on its financial position proved more damaging. The country's financial crisis stemmed as much from failure to reduce the current account deficit and poor cash management in the banking system as from fewer credits. Belgrade's current account deficit reached $1.4 billion in 1982 instead of the planned $500 million, and emergency measures to strengthen the Yugoslav National Bank's liquidity position failed. IMF credits of $600 million could not offset the shortfall in current earnings and capital flows, and Yugoslavia had to draw down its reserves by $1 billion. By yearend, with arrears of $500-600 million, the country technically was bankrupt. Because of their conservative trade and borrowing policies, Czechoslovakia and Bulgaria did not face as severe financial problems in 1982 as the other East European countries. The Czechoslovaks nonetheless slashed hard currency imports by 19 percent. The import curbs flowed from President Husak's pronouncement in 1981 that Czechoslovakia would not live on "credit." With shrinking export earnings, Prague's planners had to make deep cuts in purchases to meet the leadership's goal of reducing external indebtedness. Bulgaria's low debt and comfortable maturity schedule freed it from onerous repayment obligations. Its conservative trade policy yielded sur- pluses on the hard currency trade account. Although some firms reported problems with payments from Sofia last year, we believe these were not the result of any serious financial deterioration. Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret 25X1 Lender Attitudes. Lender attitudes toward Eastern Europe have eased slightly since last year's rush to reduce exposure, in part because their worst fears proved exaggerated. Poland did not default and Romania has improved its relations with banks. BIS and IMF involvement in Hungary's and Yugoslavia's crises has encouraged, and to some extent compelled, continuing banker involvement in these countries. Continuing wariness among bankers and closer governmental supervision of commercial bank exposure will restrain the pace and extent of new loans. Major Eurodollar syndications will be much rarer than in the late 1970s; a far greater share of lending will be short term and trade related. The cost of credit will be higher, and the debt maturity structure will remain unfavorable for most countries. Commercial banks, furthermore, are likely to insist on more Western government backing for their loans or demand security from the borrowers, including gold collateral and offset- ting deposits. As a prerequisite for increasing lending, bankers are looking for evidence that the East Europeans are addressing their payments imbalance through structural changes to improve export performance. Creditors regard the draconian import reductions of the past two years as a short-run expedient with little positive impact on long-term creditworthiness. Some bankers remain skeptical that the East Europeans will or can do as much as the fi- nancially troubled LDCs to correct their fundamental problems. To assure long-term economic discipline, they are putting more weight on IMF membership, while urging the East Europeans to provide more complete economic and financial data. Outlook for 1983-85. In 1983 we estimate the region (excluding Poland, because of the uncertainties regarding rescheduling terms) will experience another large outflow on the capital account of more than $2.4 billion. Yugoslavia will probably be the only net gainer, thanks to the Western financial rescue package. An expected slight improvement in borrowing conditions and a pickup in Western demand for East European exports should enable a few East European countries to ease the import cuts of the past two years, but we still anticipate a 1- to 2-percent decrease in Eastern Europe's (excluding Poland's) hard currency imports this year. Import gains seem likely in 1984-85, assuming continued growth in the West and continuing improvement in creditor attitudes. Only under the most favor- able lending assumptions, however, would the absolute level of imports in 1985 exceed the level reached in 1980. With a modest revival of lending, Secret Vi Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret imports in 1985 would be about 4 percent below the 1980 peak, while continued lending shortfalls would keep 1985 import levels some 8 percent below 1980 levels. Even if lending revives, some countries-notably Bulgaria, Czechoslovakia, and Romania-may be unwilling to expand imports at the rates our projections suggest, opting instead to continue reducing hard currency debt or building up reserves. Most regimes will give preference to goods needed for consumption and current production. Some economists and planners, however, are arguing more strongly that their economies need a revival of investment, using Western resources to lay the foundation for long-term growth. This may have some greater impact down the road. The prospect of slow export growth and at best small credit inflows means that financial problems will continue to beset nearly all the East European countries. In the near term, Poland-and very likely Yugoslavia-simply cannot generate enough debt servicing capacity on their own to meet obligations. Most regimes will have to restrain consumption and investment in order to lower demand for imports and free goods for export. Pressure will build to produce more output with fewer inputs. This will highlight the necessity of attacking the systemic flaws that contribute to low productivity. Poland and Yugoslavia, caught in a medium- to long-term financial crisis, seem least able to impose effective adjustment measures and to attack structural problems. Poland's insolvency and lack of progress in dealing with debt problems have locked it into a continuing economic crisis. Merely to stem the increase in its debt, Poland must generate net exports equal to annual interest payments, an effort requiring large current account surpluses and, thereby, a commitment by the regime to revive economic growth and by the populace to make large sacrifices. Even with compl3tion of this year's financial rescue package, we believe that Belgrade will need more help in `1984. Yugoslavia's position entering 1984 will be very similar to that at the beginning of this year-stocks of imported goods and foreign exchange reserves will be at minimal levels and few credits will be in the pipeline to bridge the seasonal financing gap in the first half of the year. Adjustment policies and structural reforms needed for recovery may impose a higher price than regional politicians and the population are willing to accept. Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret 25X1 Romania, East Germany, and Hungary show signs of financial recovery, but their positions remain fragile. East Berlin and Bucharest have squeezed their economies much harder than Budapest, while the latter seems further along in addressing structural problems. Bucharest has passed the peak in its debt maturity structure, but is having problems in satisfying IMF targets and in obtaining credits. Even if it meets its goal of avoiding rescheduling next year, another test of its external adjustment efforts will come in 1985 when Bucharest must begin to repay obligations rescheduled in 1982. Next year's expiration of the current IMF standby arrangement also will add to pressures for large current account surpluses. East Germany probably can avoid a rescheduling, but the country continues to face a serious liquidity problem. The recent decision of the West German Government to guarantee a $400 million five-year credit from West German commercial banks should improve prospects for covering this year's borrowing requirement. East Berlin can also draw on new government-guaranteed trade credits from France, Canada, and Austria. Over the medium term, the country will have to live more within its means, implement measures that improve export competitiveness, and promote economic growth without heavy reliance on Western imports and credit. Hungary is still on a financial tightrope despite some successes in raising credits in the first half of 1983. Budapest faces a rising level of debt repayments through 1985 and has requested a second IMF standby credit. The Hungarians must tighten adjustment policies, as well as continue to forge ahead with measures to improve efficiency and competitiveness. Fortunately for Budapest, many Western bankers believe they should support Hungary's reform program as an example for other East European countries. Due to their small debts and generally good standing with Western banks, Czechoslovakia and Bulgaria enjoy the luxury of choosing whether to continue paying off their debt or to lift self-imposed restraints on imports from the West. The Greater Implications. Our forecast of continuing serious financial problems for some countries (Poland and Yugoslavia) and, at best, slow improvement for the rest implies that the leaderships will face difficult decisions in the next few years. The problems are not new ones, but are now more severe than in the past. Muddling through-tinkering, temporizing, and relying on help from the USSR and the West-has become less of an Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret option. More than ever, the East European countries will be forced to rely on their own resources and on the ability of their economic managers and systems to adjust. Continuing financial and related problems will influence East European policy on a wide range of issues: ? Relations with the USSR, the West, and each other. ? Allocation of resources to investment, consumption, and defense. ? Economic reform-along with its political and ideological implications. The East European regimes are likely to draw some sobering conclusions from the financial crisis of the past two years and from the past decade of expanded economic ties with the West. While the Polish situation is abhorred by the rest of the region, most of the countries made some of the same mistakes, albeit to a lesser degree. In retrospect, the regimes overborrowed-at first to purchase Western capital goods with which to modernize their economies and later to buy grain and other supplies to support consumption. Although East European officials instinctively blame the West for their problems, they must also recognize that their own shortcomings made them more vulnerable to the credit cutoff. At a minimum, they probably will try to be more certain that they can repay loans and will build more caution into their forecasts of the potential impact of Western economic perform- ance on their external accounts. At the same time, the East Europeans probably will conclude that they now need the West more than ever. The problems that led them to seek Western trade and credits a decade ago are now even more pressing. Economic relations with the USSR will still figure heavily in their decisionmaking; and Bulgaria's relative economic success in recent years will stand as an example of the advantages of less dependence on the West and strong Soviet ties as well as, perhaps, increased CEMA integration. The leaderships realize that one of their chief assets is their borderline position between the USSR and the West, and they will try to play off East against West. 4 The long-talked-about CEMA summit, if and when it is held, should provide some clues as to which of these conflicting pulls is predominant. The USSR has been pressing for more balanced and possibly less subsidized trade, as well as for increased integration. The East Europeans have seen these aims as burdening their economies still more and threatening their relations with the West and have delayed the convening of the summit. Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret The increased need for efficiency and the priority of boosting sales in hard currency markets is likely to give fresh impetus to reform advocacy in most countries. The problem is that reforms take a long time to implement and can be politically unsettling, threatening the privileges of the bureaucracies and challenging the ideological underpinnings of these regimes. The prospect of greater Soviet economic demands, continued stringency in economic relations with the West, and sharp domestic adjustments to the credit squeeze are likely to heighten tensions within the leaderships and between the leaderships and the led. Although the populations have accepted recent austerity reasonably placid- ly, their patience may not survive the period of austerity ahead.. The regimes will have to decide whether to use more repression (as in Romania) or to explain the problem and enlist public support (as in Hungary). The Soviets will want to provide the minimum sustenance necessary to assure stability in Eastern Europe. With economic constraints of their own, the Soviets will want to avoid doing much more than is necessary. Eastern Europe's economic difficulties may also persuade Western govern- ments that they have new opportunities to weaken Moscow's influence in the region. To pursue these opportunities, however, would require a revival of willingness to take financial risks and to use new policy tools, such as in- cluding more East European states in the IMF, and pursuing agreements between them and the EC or assuming politically motivated aid burdens of indefinite duration and return. Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret The Credit Crunch Begins Varying Impact, Differing Responses 10 Poland and Romania: Coping With Rescheduling 10 Hungary, East Germany, and Yugoslavia: Struggling To Remain Solvent 15 Czechoslovakia and Bulgaria: Conservatism Rewarded 18 Financial Outlook 19 Creditor Attitudes 21 Implications for Import Capacity 26 Legacy of the Crisis: Lessons and Perspectives 31 Implications for Economic Partners 33 East European Debt 35 Hungary Czechoslovakia 55 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret Preface This paper is an assessment of the financial situation and outlook of the East European countries, including Yugoslavia. The study reviews the 25X1 evolution of the crisis through August 1983 from a regional perspective, considers how the countries have used various financial options in dealing with their problems, and projects prospects through 1985. The regional focus is complemented by appendixes that provide statistical and analytic details on individual countries. We also consider the broader impact of debt problems in terms of adjustments in foreign trade and projections of future import capacity. Finally, the paper analyzes the implications of the debt crisis for East European decision makers as they formulate policies to overcome their financial problems and try to get their economies back on track, and the consequences for their partners in the West and East. Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret 25X1 Table 1 Net Financing Flows From Western Banks a Million US $ Eastern Europe 5,877 6,048 5,824 10,715 11,252 5,342 -1,513 -6,685 -2,122 Bulgaria 628 407 428 556 -86 -495 -489 -320 -170 Czechoslovakia 5 609 510 485 950 541 -224 -473 71 East Germany 1,164 1,170 715 1,494 1,760 1,375 805 -1,874 -389 Hungary 892 892 1,413 1,747 1,058 64 -305 -940 -457 Poland 2,427 2,550 1,327 3,167 3,393 339 -890 -1,373 -720 Romania 133 -163 470 1,406 1,552 1,362 -707 -826 -206 Yugoslavia 628 583 961 1,860 2,625 2,156 297 -879 -251 a Net financing flows equal changes in the stock of bank claims as reported in the Bank for International Settlements (BIS) statistics. This reflects new credits less repayments. Table 2 Syndicated Loans for Eastern Europe, 1976-82 a Yugoslavia 100 323 1,415 2,291 1,972 1,371 439 East Germany _ 65 542 916 782 481 627 62 Hungary 150 350 600 1,047 550 573 434 Czechoslovakia 260 0 150 461 487 4 0 Bulgaria 120 245 276 332 0 8 0 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret Eastern Europe: Facing Up to the Debt Crisis The Credit Crunch Begins Eastern Europe's credit crunch began in 1980, well before the onset of LDC financing problems, follow- ing a decade of growing reliance on Western credits to finance mounting payments deficits (figure 1). Net credit flows from Western banks (new credits less repayments) slowed to $5.3 billion in 1980, less than half the 1979 level (table 1).1 Most of the decline can be attributed to Poland and reflected growing concern that Warsaw was headed for insolvency. The other countries continued to raise credits, but the net inflow was less than in 1979. Fears about Poland were beginning to give bankers second thoughts about lending to other East European countries. Other factors that contributed to the slowdown in lending were the Soviet invasion of Afghanistan and subse- quent Western sanctions, Tito's death in 1980 and growing doubts about the prospects for stability in Yugoslavia, and the adjustment efforts leading to less borrowing by a few regimes (notably Hungary and Bulgaria). The credit squeeze tightened in 1981 when bank claims on Eastern Europe fell by $1.5 billion. The Poles and Romanians shouldered the largest reduc- tions in bank exposure and were forced to reschedule, but Hungary and Czechoslovakia also paid debts more quickly than planned. East Germany and Yugo- slavia-with the largest financing requirements aside from Poland-managed to obtain a net inflow of credit, but at substantially reduced levels from previ- ous years. Only in Bulgaria did the reduction in debt to banks probably reflect regime intentions.F_~ The slowdown in bank lending to Eastern Europe in 1980-81 involved medium-term commercial credits, particularly syndicated Eurodollar loans. Data com- piled by Euromoney show that, after peaking at $6.9 billion in 1979, syndicated loans slowed to $3.0 billion by 1981 with no major loans arranged after midyear (table 2). This type of lending was very sensitive to worsening banker attitudes because syndicated loans generally involve a lengthy commitment without a Western government guarantee and usually do not finance sales made by banks' clients. trading in promissory notes, which had come to a halt for Poland in 1979, stopped for the other East European countries in late 1981. Although a relative- ly small sourcb of credit, the collapse of the afforfait The financial and trade data presented in this paper are in nominal terms. We have not adjusted for price and exchange rate movements because we lack adequate price indexes and data on the currency composition of trade and credit flows Figure 1 Eastern Europe: External Debt, by Type of Lender International financial institutions 25X1 25X1 25X1 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret Figure 2 Net Resource Transfer to Eastern Europe From Western Financing" a New credits minus repayments of principal and interest. and multilateral institutional financing market for Eastern Europe indicated that banks were becoming increasingly wary about extending medium- term trade financing as well.' The falloff in unguaranteed commercial lending in- creased the importance of credits from Western gov- ernments and international financial institutions.' 'The a forfait market or nonrecourse market trades in promissory notes that generally have maturities of three to five years and do not carry Western government guarantees. A Western exporter sells notes obtained from the East European buyer to a bank which can either hold the notes until maturity or resell them to another bank. The holder of the notes bears the full risk of collecting payment from the importer and has no recourse to intermediate parties. For this reason the a forJait market's assessment of a borrower is a very good indicator of bankers' underlying perceptions of creditworthiness An undetermined share o bank credits guaranteed by Western governments is included in BIS statistics on bank lending to Eastern Europe. Data on official and officially backed credits collected by NATO, the OECD, and the Berne Union of Credit Insurers indicate that Eastern Europe's debt on these credits continued to rise through 1981; therefore, the amount of bank loans guaranteed by Western governments appearing in BIS data pre- sumably increased as well. This would mean that the reductions in unguaranteed bank exposure were even greater than the overall slowdown in lending shown in table 1 Data from official Western and East European sources indicate that Eastern Europe's officially backed debt grew in 1980 and 1981 while Yugoslavia and Romania increased their borrowings from the IMF and the World Bank. By yearend 1981, Eastern Europe owed nearly 30 percent of its debt to official institutions compared with 20 percent at yearend 1978. Large disbursements of official and officially backed loans maintained a strongly positive net re- source transfer from the West to Eastern Europe in 1980 despite the slowdown in commercial lending; however, new government-backed loans were insuffi- cient in 1981 to reverse fully the net resource outflow resulting from the reduction in Western bank expo- sure with Eastern Europe (figure 2)F___1 25X1 Although Eastern Europe's debt on disbursed govern- ment-backed credits continued to rise, outstanding commitments from Western official credit agencies- guarantees pledged for both disbursed and undis- bursed credits-declined in 1981 (table 3). The appar- ent cancellation of some unused credit lines for Po- land accounted for most of the decrease. Western official data, nonetheless, indicate a slowdown in new commitments to most other countries. This may have resulted partly from reduced East European demand for new credit lines. Some regimes, concerned over worsening debt management problems, cut back or- ders for capital goods in particular. A sizable share of 125X1 these goods typically is financed by government- backed credits. On the other hand, the supply of new credits was probably becoming more constrained. According to Western press reporting, some Western official credit agencies began taking a harder look at Eastern Europe's credit rating following Poland's rescheduling request in early 1981.25X1 The slowdown in new government-backed commit- ments lowered Eastern Europe's stock of undisbursed official credit lines from $12.6 billion in 1979 to $6.5 billion in 1981 (table 4). Poland and Yugoslavia accounted for ever three-fourths of the decline al- though East Germany and Romania also drew down their commitments. Statistics published by the Bank Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Table 3 Commitments of Major Western Government Credit Insurers to Eastern Europe a b Bulgaria 737 649 688 675 722 1,034 863 1,314 Czechoslovakia 848 762 899 1,306 1,451 1,762 1,710 1,713 Last Germany 987 947 1,204 2,939 4,647 4,512 5,358 5,487 Hungary 244 173 129 212 430 828 844 1,069 Poland Romania Yugoslavia NA NA NA NA 7,627 7,902 6,368 6,205 ? Commitments are pledges by official credit agencies to insure payment of principal and interest on credits extended by banks and suppliers. Commitments refer to both disbursed and undisbursed credits. . Sources: Berne Union of Credit Investment Insurers. rcduction-by $2.7 billion-in undisbursed credit lines with commercial banks during 1981.' By year- end, the ratio of undisbursed credits to outstanding debt to banks stood at less than 12 percent, a low ratio in comparison with other borrowing countries. This drawdown of commercial and official funds in the pipeline left Eastern Europe with a diminishing re- serve of credit lines available to finance imports and to cover debt service payments. With fewer medium-term loans available, the East Europeans had to draw down reserves and rely on More short-term borrowing. This placed growing strains on the liquidity positions of most countries. In the words of one commercial banker, the East Europe- ans cut corners and they soon got caught. During the first half of 1981, the East Europeans reduced their cash holdings in Western banks from $9.3 billion to $7.8 billion. Between July and December, the East Europeans shifted toward more short-term borrowing ' There undoubtedly is some overlap between the BIS statistics on undisbursed credit bank lines and our estimates of undisbursed government-guaranteed credits. BIS sources indicate that a sizable share of reported undisbursed bank credit lines represent commit- mcnts backed by official guarantees, but not all such commitments to cover their financing requirements and to stem the loss of reserves, which compressed the maturity struc- ture of debt and raised interest costs. At yearend 1981, Eastern Europe's ratio of reserves to debt maturing within one year-a measure of liquidity- stood at only 26 percent (table 4). 25X1 By yearend 1981, the East European countries showed differing degrees of financial vulnerability (table 4): 25X1 ? Poland and Romania already were in a financial crisis requiring rescheduling. ? Hungary's position was very shaky. Budapest could cover from its reserves less than one-fourth of its bank debt maturing in 1982 and had few undis- bursed credit lines available with Western banks and export credit agencies. Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87BOO342ROO0100200011-3 Table 4 Eastern Europe: Selected Financial Indicators a b Proportion of Bank Loans With Reserves as a Share of Debt Maturing 1979 1980 ern Europe 39.9 36.3 Bulgaria 41.1 36.3 Czechoslovakia 47.1 43.1 East Germany 42.7 38.6 Hungary 47.4 42.9 Poland 39.1 33.1 Romania 50.5 42.7 oslavia Yu 22.6 28.1 g Annina countries ex- 42.7 45.6 cluding Middle Eastern countries 1981 1982 1979 1980 1981 1982 37.0 34.0 48.1 51.7 37.6 31.2 42.6 39.0 40.4 33.2 36.1 32.8 35.3 38.9 28.4 26.7 46.2 45.7 Undisbursed Bank Commitments as a Share of Outstanding Debt (percent) 1979 1980 1981 1982 ern Europe Bulgaria Czechoslovakia P.Inninor countries ex- cluding Middle Eastern countries a Source: BIS, IMF, CIA estimates. b At yearend. ? Yugoslavia and East Germany could cover only 35 to 40 percent of maturing obligations from their foreign exchange assets. While both still had rea- sonably large undrawn commitments, Yugoslavia's lines had been declining since 1979. East Germany, on the other hand, had been better able to maintain its reserve of undisbursed bank and government- backed commitments. 28.8 29.0 26.3 22.1 31.0 53.5 55.4 68.7 46.8 65.3 55.7 53.4 46.7 45.2 40.7 42.5 27.2 34.0 23.6 32.0 14.7 7.5 9.7 9.0 9.6 9.4 8.9 9.5 46.3 36.9 35.5 15.9 119.8 100.6 91.4 78.2 (million US $) 1979 1980 1981 1982 8.4 12,564 10,723 6,497 4,883, 15.5 129 341 157 390 10.4 494 579 493 510 13.3 1,918 1,206 1,344 1,025, 7.2 191 398 314 3781 4.8 4,152 3,579 1,682 7N 5A 9.8 1,891 1,270 953 Al 987.5 3,789 3,349 1,554 1,604. 1 l .8 a~ ? Czechoslovakia and Bulgaria enjoyed the most cure financial positions. Both had relatively l-, debt service ratios and could cover over half of maturing credits out of their hard currency;d in Western banks. Bulgaria also had the high! ratio of undisbursed commitments to outstay debt among the East Europeans. Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87BOO342RO00100200011-3 16.5 17.4 11.7 8.4 16.7 24.5 9.7 8.3 6.7 East Germany 16.5 15.2 16.2 Hungary 5.2 8.4 4.6 Poland 24.6 23.9 11.8 Romania 18.3 18.2 9.4 Yugoslavia 23.8 19.0 11.9 26.6 23.2 20.5 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret Debt Service Burden Increases Growing debt service payments contributed to the deterioration in Eastern Europe's financial position (see table 5). The rapid accumulation of debt in the early-to-mid-1970s saddled most countries with in- terest and repayment obligations that mounted more quickly than earnings from exports and services. This trend was aggravated by the upward march of inter- national interest rates in 1980-81 and by the growing reluctance of banks to lend at longer maturities. The increase in debt service ratios meant that most East European countries were becoming increasingly de- pendent on borrowings to meet their debt obligations. The significance of debt service ratios in assessing the financial situation of Eastern Europe is ambiguous. The steady climb of Poland's debt service ratio reflected the country's slide into insolvency. The moderately high and rising debt service ratios of both Hungary and East Germany-while not necessarily indicators of imminent insolvency-warn that these countries will need continued sizable inflows of credit in order to meet debt service payments without large drawdowns of reserves and import cuts. Romania, however, encountered debt servicing problems in 1981 despite having one of the lowest debt service ratios in Eastern Europe. Interest payments on gross debt and repayments of medium- and long-term debt were less than 30 percent of current account earnings through 1981. The more telling indicator in Romania's case was the rapid buildup of short-term debt in 1978-80 that resulted from burgeoning trade deficits caused mainly by skyrocketing oil import bills. This left Bucharest with reserves equal to only 9 percent of maturing debt by yearend 1980 and, hence, put it in a vulnerable position once banks began to cut back The Crash of 1982 The cutback in bank lending to Eastern Europe accelerated at the beginning of 1982. Concerns about the region's creditworthiness were heightened by bankers' rescheduling experiences with Poland and Romania and by the chill in East-West relations Table 5 Eastern Europe: Debt Service Ratios a Bulgaria 29 35 30 32 29 Czechoslovakia 13 20 18 18 19 East Germany 19 46 44 52 58 Hungary 16 31 32 37 37 28 80 89 176 53b Romania 19 20 24 27 45 Yugoslavia 14 19 20 26 25 c a Repayments of principal on medium- and long-term debt plus interest payments as a share of earnings from exports and services. b Reflects debt service paid. Ratio based on amounts owed equals 213 percent. c Excludes $400-500 million in arrearages. following the imposition of martial law in Poland. bankers quickly imple- mented large cutbacks in their exposure to Eastern Europe with little or no consideration given to the relative creditworthiness of individual countries. Commercial banks reduced their gross claims on Eastern Europe by $6.7 billion or by 12 percent of their yearend 1981 exposure. In percentage terms, the reductions in bank exposure ranged between a high of 18 percent for East Germany; 12 to 16 percent for Hungary, Bulgaria, Czechoslovakia, and Romania; and less than 10 percent for Yugoslavia and Poland.' ' The strengthening of the dollar in 1982 overstates the decline in bank exposure to the extent credits are denominated in currencies other than the dollar. The BIS estimates that roughly one-third of last year's decrease in Eastern Europe's debt to Western banks- when measured in US dollars-resulted from exchange rate move- ments0 Since Poland4paid off a very small portion of its obligations to banks, most of the reduction in Polish liabilities reflected bank writeoffs of loans and payments of claims on bank loans insured by 25X1 25X1 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret Table 6 Western Bank Claims, by Region a 1978 1979 1980 1981 Total bank claims 326,987 441,667 547,569 689,660 902,979 1,110,909 1,321,919 1,549,440 Eastern Europe 11,644 17,521 23,569 29,393 40,108 50,236 55,835 54,322 Developing countries b 77,488 124,289 163,707 197,800 243,695 309,315 379,121 464,253 Developed countries 215,268 273,971 323,599 401,614 531,515 652,791 780,518 909,911 Other 22,587 25,886 36,694 60,853 87,661 98,567 106,445 120,954 a Source: Bank for International Settlements. b Excludes oil-exporting countries. The credit squeeze was comparatively more severe for Eastern Europe than for the developing countries. Whereas Eastern Europe suffered an outright reduc- tion in credit lines, banks continued to provide a net flow of loans to developing countries, albeit at a much slower annual rate of increase in 1982 (10 percent) than in preceding years (24 percent annually in 1979- 81) (table 6). Even the most financially troubled developing countries, such as Mexico, Brazil, and Argentina, increased their debt to Western banks last year. Consequently, the East Europeans were under even greater pressure for adjustment than the Third World.0 25X1 The crisis was most severe in the first half of 1982 when Western banks reduced their short-term expo- sure in addition to refusing requests for new medium- term credits. This dealt a severe blow because most countries had become dependent on short-term bor- rowings to cover their financing requirements after the halt in medium-term lending. Using BIS data on the maturity structure of East European debt, we estimate that Western banks reduced short-term claims on Eastern Europe from $11.3 billion to $8.2 billion with the entire reduction occurring in January- June. For the year as a whole, Western banks rolled over only $3.6 billion of the $9.1 billion in maturing medium- and long-term debt. A sizable share of the medium-term credits Eastern Europe obtained from banks presumably came from continued drawdowns 1982 1983 First Quarter 1,687,522 47,637 512,563 996,329 130,993 1,689,147 45,515 518,592 996,457 128,583 of undisbursed commitments, which fell from $6.4 billion at yearend 1981 to $4.1 billion at the end of last year. Some of the decline probably reflected cancellation of unused credit lines as well.1 Unlike 1980-81, government-backed credits did not offset any of the cutback in commercial loans last year. We estimate that the region as a whole drew down new government-backed loans at roughly the same pace as repayments, leaving government- guaranteed debt stable at just over $20 billion. Total Western government commitments (encompassing both disbursed and undisbursed credits) continued to decline largely because of cutbacks to Poland and Romania. For most of the other countries, guarantees of short-term credits increased while medium- and long-term commitments stagnated or fell. Banks and suppliers evidently were more likely to seek official guarantees for short-term trade financing than they had in the past. In terms of medium-term credits, the Berne Union reported that Western governments were willing to pledge new guarantees to all East European countries except Poland and Romania. Reporting from US Em4bassies indicates that some governments turned down East, Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret Figure 3 Eastern Europe: Trade and Current Account Balance 10 I I I I I I I I I European requests for new credits and tried to reduce their exposure by holding new commitments below repayments. Even when governments were willing to insure new credits, commercial banks often refused to assume the 15- to 20-percent unguaranteed portion of the loans. With other financial options running out, the East Europeans reduced substantially their deposits with Western banks early in the year. With cash holdings at or near minimal levels needed for day-to-day trade transactions, most regimes slashed imports. This en- abled the region to run its first hard currency trade surplus in more than 20 years and to bring its current account into balance (figure 3). This helped the East Europeans to pay off $2 billion to banks in the last three quarters of 1982 and to rebuild their reserves by $1.5 billion. The East Europeans placed a higher priority on rebuilding their financial strength over more imports, perhaps out of fear that they would be subjected to renewed withdrawals of short-term cred- The credit crunch of 1980-82 produced a dramatic shift in Eastern Europe's hard currency trade. In marked contrast to the record deficit of $10.3 billion in 1979, the region attained a surplus of $2.6 billion by 1982. In 1980 trade adjustment had focused on both increases in exports and slower growth of im- ports. But as credits dried up and exports sagged in 1981-82, almost all countries had to impose sharp reductions in imports. The abrupt turnaround in the trade account has contributed to slow growth and has confronted regimes with increasingly difficult trade-offs between sustaining consumption and invest- ment The first signs of a shift toward living on less credit had appeared in the late 1970s when Bulgaria and Hungary moved to reduce their trade deficits. Sofia's actions-prompted by a close scrape with insolvency in the mid-1970s-were supported by strong growth in exports and paid off in a nearly $700 million surplus by 1979 (see figure 4). In the same year, Budapest cut its deficit by more than $600 million as 25X1 a result of a jump in exports and a reduction in imports. 25X1 The slowdown in lending in 1980 helped bring about a reduction in the region's trade deficit of $1.9 billion. All countries except Romania improved their trade positions, although the gains were small for East Germany and Yugoslavia. Eastern Europe's imports continued to climb to a record of $47.2 billion, but the 13-percent increase was little more than half the 1979 rate. Buoyant growth of exports helped boost import capacity despite fewer new credits. The 24-percent surge in hard currency sales did not reflect improved competitiveness, but rather windfall gains from boom- ing world prices for energy and raw materials. Ex- ports of petroleum products-in large part refined Soviet oil-increased sharply, and the East Europeans possibly diverttd other goods from domestic supply or sold from stocks. The spending spree of less developed countries, particularly oil producers, also increased export earnings for several countries. Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret Figure 4 Eastern Europe: Hard Currency Trade I I I I I I I I i I i I I I I I I 0 1971 73 75 77 79 81 82 0 1971 73 75 77 79 81 82 I I I i I I I I 0 1971 73 75 77 79 81 82 I I i I 1 1 1 I 1 I i 0 1971 73 75 77 79 81 82 4 2 1971 73 75 77 79 81 82 25X1 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret Figure 5 Eastern Europe: Trade With the Developed West, 1977 and 1981 I'cr.cnl 1977 Other 1.9 Fuels 1.2- 1 ransportation 6.4 Foodstuffs 8.4 Chemicals 5.9- \iachinery 6.6 Consumer goods 18.9 Foodstuffs 17.0 The collapse of lending forced an improvement in the trade balance of $4.6 billion in 1981 and $6.4 billion last year. With a simultaneous slump in exports as a result of recession in the West, the East Europeans had little choice but to slash imports by 30 percent over the two-year period; the deepest cuts were made by Poland, Romania, and East Germany. The $12.8 billion reduction in imports lowered the region's fi- nancing requirement by about 15 percent. Planners focused import cuts on those items that would have the least immediate impact on their economies and populations. Purchases of capital 1981 Imports Fuels 3.0 Transportation 6.2 Raw materials 7.6- Chemicals 8.2-- equipment were put off, wherever possible, because their loss would not jeopardize current production. The share of machinery and transportation equipment in imports from the developed West fell from 40 percent in 1977 to 31 percent in 1981 (figure 5). Restrictions *ere less severe on imports of raw mate- rials, chemicals, and other semifinished goods needed for production, which together maintained their 45- percent share of imports from developed countries. 25X1 Fuels 20.4 Consumer goods 17.6 Semifinished 16.6 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret Figure 6 Eastern Europe: Domestic Economic Indicators I I I I I I I -10 1977 78 79 80 81 82a 83b a Preliminary. b Projected. GNP Per capita consumption Most regimes were cautious about reducing purchases of consumer goods and foodstuffs; the share of these goods in imports rose from 12 to 22 percent between 1977 and 1981 but may have declined somewhat last year because the good harvest permitted substantial cutbacks in imports of grain. F 25X1 The net resource outflow-excess of exports over imports-needed to cope with the financial crisis has been a key factor in the region's deteriorating eco- nomic performance (figure 6). For the six CEMA members, real GNP fell by 0.5 percent annually in 1980-82 compared with 2.5-percent annual growth in 1976-79. For Yugoslavia, growth slowed from a peak of 7.0 percent in 1979 to only 0.3 percent last year. Investment in the CEMA members fell by 1.9 percent annually in 1980-82 and by 5.7 percent in Yugoslavia. Per capita consumption, on the other hand, dropped by only about 0.5 percent annually on average throughout the region. Varying Impact, Differing Responses The financial problems of the individual East Europe- an countries varied in terms of their timing and severity, and evoked differing responses from the regimes. F__~ 25X1 Poland and Romania: Coping With Rescheduling Poland. Unable to cover their 1981 financing require- ments, Poland and Romania were forced to resched- ule. As 1982 began, Poland was $400 million in arrears on interest payments necessary to conclude the 1981 bank rescheduling agreement; payments were completed in March 1982 and the agreement was signed in April. In January, Western govern- ments protested the imposition of martial law by refusing to reschedule 1982 debt and by not extending new government-guaranteed credits. This decision and Poland's failure to repay debt service to govern- ments did not result in default, however, and Warsaw secured de facto debt relief simply by not making payments to governments. The resulting buildup in arrears has boosted the 1983 financing requirement and further worsened Warsaw's chances for financial recovery0 25X1 25X1 Warsaw negotiated debt relief from Western banks in 1982 on more generous terms than in 1981. Although Western banks held off rescheduling for the first several months of the year, by midyear they decided to begin negotiations. The Poles first requested total relief from principal and interest, but in August they accepted rescheduling of 95 percent of principal. Unlike the year before, the banks agreed to defer interest payments due in 1982 for payment in install- ments in November and December 1982 and March 1983. Another major concession was that the banks agreed to relend 50 percent of interest payments in the form of short-term trade credits to finance im- ports from the West earmarked for Polish export industries. This arrangement in effect broke the banks' taboo against rescheduling interest payments (see table 7)0 25X1 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87BOO342ROO0100200011-3 Secret Table 7 Rescheduling Agreements Agreement Date of Date of Obligations Amount of Repayment Terms Comments Agreement Signature Covered Debt Relief Interest Repayment Rate Period Poland 1981 Paris March 1981 27 April 1981 90 percent of prin- $2.2 billion Club Agree- cipal and interest nicnt on medium- and long-term loans in arrears of 1 May- December 1981 1981 Bank August 6 April 1982 95 percent of pay- $2.3 billion Agrcement 1981 ments on medium- and long-term debt due 26 March 1981-31 December 1981 1982 Bank August 7 November 95 percent of prin- $2.2 billion Agrccmcnt 1982 1982 cipal on medium- and long-term debt due in 1982 ?'~ 3 Bank August November 95 percent of prin- $1.2 billion \grccment 1983 1983 (planned) cipal on medium- and long-term debt due in 1983 Varies with January 1986- Bilateral accord creditor; gener- July 1989 with the United ally I percent States not signed above domestic because of $28 government million arrears on borrowing rate unrescheduled payments due in 1981. LIBOR plus December 1981 interest 1.75 percent 1985- payments com- December pleted in March 1988 1982. LIBOR plus September Interest paid in 1.75 percent 1986- three install- September ments, November 1989 1982, December 1982, and March 1983. Separate agreement pro- vided that 50 per- cent of interest payments be re- lent in the form of 6-month trade credits, rolled over for 3 years at an interest rate of 1.5 percentage points over LIBOR. LIBOR plus January 1988- Principal repay- 1.875 percent July 1992 ment schedule is graduated: 10 percent due in 1988, increasing 5 percent annual- ly to reach 30 percent in 1992. 4 Separate agree- ment provides for 65 percent of in- terest payments to be relent in the form of 6-month trade credits, rolled over for 5 years at an inter- est rate of 1.75 percentage points over LIBOR. Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87BOO342ROO0100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Table 7 Rescheduling Agreements (continued) Agreement Date of Agreement Date of Signature 1982 Bank Agreement February 1982 7 December 1982 1982 Paris Club Agree- ment June 1982 28 July 1982 1983 Bank Agreement February 1983 21 June 1983 1983 Paris Club Agree- ment 18 May 1983 18 May 1983 Obligations Amount of Repayment Terms Covered Debt Relief Interest Repayment Rate Period 80 percent of pay- $1.3 billion LIBOR plus 1985-88 ments on all debt, 1.75 percent including short- term 80 percent of pay- $400 million Varies with 1985-88 ments on medium- creditor, gener- and long-term debt ally 1 percent above domestic government borrowing rate 70 percent of pay- $601 million LIBOR plus 10 percent of Amount not be- ments due in 1983 1.75 percent rescheduled ing rescheduled amount due in due August- 1984; remain- December 1983. der to be paid March 1987 to September 1989 60 percent of prin- $148 million Varies with 31 December Of the 40 percent cipal payments on creditor, gener- 1986 to 31 De- not rescheduled, medium- and long- ally I percent cember 1989 30 percent due term debt above domestic within one month government of original due borrowing rate date, 10 percent due on 30 No- vember 1984. Unrescheduled principal paid in January and March 1983. Agreement cov- ered much less than orginally planned because suppliers and many banks re- fused to participate. Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret Despite more generous terms from commercial banks, Warsaw only managed to cover less than half of its 511 billion financing requirement last year.' Debt relief from banks covered $2.6 billion and use of previously committed government-guaranteed credits provided $1.5 billion in loan receipts. Under pressure to meet bank rescheduling terms, Warsaw also ran a surplus of $761 million on its current account (exclud- ing interest). Warsaw slashed imports by 15 percent to earn the surplus; the lack of imported supplies for industry hampered Polish economic recovery. Lack of rescheduling agreements with Western governments meant that the bulk of receipts was used to cover payments due to banks. Western bankers report that payments of interest, fees, and principal under the 1981 rescheduling agreement were made on schedule as well as payments required under the 1982 agree- ment. Poland finished 1982 with arrears estimated at S6.6 billion. Romania. The credit crunch hit Romania in the spring of 1981 when Western banks ceased lending in part because of concerns about Poland but mostly due to doubts about Bucharest's creditworthiness. Despite ttic approval of an IMF standby program in June, arrears began to mount in the summer and reached S 1.1 billion by the end of the year. At first, the Romanian authorities refused to respond to banks' demands for payment and appeared incapable of dealing with the emerging crisis. We believe that President Ceausescu must take some of the blame for Bucharest's refusal to come to grips with its hard currency problems sooner. The delay in seeking for- mal debt relief probably reflected his reluctance to take any action that would put Romania in the same boat with Poland. With a nudge from the IMF, Bucharest finally ap- proached Western banks in January 1982 with a request for rescheduling. While an agreement was ux)n reached on terms, the negotiations dragged on for I I months because of disputes among the banks and between banks and other creditors. On 7 Decem- ber. Romania and Western banks signed an agree- ment to reschedule 80 percent of arrears from 1981 and Principal payments due in 1982. According to data supplied by Romania to the banks, the debt relief from banks was worth only $1.3 billion-about $1 ' %cc table on Poland in appendixF__1 billion less than requested. Firms had balked at the Romanian request to convert their short-term loans into six-and-a-half year credits, and several banks managed to obtain payments and avoid rescheduling (see table 7). By mid-1982 there was a noticeable turnaround in Romania's approach to its financial problems. Bank- ers noted that Romanian officials had become more businesslike and realistic in their approach to resched- uling. A US Embassy official reported that the Romanian Bank for Foreign Trade, which previously had played a passive role in managing the country's finances, began holding daily meetings to decide how to allocate hard currency payments to creditors and foreign suppliers. Although his direct involvement has not been visible, President Ceausescu's oft-reported tight overall control over government policy suggests 25X1 that he probably played the major role in deciding to pursue more rational financial policies. Negotiations for debt relief from Western govern- 25X1 ments began in June 1982 after the IMF restored Bucharest's access to drawings. The Paris Club quick- ly agreed to reschedule 80 percent of principal and interest payments due in 1982 and arrears from 1981, providing debt relief of $400 million. The agreement rescheduled only medium- and long-term debt and required that $260 million in short-term credits be paid. Failure to pay these short-term obligations delayed for months conclusion of bilateral agreements 25X1 with the 15 signatory to the Paris Club accord. Romania was overly optimistic about the amount of debt relief and new credits that it could come up with in 1982 to cover the year's $4.3 billion financing 25X1 requirement.' In addition to the shortfall in the debt relief it secured, IMF data show that new loans were $470 million less than the $1.7 billion target set early in the year. Bucharest reacted to the shortfall by cutting imports by one-third to earn a current account surplus of $655 million-an improvement of $1.5 billion compared with 1981. Despite this drastic ad- justment, Romania was left with a gap of nearly $400 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 The Rescheduling Experience Both Poland and Romania have dealt with a wide range of problems associated with rescheduling. Creditors have insisted on tough terms, negotiations have been lengthy and complicated, the debt relief provided has been inadequate, and both countries have been threatened with default. Dodging Default. Creditors have used the threat of default as one of their bargaining ploys during re- scheduling negotiations. creditors have threatened Poland with default several times, and Warsaw has taken steps to protect its assets from seizure. Romania's failure to honor a $3 million payment under a foreign exchange contract led a US bank to begin default proceedings in late 1981, but the bank did not carry through. The risk of default has receded significantly in the past year. Romania's successful rescheduling and the possibility of a financial turnaround make it increas- ingly unlikely that creditors would take legal action, even as Warsaw's poor long-run prospects make default still an eventual possibility. In fact, one of the most important lessons of the Polish experience is how much creditors will tolerate without declaring default. By requiring large and rapid debt writeoffs and halting the trickle of payments, default could damage the creditors more than the debtors. More- over, the emergence of LDC debt problems has made a declaration of default even more dangerous, since it would risk a chain reaction that could lead to other defaults. Problems With Creditors. One of the biggest sources of problems and delays during rescheduling has been disputes among creditors and creditor groups. In some cases, negotiations between debtors and bank groups have gone more smoothly than negotiations within bank groups. Romania, for example, agreed on financial terms for the 1982 bank rescheduling in February after a few meetings with nine major bank creditors, but objections by other creditors held up conclusion of the pact until December. The Polish negotiations have proceeded in the opposite way: the banks have negotiated among themselves for several months before presenting an agreed position to War- saw.0 25X1 25X1 25X1 The principle of equitable treatment of creditors has been difficult to apply. Poland has been the most serious problem. The martial law sanctions prevented the governmental creditors-the Paris Club-from rescheduling even as banks were rescheduling and added a political dimension to the debt relief ques- tion. With Romania, the bank creditors, the Paris Club, and the IMF each made their agreements in 1982 contingent on conclusion of pacts with the other groups; the banks complained that the Paris Club rescheduled only loans with a maturity of one year or longer while they rescheduled short-term credits. A key difference between banks and governments is that the latter in the Paris Club allow rescheduling of interest while banks insist that interest be naid. F_ 25X1 Western creditors also have had difficulty in verifying the terms for debt relief from creditors outside Western bank groups and the Paris Club. Both Poland and Romania owe substantial sums to Mid- dle Eastern and CEMA lenders. The Poles have given few details on the status of their payments to and debt relief from these creditors, while the Romanians have asserted that debt relief from non-Western creditors was obtained last year without specifying Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret The equity issue also complicates new loans granted during rescheduling. New loans are usually intended to increase the debtor's imports, but the debtors can use the loans to finance imports of goods that other- wise would have been bought with cash. This frees export receipts for payments to creditors, including those not providing the loans. Polish data recently provided to government creditors show that, when Western governments extended or guaranteed some 55 billion in loans in 1981, Warsaw halved imports from $2.14 billion in the first quarter to $1.07 billion in the fourth quarter, mainly by cutting cash imports. In the third quarter, for example, credits covered about 92 percent of imports. In order to secure debt relief, Poland and Romania have been forced to provide creditors with unprece- dented amounts offinancial and economic data. Previously secret details on balance-of-payments per- jorntance and projections, payments due to creditors h, types of creditor and country of origin, holdings of kind and other reserves, and financial relations with the USSR have been submitted to large numbers of hank and government creditors, and much of the Information has appeared in the Western press. Rescheduling has led creditors to try to become more lm?olved in the debtor countries' economies. Roma- nia's membership in the IMF has allowed the Fund to hell this role for the creditors, but, in the case of Poland, the creditors have been frustrated in their utteinpts to encourage economic reform and policies chat would lead to economic recovery. The bank croup established an International Economic Com- 'ntttee for this purpose, but the group has been able to do little more than collect data because Warsaw refuses to allow creditors a significant role in the million at the end of theeyear, reflecting arrears to suppliers and Paris Club members. Moreover, the import cuts intensified shortages of food, gasoline, and other consumer goods. Data presented to the IMF show that consumption fell for the first time since World War II and that the rate of growth of industri- al production fell to a postwar low of 1 percent Hungary, East Germany, and Yugoslavia: Struggling To Remain Solvent Since Poland and Romania already had gone broke in 1981, last year's banking "run" on Eastern Europe hit hardest at Hungary, East Germany, and Yugoslavia-the countries most dependent on new credits to meet debt obligations. With loans drying up, Budapest, East Berlin, and Belgrade faced three policy options: ? Impose tough adjustment measures in an attempt to pay off debt by running current account surpluses. ? Appeal for emergency help from Western govern- ments and international financial institutions. ? Request debt rescheduling from private and official creditors. 25X1 The problems that Poland and Romania had faced in negotiating reschedulings reinforced the reluctance of other countries to risk the domestic political costs of rescheduling. The three hard-pressed regimes, howev- er, proved to have different capabilities for imposing effective adjustment policies and for wheedling help out of the West: ? Although reluctant to impose austerity on consum- ers, Hungary implemented some adjustments and won enough financial help from Western govern- ments, central banks, and the IMF to avoid rescheduling. Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 ? East Germany could not hope to obtain much help from the West and opted to meet its obligations by wringing a large current account surplus out of its economy. ? Yugoslavia's financial problems were too large, and its adjustment efforts too weak, to forestall bank- ruptcy. 25X1 Hungary. Budapest was vulnerable to a loss in banker confidence because of reliance on short-term borrow- ing to cover its financing needs. The pullout of $1.3 billion in short-term credits by Western, OPEC, and CEMA banks and inability to roll over $200 million in maturing medium-term credits brought Hungar to the brink of a liquidity crisis in early 1982. billion to less than $400 million, or little more than one month's imports, between January and March. As a result, a growing number of Western suppliers reported delayed payments from Hungarian import- The Hungarians parlayed their good relations with the West and reputation as sound managers into enough emergency support from Western govern- ments, the BIS, and the IMF to avoid a debt resched- uling. The Hungarians argued that a financial crisis would undermine their economic reforms and gratify those who want to tie Hungary more closely to the East. Budapest also tried to convince creditors that its difficulties resulted primarily from a temporary li- quidity squeeze, not from serious or fundamental problems that might threaten its solvency. Hungary's arguments persuaded West European central banks and governments in April to provide $210 million in short-term bridge loans through the BIS to shore up Budapest's reserves. The BIS indicated that addition- al credits would be available later in the year if Hungary made progress in negotiating a standby credit agreement with the IMF. Several West Euro- pean governments also extended guaranteed trade credits. This show of official Western support and some arm twisting by Western governments convinced 15 commercial banks to arrange a $260 million loan for Hungary in August While the regime temporized for several months over tightening its adjustment measures, Budapest came under growing pressure from the BIS and IMF to take more austerity steps in return for emer y loans. the IMF expressed concern to top-level officials over Budapest's lack of political will to impose tougher stabilization measures. During the second half of 1982, the Hungarians responded by raising prices and cutting subsidies on some consumer goods and serv- ices, tightening domestic credit, imposing controls on hard currency imports, and devaluing the forint. The BIS lent another $300 million in September, and the IMF approved $620 million in credits in December; about a third of the IMF loan was disbursed immedi- ately to repay the April BIS loan, with the remainder to be drawn this year. These loans and a growing trade surplus enabled Hungary to meet its debt service obligations, clear up its arrearages, and re- 25 25X1 deem most of its collateralized gold. By the end of 1982, Hungary had rebuilt its foreign exchange re- serves to nearly $1.2 billion. 25X1 East Germany.' Although saddled with the largest cutback in credits and the second-highest debt service ratio in Eastern Europe, East Germany was the only financially troubled country in the region that did not require debt relief or emergency loans from Western creditors in 1982. Western bankers have often sus- pected that the USSR or West Germany gave special financial help. We, however, believe it probable that the East Germans managed last year's credit crunch on their own through tough adjustment measures and LJ/\ I We estimate that the East Germans moved their current account from a $500 million deficit in 1981 to a $1.2 billion surplus last year.9 Imports fell an estimated 15 percent due to cutbacks in purchases of grain, capital goods, industrial materials, and con- sumer goods while exports grew by more than 6 percent despite depressed Western markets. The trade adjustments-offset more than 80 percent of the cut- back in bank credits. The rapid adjustment of trade Analysis of East Germany's financial performance in 1982 is complicated by the lack of official balance-of-payments statistics. 'See table on East Germany in appendix. 25X1 25X1 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret exacted a stiff price, however, from the domestic economy. According to Embassy reporting, shortages of needed goods caused disrup- tions in production and consumer supply, and invest- ment was cut back even in priority sectors. We estimate that GNP growth fell from 2.4 percent in 1981 to 0.5 percent last year. The East Germans improved their cash flow by accelerating collection of export receipts, delaying payments for purchases, and shifting Western imports into intra-German trade. he East Germans were successful in exporting for cash while pressing suppliers for extend- ed grace periods on their own payments. East Ger- many also increased imports from West Germany from $2.5 billion in 1981 to $2.9 billion last year while cutting imports from other OECD countries. This shift occurred in large part because of easier access to trade credits in West Germany, including the swing credit.'? Moreover, the East Germans gained by build- ing up their trade surplus with OECD countries other than West Germany because-unlike surpluses earned with other Western partners-a surplus earned in inter-German trade does not yield cash that can be used to service hard currency debts." The payments surplus and tighter cash management reversed the $900 million reduction in reserves that occurred in the first nine months of 1982. Reserves recovered by $700 million in the final quarter and stood at $1.9 million by the end of the year. The unexpectedly large late-year gain probably resulted from the regime's desperate efforts to adjust its trade and improve its cash flow. The East Germans may also have tried to improve their reserve position as re- ported by the BIS by borrowing short-term credits The swing credit is an interest-free overdraft account for trade with East Germany maintained by the West German central bank. The credit ceiling totaled $360 million in 1982 but will be gradually reduced to $250 million by 1985 " Intra-German goods trade and most services are paid through bilateral clearing arrangements. Surpluses earned by one country can be used only to clear past debts with the other partner or to obtain increased future deliveries. The trade surpluses are not available to make payments to third parties. Some West German 'crvice payments and all currency exchanges by tourists are convertible currency that East Berlin can use for payments to other ru rt ies. l from banks not included in the BIS survey (for example, Middle Eastern banks) and redepositing the funds in Western banks. 25X1 The credit squeeze would have hit East Germany even harder if the country had not had credit commitments with Western banks and governments. BIS statistics show that East Berlin may have mobilized as much as $560 million-nearly 20 percent of its gross borrow- ings from commercial banks last year-through draw- downs of previously committed credits. Berne Union statistics indicate only small growth in commitments of Western government-backed credits. We estimate that the East Germans had to draw down their stock 25X1 of undisbursed officially backed loans by nearly $320 million. 25X1 East Germany's unblemished record in meeting pay- ments led some Western bankers to conclude that the regime received special financial help from West Germany in 1982. 25X1 Of course, the roughly $1 billion obtained from West Germany through official 25X1 service payments and tourism receipts were vital to East Germany's efforts to meet its obligations. Bonn, however, did not meet East Germany's request last 25X1 year for special credits. According to press reports East Germany asked in late 1981 for official West 25X1 German help in raising nearly $2 billion, but the West Germans held back, apparently because East Berlin refused to make concessions on political issues. This request, nonetheless, resulted in mid-1983 in a West German Government guarantee for a $400 million West German commercial bank loan but without explicit political concessions by the East'Germans. Yugoslavia. Yugoslavia's financial crisis stemmed as much from failure to reduce the current account deficit and poor cash management in the country's banking system as from reduced Western bank lend- ing. Western bank exposure with Yugoslavia fell by 25X1 only some 6 percent, or $650 million, in 1982-the smallest percentage reduction for any East European Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 country (excluding Poland). Nonetheless, by the end of the year Yugoslavia had mounting arrearages to foreign creditors and no prospect of meeting its 1983 obligations without Western financial help Belgrade in 1982 failed to cut its current account deficit to its target of $500 million and instead ran a deficit of $1.4 billion because of poor export perform- ance, falling worker remittances, weak tourism re- ceipts, and high interest costs." Yugoslavia also suf- fered a $400 million outflow on the capital account, resulting mainly from reductions in short-term debt as Western bankers grew increasingly worried about the solvency of some Yugoslav regional banks. Growing concern about Yugoslavia's prospects also prevented Belgrade from meeting its target for medium- and long-term borrowing. Disbursement of some $600 million in IMF credits was inadequate to offset the shortfall in current earnings and capital flows, and Yugoslavia was forced to draw down its reserves by $1 billion 25X1 Almost all of the decline in reserves came from the official foreign exchange assets of the Yugoslav Na- tional Bank. Belgrade decreed emergency foreign exchange controls in May 1982, requiring regional banks and enterprises to contribute to a liquidity fund with which the National Bank was to pay off arrear- ages of overextended commercial banks and build up its reserves. The banks and enterprises failed to comply, however, and as a result the National Bank lost reserves in a futile attempt to clear up overdue payments of the commercial banks. Belgrade imposed additional foreign exchange controls in October in an effort to save its dwindling reserves. By yearend, however, the National Bank's assets were inadequate to cover the overdue payments of commercial banks and meet other contingent liabilities. With arrears of $500-600 million, the country was technically bank- rupt. Czechoslovakia and Bulgaria: Conservatism Rewarded Creditors did not favor Czechoslovakia and Bulgaria much over the rest of Eastern Europe in 1982, but Prague's and Sofia's past conservative trade and borrowing policies paid off. Both countries had small financing requirements, which insulated them from the full effects of the credit crunch. 25X1 25X1 Czechoslovakia. The cutback in bank lending appar- ently accelerated Czechoslovakia's plans for curbing imports from the West and paying off hard currency debt. Bank exposure in Czechoslovakia fell by $400 million, most of which was covered by an estimated $210 million current account surplus and a $110 million drawdown on reserves." The Czechoslovaks slashed hard currency imports by 19 percent. Prague's resolve to restrict purchases from the West led to the establishment of a so-called anti-import commission charged with monitoring all applications for spending hard currency to determine that no substitutes were available from domestic or CEMA sources. The impo- sition of this and other administrative measures to constrict imports flowed from President Husak's 1981 pronouncement that Czechoslovakia would not "live on credit," as well as from the $662 million decline in export receipts last year. With shrinking export earn- ings because of Western recession, Prague's planners had to make deep cuts in purchases to meet the leadership's goal of reducing external indebtedness. By the end of 1982, Czechoslovakia's net debt had declined to $3.2 billion from $3.5 billion the year before. 25X1 Despite the country's relatively small financing needs, Czechoslovak bankers apparently were concerned about their liquidity position and doled out little cash to importers. According to the Western business press, Czechoslovak foreign trade enterprises pressed harder for countertrade deals and for one- and two- year supplier credits for raw materials normally pur- chased for cash. Despite Husak's dictum against more borrowing, Czechoslovakia's Foreign Trade Bank also discussed in late 1982 the possibility of a $100-200 million syndicated loan with Western banks presum- ably to reduce its short-term debt or to rebuild its reserves. Although press reports claimed that the Czechoslovaks found a positive response, 25X1 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret Western bankers balked at the long maturity and low interest rate Prague's bankers were seeking. Bulgaria. Sofia's relatively low debt and lack of dependence on the West paid off during last year's bank freeze of Eastern Europe. Creditors seemed less anxious to reduce their exposure to Bulgaria than to the rest of Eastern Europe. Although bank exposure fell by some $320 million during the year, the drop probably reflected Sofia's policies as much as banks' efforts to reduce exposure. After a dip in its deposits in Western banks in the first half of the year, Sofia managed an increase for the year. As a result, we estimate that Bulgaria's debt fell below $2 billion, continuing the steady decline begun in 1980. Not only was the bank pullout less severe for Bulgar- ia, but Sofia's minimal financing requirement left it better able to adjust. Its low debt and comfortable maturity structure meant that repayments were not large, and the regime's conservative trade policy icldcd a surplus on the hard currency current ac- count.' lulgaria, however, was not totally immune from financial problems last year. The US Embassy in Sofia reported last July that Western firms experi- enced payment delays of several months because of: ? A drop in revenues from transportation and tourism. ? Delays in payments to Bulgaria by troubled West- crn firms (for example, AEG-Telefunken) and coun- trics strapped for hard currency (for example, Iraq and Libya). ? Sofia's perception that it could obtain free credit unilaterally by extending payments periods. hanks reported no payments problems, however, and, after a few months, the reports of arrearages to firms Financial Outlook "IS statistics show another $2.1 billion fall in bank claims on Eastern Europe during the first quarter of we rabic on Bulgaria in appendix. 1983, but more recent developments suggest some improvement in the region's borrowing prospects: 25X1 ? Hungary obtained a $200 million three-year syndi- cated credit in April, and a group of Arab and Japanese banks are now arranging a $250 million cofinancing loan to accompany project loans ap- proved by the World Bank in June. Both Hungarian and Western bankers report that the outflow of short-term credits, which continued into early 1983, has now been reversed. business opportunities were improving throughout Eastern Europe except for Poland and25X1 Yugoslavia. West European bank marketing offi- cers, in particular, have begun to press their senior managers to look for more business in Eastern Europe. the $400 million West German Government-guaranteed loan to East Germany has reinforced their already improving 25X1 assessments of East Berlin's creditworthiness and has accelerated their plans to provide new trade credits. Czecho- slovakia obtained a $50 million club loan with a four-year maturity from a group of six Western banks in mid-July. Ithe "a forfait" market is reviving for short-term Hungarian, East German, and Czechoslovakian trade notes. The panic that gripped Eastern Europe's creditors in 1982 is receding. The success of most countries in improving their balance of payments appears to have persuaded many bankers that Poland's problems do not necessarily typify those of other East European countries. Improving lender attitudes, revival of the 25X1 25X1 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 The USSR has not provided sign cant hard currency loans or financial aid to its allies in Eastern Europe since early 1981, when Moscow agreed to lend War- saw up to $1 billion. The gains from trade with Moscow also have fallen steeply from their peak in 1980-81 (see figure 7). In 1982 the reduction in oil deliveries to some East European countries, combined with the increase in East European exports to the USSR, suggests a reduction of real resource flows from the USSR. In 1982 Eastern Europe's deficit with the USSR was reduced to $2.7 billion from $4.4 billion in 1981. This reduction occurred despite a sharp deterioration in Eastern Europe's terms of trade with the USSR as the effect of Western inflation worked its way into CEMA prices. Although trade grew at some 12 percent annually during 1979-82, the increase result- ed largely from price increases. Soviet subsidies in the form of price advantages to Eastern Europe also have fallen substantially. In 1982 Soviet oil prices to Eastern Europe rose about $5 per barrel, while OPEC prices fell slightly. The gap between Soviet and OPEC prices narrowed from the maximum of $17 to $18 per barrel in 1980-81 to $12 in 1982. The Soviet price of crude oil to Eastern Europe is about $26, the same price of some spot trades in early l983.F___1 25X1 The USSR has shown more generosity toward Yugo- slavia in 1983 than toward its financially strapped Warsaw Pact allies. Moscow's actions presumably have resulted, in part, from concern that the "Friends of Yugoslavia "financial rescue package would in- crease Western influence in Belgrade. In the 1983 Yugoslav-Soviet trade protocol, the USSR agreed to permit a small deficit in Belgrade's favor in contrast to the large surpluses run by Yugoslavia in recent years. This concession apparently has been helpful since the IMF reports that diversion of goods from CEMA markets contributed to Yugoslavia's strong hard currency export performance in the first months of 1983. Moscow has also been receptive to Yugoslav requests for additional oil deliveries. In March, the USSR agreed to ship an additional 200,000 to 300,000 tons of oil above the 4.5 million tons of crude agreed to in the 1983 trade protocol. The Soviets, however, apparently demanded more Yugoslav hard goods in return. More recently, a Yugoslav official told the US Embassy that the Soviets have agreed in principle to provide an additional I million tons of oil apparently without requesting more Yugoslav exports this year. 25X1 The Soviet assistance apparently has enhanced the USSR's standing in Belgrade. According to the US Embassy, Moscow's forthcoming attitude on addi- tional oil deliveries and Belgrade's political interest in counterbalancing its financial dealings with the West have quieted much of the squabbling between the USSR and Yugoslavia that was evident last year and in early 1983. Recent criticism by the Soviet media of Yugoslavia's economic and financial rela- tions with the West probably served as a reminder to Belgrade to keep its relations with the East in good repair. Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Figure 7 Eastern Europe: Diminishing Economic Benefits From Trade With the USSR Sob let Trade Surplus With Eastern Europe Million US $ 198 79 80 81 82 Eastern Europe: Crude Oil Prices Dollars per barrel __ I I I I I 0 1978 79 80 81 82 Wcstcrn economies, and lower Eurodollar interest rates should ease somewhat the financial burden of most East European countries. The outbreak of new financial crises seems unlikely provided the regimes can maintain their austerity policies. I he region's hopes for financial recovery, however, arc fragile. Lenders who have been burned by debt txoblcros in Eastern Europe and elsewhere remain cautious about the region's creditworthiness. An early return to the easy credit conditions of the 1970s is not foreseeable, and bankers will examine much more etosclY the quality of economic management and Performance before increasing their exposure. Poland and Yugoslavia will continue to cause major head- aches for creditors and will not be cured in the near future. The possibility of more reschedulings and 'Nuests for Western aid cannot be ruled out0 Llrnited access to loans will force the region to c'satinue running trade and current account surpluses at4 to make difficult decisions about allocating scarce hard currency either to repay debt or to import. With fewer loans, import capacity will depend heavily upon success in boosting exports. 25X1 25X1 Creditor Attitudes The emergence of LDC debt problems in mid-1982 may have complicated Eastern Europe's borrowing woes, but it also put the region's difficulties in a more balanced perspective. Although wary about new lend- ing, bankers seem a little more relaxed about the region's financial situation because their worst fears proved exaggerated. Poland did not default or repudi- ate its debt and has kept current on its rescheduling agreements with the banks; Romania has made con- siderable progress in normalizing relations with its creditors. Other heavily indebted countries-notably Hungary and East Germany-survived the 1982 credit crunch without rescheduling, an achievement that may revive creditor confidence in these countries. 25X1 25X1 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 ... Friends in Deed Eastern Europe's financial crisis has increased the importance of international financial institutions to the region. The IMF, BIS, and World Bank were the only creditors to increase their exposure to Eastern Europe last year. Moreover, to varying degrees, the IMF and BIS have helped manage the relations of Hungary, Yugoslavia, and Romania with both private and official creditors over the past two years. Since the internationalfinancial crisis first arose in Eastern Europe, the IMF and BIS set precedents in dealing with the problems of East European members that were to be repeated on a large scale with troubled Third World borrowers.0 25X1 The BIS-IMF Rescue of Hungary. The $210 million in emergency help given to Hungary by the BIS and West European central banks in early 1982 represent- ed the first major support operation by central bank- ers. (In mid-1981, France led an unsuccessful effort to organize a $500 million bridge loan for Poland through the BIS.) Once it had established a precedent with Hungary and the danger of a spreading world financial crisis had became obvious, the BIS ar- ranged emergency bridge loans similar to the Hun- garian credit for Mexico, Brazil, Argentina, Chile, and Yugoslavia 25X1 The BIS decision to aid Hungary-when it had refused to help Poland-stemmed from the very different nature of the problem. In the eyes of most central bankers, Hungary was fundamentally sound and well managed but was close to illiquidity because commercial bankers had reduced their exposure to the country rapidly. The central banks hoped that a quick infusion of cash would stem the bankers' run on Hungary; moreover, the BIS commitment would only have to be short term. Budapest was negotiating its entry into the IMF and presumably could draw on Fund credit facilities by late 1982 to repay the BIS loans. Poland, by contrast, suffered a problem of basic insolvency that only its creditors could resolve by granting substantial debt relief for an extended period of time and in turn could severely undermine the internation- alfinancial system. West European central banks and governments, which put up most of the funds for the BIS loan, feared that a Hungarian debt resched- uling would discredit Budapest's program of econom- ic and political liberalization The help for Hungary accomplished the central banks' objective of preventing bankruptcy until Buda- pest could arrange credits from the IMF and return to the syndicated market. The operation, however, has not been without pitfalls for the BIS. The Bank's commitment to Budapest has proved to be longer term than anticipated and it has come close to violating the dictum that central banks should not give explicit guarantees to commercial banks. The group of 15 commercial banks, which arranged a $260 million club loan for Hungary in August 1982, tried to make this backing explicit by tying their loan to a pledge from the BIS to disburse its then pending 8300 million credit for Hungary. BIS decision to extend another $IOU mt ton to Budapest in April of this year-after commercial banks put up an additional $200 million-suggests willingness to backstop banker's risk r- L' ' 'gary.C 25X 25X1 Problems With Yugoslavia. The BIS-IMF rescue of Hungary set the stage for the far larger and more complex effort to save Yugoslavia. The first IMF program began in 1980 and was replaced in 1981 by the current three-year agreement worth $2.1 billion. By its own admission, the IMFfailed to appreciate the seriousness of Yugoslavia's economic situation- particularly as Western commercial credits dried up in 1981-82--and overestimated the responsiveness of the economy to corrective measures. The IMF staff's repeated overoptimism about Yugoslavia damaged the Fund's credibility in the eyes of commercial bankers and led the Fund to assume a leading role in trying to work out the country's problems in 1983L1 . 25X The multilateral rescue effort began to take shape in September 1982 when the Yugoslavs appealed to the BIS for a three-year, $500 million credit to bolster the National Bank's reserves and pay off arrearages. 25X1 The BIS and West European central banks also aided Hungary out of concern over the economic and political implications of Budapest's impending finan- cial crisis. According to press reporting, BIS Presi- dent Leutwiler believed that a Hungarian financial collapse would bring down the rest of Eastern Europe Secret Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 The central banks refused on grounds that they could only extend short-term financing that would cover obligations until a longer term refinancing program was in place. Shortly thereafter, senior IMF officials began warning Western governments that a financial crisis was imminent and that the Fund would have to halt disbursement of the standby loan. Although Yugoslavia's situation called for rescheduling, the IMF argued on political grounds that a rescheduling could prove divisive in Yugoslavia. In return for a tougher 1983 stabilization program, the IMF pressed Western banks, governments, the World Bank, and BIS to provide $6 billion in refinancing and new credits The Yugoslav rescue effort has been a trying experi- ence for both the IMF and BIS, and more difficult decisions are in store for both institutions. The BIS has had problems arranging the $200 million gold- secured tranche of its $500 million credit because some creditors have refused to waive Yugoslav pledges entitling them to equal security. Since Yugo- slavia's liquidity problems show no sign of easing, the B/S probably will have to renew its credit. Yugoslav authorities have indicated they will need another I,MF standby credit next year. Since the Yugoslavs have made little progress in controlling inflation, the IMF will have to press for even tighter adjustment Prreasures if the stabilization program is to remain credible in the eyes of Western creditors. The Fund has already been caught between Western govern- ments and banks in disputes over burden sharing in this year's effort. The problem almost certainly will worsen if as seems likely, the Fund presses for another rnancing effort in 1984 in lieu of resched- The Fund's Mixed Results With Romania. In June 1981 the IMF and Romania agreed on a three-year, SI.2 billion standby arrangement. The pact proved to be too little, too late: ? The Fund's seal of approval did nothing to bolster banker confidence and the program quickly fell apart. ? Bucharest had little time-and probably not much enthusiasm-to implement the program's measures on energy prices, exchange rates, interest rates, and the organization of foreign trade. ? The first disbursement of 140 million SDR was sN'amped by the tide of the bank pullout. ber the IMF suspended further drawings ? The large accumulation of arrearages violated con- 25X1 ditions of the standby arrangement, and in Novem- Bucharest to take the distasteful step of requesting debt relief in January 1982, the first move Bucharest made to address its difficulties. Until then, the Romanians had seemed stunned and defiant, refusing to respond to creditors' demands for payments. The IMF's hold over access to disbursements under the standby arrangement provided incentives for success- ful conclusion of negotiations with banks and the Paris Club. Last December the IMF released $300 million to Romania, which Bucharest set aside to make the downpayments due the banks under the rescheduling agreement. Romanian payments data also show a $100 million BIS loan in 1982, repayable in $25 million installments due this February, March, July, and December. 25X1 that IMF officials were instrumental in convincing The standby arrangement-launched at the time that Bucharest's financial situation was just beginning to sour-cast the Fund in a major role in the resolution of Romania's difficulties. The IMF has had difficulty in applying conditions and monitoring performance for Romania, the first CEMA country to join the Fund. Although Romania is a centrally planned economy without a convertible currency, the Fund's policy prescriptions have fo- cused on reducing the number of exchange rates, raising domestic prices, tightening domestic credit policy, and eliminating subsidies-measures that ex- perience shows have had little impact on improving Romania's external payments position. Warsaw's IMF Application on Hold. After years of indecision and apparent resistance from Moscow, Poland decided in late 1981 to apply for IMF membership. Shortly afterward, martial law was declared and the application shelved. Polish officials and press continue to urge the completion of the application and accuse the West of blocking it for political reasons. Warsaw is likely to press the West to allow membership when negotiations with the Paris Club resume this fall, although some Poles probably remain wary about the conditions Warsaw would have to accept in order to gain access to IMF credits.0 25X1 LJ/~ I 23 Secret Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret Eastern Europe's problems no longer appear unique nor even extraordinarily severe, Poland excepted. Concern over the threat to the world's financial system from overextended borrowers has demonstrat- ed that both debtors and creditors bear responsibility for resolving financial problems. In particular, the involvement of the BIS and IMF in Hungary's and Yugoslavia's crises has encouraged-and to some extent compelled-continued banker involvement with these countries 25X1 Warsaw's plight, however, has changed bankers' long- term thinking about Eastern Europe. The banks can no longer point to Eastern Europe's financial conserv- atism and unblemished payments record, and they have learned that they cannot trust in Soviet financial support as adequate justifications for lending to the region. Instead of making blanket judgments about the area's creditworthiness, bankers are beginning to draw sharper distinctions among the countries on the basis of economic policy and performance, thus reduc- ing somewhat the danger of spillover 25X1 Continuing unease among bankers about foreign lend- ing and closer government supervision of commercial bank exposure will impede the ability of Eastern Europe and the LDCs to return to Western financial markets, although both could benefit if Western countries seek to support their own exports by boost- ing credits through guarantee and insurance pro- grams. Even when they return, comparisons will be made between the two groups of countries on the extent and success of adjustment programs. While Eastern Europe may look better in the short run because of the dramatic trade adjustments made during the last two years, its longer run economic prospects probably are bleaker. Political developments, in our opinion, also could influence borrowing prospects. Any further cooling in the East-West political climate or outbreaks of unrest or violence could further undermine creditor confi- dence. Threats to political stability could result from popular reaction to the pinch of austerity measures or from struggles over succession, and problems in one country could spill over and poison lenders' attitudes about the whole region t As a prerequisite for increased lending, bankers are looking for evidence that the East Europeans are addressing their payments imbalance through struc- tural changes to improve export performance. Credi- tors regard the draconian import reductions of the past two years as a short-run expedient with little positive impact on long-term creditworthiness. Some bankers remain skeptical that the East Europeans will or can do as much as financially troubled LDCs to correct their fundamental problems. As a result, they are putting more weight on IMF membership, while urging the East Europeans to provide more complete economic and financial information. Even when providing new loans, many Western bank- ers indicate they will keep Eastern Europe on a short leash. The days of granting large untied credits at long maturities and low interest spreads are gone. Major Eurodollar syndications will be much rarer than in the late 1970s; a far greater share of lending will be short-term and trade-related. Commercial banks will probably insist on more Western govern- ment backing for their loans or demand security from the borrowers, including gold collateral and offsetting deposits. The cost of credit will be higher than in the late 1970s, and the debt maturity structure will remain unfavorable for most countries. Prospects for Credit Flows Eastern Europe's hopes for easing restrictions on imports depend upon whether the region can reduce- and eventually reverse-the net outflow of funds suffered in 1981-82. In 1983 we estimate that the region (excluding Poland) will experience another large outflow on the capital account of more than $2.4 billion (table 8).15 This actually reflects some improve- ment in borrowing capacity over 1982 when the net credit outflow exceeded $3.5 billion; Yugoslavia, how- ever, will probably be the only net gainer this year, thanks to the Western financial rescue package. Projecting financing flows in 1984-85 is more uncer- tain because of factors affecting both the supply of " See appendixes for projections of 1983 financing requirements for individual countries. The totals discussed in this section exclude Poland because of the many uncertainties underlying debt relief for Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret Table 8 Net Financing Flows: a 1976-82 Actual, 1983-85 Projected 1976-80 (annual 1981-82 1983 1984-85 b (annual average) (annual Projected average) average) Total Bulgaria 185 -360 Czechoslovakia East Germany 1,800 -505 Hungary 1,230 -750 Romania 1,305 -390 Yugoslavia 2,210 340 ? New credits less repayments. See insert on page 26 for explanation of Scenarios I, II, and III. and demand for credit. We cannot easily quantify the impact of IMF stabilization programs, Western res- cue packages, and developments in international fi- nancial markets on the willingness of creditors to lend. It is difficult, in addition, to generalize about the prospects for new borrowings by the region as a whole because lenders are likely to differentiate among these countries more than in the past in making decisions about new credits, and some regimes-notably Czechoslovakia and Bulgaria-may be unwilling to make full use of available borrowing capacity. In the attempt to establish a range for likely net credit inflows and outflows for Eastern Europe (excluding Poland), we have made broad assumptions about each country's ability to raise credits over the next two years under three scenarios: ? Scenario I-our most pessimistic variant-envisions a continued outflow from Eastern Europe of $2.2 billion annually in 1984-85. This presumes that bankers continue to reduce their exposure because of financial problems in the region or reluctance to undertake foreign lending in general. Under this scenario, Yugoslavia almost certainly would need another debt refinancing or rescheduling because it has little margin for paying down its debt from reserves or current earnings. Hungary, East Germa- ny, and Romania would remain under intense pres- sure to run large trade and current account surplus- es to avoid reschedulings. ? Scenario II presumes enough revival of lending to leave the region's net financing flows roughly in balance over the next two years, with a moderate inflow of credit in 1985 offseting some outflow in 1984. This variant assumes that Eastern Europe's adjustment efforts instill enough confidence in bankers first to halt reductions in exposure and then to begin extending small amounts of new credits. The modest net credit inflow for Yugoslavia is based on IMF projections, which we believe presume at least some additional refinancing in 1984 at least. 25X1 The positions of Hungary, East Germany, and Romania are more manageable, but these countries will not receive the large inflows that buoyed eco- nomic performance in the 1970s. ? Scenario III, which provides for an average net credit inflow of $2.4 billion in 1984-85, is optimistic about Eastern Europe's ability to return to interna- tional capital markets. In this case, most East European countries are able to reestablish their credit rating with Western banks, -and the interest of Western exporters in reviving markets provides more trade financing. Even under these circum- stances, the region's net resource inflow is less than a third of that enjoyed in 1976-80. Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret Credit Flows. We have established three scenarios regarding the size of net financial flows (new credits less repayments) in 1984-85 for each East European country except Poland. Scenario I is the most pessi- mistic about Eastern Europe's borrowing prospects and assumes either no change in net financial f lows or a small reduction in net debt; Scenario II presumes a small revival of lending; and Scenario III assumes all countries can resume net borrowings. We have differ- entiated among the countries on the basis of banker perceptions of creditworthiness and have computed credit flows on the basis of changes in net debt. We assume that Czechoslovakia and Bulgaria have the best borrowing prospects: ? Scenario I presumes no net credit inflow or outflow in 1984-85. ? Scenario II presumes a 5 -percent increase in net debt each year. We have estimated the flows for Yugoslavia and Romania from IMF projections for 1984-85: ? Scenario I for Romania is the IMF s projection of a net capital outflow averaging $600 million in 1984 and 1985. We assume that, in each year, Yugosla- via falls $500 million short of the IMFs projected financing sources which total $5 billion in 1984 and $4.75 billion in 1985. The shortfalls presume Yugo- slavia fails to obtain projected medium-term bank credits. 25X1 ? Scenario II assumes Romania raises enough credits to run a balanced current account in 1984-85 while Yugoslavia obtains the IMF's projected credit flows. ? Scenario III assumes Romania increases its net debt by 5 percent in 1984-85 while Yugoslavia obtains $500 million more in untied bank loans than the IMF projectsF I 25X1 ? Scenario III presumes a 10 percent increase in net debt each year.F__~ 25X1 We assume that both Hungary and East Germany will experience a net loss of credits under Scenarios I and II and will be net borrowers under Scenario III: ? Scenario I presumes a 7 -percent fall in net debt each year, the average rate of decline for both countries in 1981-83. ? Scenario II presumes a 3.5 percent fall in net debt in 1984 and no change in 1985. ? Scenario III presumes a 5 -percent increase in net debt both years.F____-] 25X1 Implications for Import Capacity Some improvement in borrowing conditions and a pickup in Western demand for East European exports should enable the East Europeans (excluding Poland) to ease the import cuts of the past two years. Since the revival of both lending and Western economic growth will probably be slow, we anticipate another 1- to 2- percent decrease in Eastern Europe's hard currency Exports. We assume that the relationship between the growth of Eastern Europe's exports to developed countries in 1984-85 and projected growth in the OECD will be the same as that between increases in exports and OECD growth in 1976-81. We have excluded Eastern Europe's exports of petroleum products from the 1976-81 base because of their extraordinarily rapid increase in this period, which is unlikely to be repeated. We assume exports to devel- oping countries in 1984 will be 5 percent below last year's level and will return to the 1982 level in 1985. These projections are probably optimistic because competition from LDCs in developed country markets and Western protectionism could hold relative export gains below the levels achieved in the 1970s. Re- straints on Eastern Europe's imports could also undercut export performance.F 25X1 imports this year. Gains in import capacity probably will be achieved in 1984-85, assuming continued growth in the West and improvement in creditor attitudes, but only under the most favorable lending assumption (Scenario III) does the absolute level of imports in 1985 ($39.0 billion) exceed the level reached in 1980 ($38.7 billion) (see figure 8). With Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret Figure 8 Eastern Europe: Hard Currency Imports 1980, 1982, and projected 1985, Under Financing Scenarios Billion US S Fastern Europe, Excluding Poland 1980 1982 1985, Scenario I Scenario 2 Scenario 3 Czechoslovakia 1980 1982 1985, Scenario 1 Scenario 2 Scenario 3 198() 1982 1985, Scenario I Scenario 2 Scenario 3 L I I I I 1980 1982 1985, Scenario I Scenario 2 Scenario 3 4 6 8 10 12 1980 1980 1982 1982 1985, Scenario 1 1985, Scenario I Scenario 2 Scenario 3 Romania 1980 1982 1985, Scenario I Scenario 2 Scenario 3 Scenario 2 Scenario 3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 only a modest revival of lending (Scenario II), imports in 1985 are about 4 percent below the 1980 peak and 8 percent below the least favorable lending assump- tion (Scenario I).F_~ 25X1 Under our assumptions, Bulgaria exhibits the greatest capacity for gains in imports while Yugoslavia has the least. ? Under almost any circumstances, Sofia should be able to increase imports at a faster rate than achieved in 1976-80. ? Although we assume the same borrowing prospects for Czechoslovakia as for Bulgaria, Prague probably can do little better than resume growth of imports at the late 1970s' pace because of sluggish export growth. Projected import capacity in 1985 would reach the 1980 level only under the most favorable lending scenario. ? The import capacity of both East Germany and Hungary in 1985 would be more than 5 percent above the 1980 level under Scenario II and more than 10 percent higher under Scenario III. Our projections permit much faster import growth for East Germany in 1984-85 than for Hungary. East Berlin, however, would need much of this to offset the far sharper cutbacks in imports which it made in 1981-82. ? Romania's import capacity, on the other hand, would reach only 80 percent of the 1980 level under the most optimistic scenario and would be as low as 70 percent under the most pessimistic assumptions. ? The poor growth in Yugoslavia's import capacity results from the nearly 10-percent reduction in imports this year, which overwhelms modest in- Even if lending revives, some countries may be unwill- ing to expand imports at the rates our projections suggest. Some regimes (Czechoslovakia, Bulgaria, and Romania) may opt instead to continue reducing hard currency debt or building up reserves. But, while regimes currently place high priority on continuing to run trade and current account surpluses, their resolve may weaken if more credits become available. Pres- sures to make full use of available import capacity will be intense because most economies need more Western inputs.) 25X1 In the short run, Eastern Europe's import priorities will most likely remain those of the past two years. Most regimes will give preference to goods needed for consumption and current production. Purchases of grain and food products will fluctuate in accordance with agricultural performance. Some economists and planners (notably in Hungary and Czechoslovakia), however, are arguing more strongly that their econo- mies need a revival of investment using Western resources to lay the foundation for long-term growth, and this may have some greater impact down the road. Bulgaria, in fact, has recently shown more interest in purchases of Western equipment and tech- nology. To raise imports significantly, the East Europeans need robust gains in hard currency sales. Their ability to power an export drive is open to question: ? Exports suffer from longstanding problems of quali- ty and marketing, and tinkering with trade bureauc- racies is unlikely to infuse more export orientation. ? Cutbacks in imports of capital goods have probably widened the technology gap between the West and Eastern Europe. ? Many of Eastern Europe's traditional exports face increasingly stiff competition from LDCs and grow- ing protectionist sentiment in Western Europe. ? The East Europeans are unlikely to repeat sizable gains in exports of raw materials and petroleum products because of softer prices and cutbacks in deliveries of Soviet oil. ? Cash shortages are forcing OPEC and other devel- oping countrie6 to slash imports, possibly leading to a greater share of East European sales to these countries through bilateral clearing arrangements and not for cash. ? Efforts to expand exports through countertrade deals with Western trading partners have limited prospects for success due to their resistance to East European barter goods. Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret Debtor Prospects 16 The prospect of slow export growth and more credit outflows, or at best small inflows, means that finan- cial problems will continue to beset nearly all the East European countries. In the near term, Poland-and very likely Yugoslavia-simply cannot generate enough debt servicing capacity on their own to meet obligations. The outlook for other countries may be less bleak, but further reductions in credit availability could expand the number of countries needing re- scheduling or Western aid. Even if the likelihood of more reschedulings recedes in 1984-85, limited import capacity will continue to hobble economic perform- ance. Most regimes will have to restrain consumption and investment in order to lower demand for imports and free goods for export. Within these constraints, pressure will build to produce more output with fewer inputs. This will point up the necessity of attacking the systemic flaws that contributed to low productivi- The nature of the financial problems and the capacity rd individual countries to respond seem likely to dncrge even more over the next several years: ? Poland and Yugoslavia are caught in a medium- to long-term financial crisis, and their regimes seem the most ineffective in imposing adjustment meas- ures and attacking structural problems. Warsaw's financing gap far exceeds Belgrade's, but Western creditors will have to give Yugoslavia debt relief beyond this year's rescue package. ? Romania, East Germany, and Hungary show signs of financial recovery, but their positions remain fragile. East Berlin and Bucharest have squeezed tbcir economies much harder than Budapest, while the latter seems farther along in addressing struc- tural problems. East Germany probably retains the ?:congest financial safety net (particularly by ob- taaaing help from West Germany), but Hungary, 40d to a lesser extent Romania, are better posi- Wricd to win general Western support, including help from the IMF. ? wt+gcnd iled discussion of the prospects of individual ? Thanks to their smallidebts and generally good standing with Western banks, Czechoslovakia and Bulgaria have the option of choosing to continue paying down their debt or to lift self-imposed re- straints on imports from the West. Poland. Insolvency and lack of progress in dealing with its debt problems have locked Poland into a crisis that is likely to prevent economic recovery for several years. Poland has almost no hope of earning a surplus and obtaining debt relief, credits, and a trade surplus sufficient to cover its $13 billion financing require- ment this year. While its rescheduling agreements with banks and governments are not yet concluded, its debt continues to grow by the amount of unpaid interest as creditors involuntarily increase their expo- sure. Merely to stem the increase in its debt, Poland must generate net exports equal to annual interest payments. Financial recovery-at a minimum, halting the growth of the debt-will require both large current account surpluses and commitments by the regime to revive economic growth and by the populace LOA I Yugoslavia. Completion of the financial rescue pack- age should provide Yugoslavia with nearly enough debt relief and new credits to cover this year's $5.8 billion financing requirement, but there will be little or no rebuilding of reserves. We believe that Belgrade will need more help in 1984 and 1985 and that it may be difficult to avoid rescheduling, particularly because creditors may not want even to maintain their expo- sure, much less increase it. The key to Yugoslavia's financial recovery is Belgrade's ability to attack the economy's deeply entrenched inflationary tendencies and to correct systemic problems and weak financial management. But needed adjustment policies and structural reforms may impose a higher price than the population and regional political leaders are willing to Romania. The 1983 financial picture looks much better than last year's, primarily because Bucharest has crossed the hump in its debt maturity structure. It has already concluded negotiations to reschedule its Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Yugoslavia: A Little Help From Its Friends The IMF and the US Government appealed to West- ern governments to pledge enough credits to Yugosla- via that commercial banks would be encouraged to refinance their own maturing loans and provide new medium-term credits to replace last year's withdraw- al of short-term loans and rebuild reserves. A group of 15 governments responded in January with a $1.4 billion credit package. The commercial banks' Inter- national Coordinating Committee (ICC) subsequently proposed a $3.8 billion restructuring of commercial obligations consisting of $1.4 billion in refinancing of maturing medium-term loans, a two-year renewal of $1.8 billion in short-term debt, and $600 million in new credits. These refinancing packages are more generous than the reschedulings done for Poland and Romania by Western banks and governments. If Yugoslavia had rescheduled its debts under the terms obtained by Poland in 1982, it would have received only $3 billion instead of the $5.1 billion in rollovers and new credits pledged by banks and governments. In addition to the refinancing packages provided by its creditors, Yugoslavia is receiving substantial fi- nancial support from international financial institu- tions. The IMF is providing the last $600 million tranche of Yugoslavia's three-year standby credit. The BIS has approved a $500 million short-term loan to bridge Belgrade's cash needs until the entire credit package is disbursed, although problems over the use of gold as collateral have limited drawings to $300 million. Finally, the World Bank has contributed a $275 million structural adjustment loan in addition to some $175 million in new project credits. Despite the generous amount of assistance, the effort to avoid a formal rescheduling has not provided Yugoslavia with the type of aid needed and has led to problems among creditors that delayed conclusion of the package. In contrast to a conventional Paris Club rescheduling agreement, each government decid- ed the type and amount of financial assistance it wished to provide to the rescue plan. The contribu- tions from most governments consisted largely or entirely of 2- to 3-year credits tied to future exports from their countries. While Yugoslavia clearly need- ed trade financing, Belgrade's more pressing problem was cash to cover maturing obligations and an ex- tended period of relief from debt repayments. More- over, the decision of governments to offer new trade loans instead of rolling over maturing claims meant that the governments were not bearing a commensu- share of the rnancing. rate X1 The package led to problems over burden sharing between governments and banks because the IMF pressed banks to provide in effect a rescheduling of all maturing loans plus new money. Although banks pressed governments to refinance maturing loans, the latter could not easily restructure their package. Some governments were already disbursing new cred- its, and some made disproportionately large pledges of new funds in lieu of extensions on obligations falling due. The banks concluded that the govern- ments are not providing a long enough maturity on new loans and are not providing the type of credits Yugoslavia needs. Moreover, some Western govern- ments are actually receiving more repayments from Yugoslavia in 1983 than they pledged in new credits while the banks are increasing their exposure. The ICC, nonetheless, decided it had to accept the govern- ment package to keep the rescue effort on track. E 25X1 25X1 1983 debt to banks and governments. The Roma- shortfall in credits, could lead to a substantial finan- nians, however, have balked at the IMF's demands to cial gap this year. Bucharest has vowed that it will not establish timetables for adjusting exchange rates and need debt relief next year and counts on a current domestic energy prices, and the Fund has suspended account surplus to cover more than half of its 1984 drawings under the standby arrangement. The stale- mate with the Fund, combined with a continued Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 financing requirement. The test of Romania's exter- nal adjustment efforts will come in 1985 when Bucha- rest must begin to repay obligations rescheduled in 1982. Next year's expiration of the current IMF standby arrangement also will increase pressure for large current account surpluses. Romania's ability to cover its financial obligations will depend on whether it has used debt relief to deal with underlying econom- ic problems, on whether creditors judge that Bucha- rest has overcome its debt woes, and on how debilitat- East Germany. East Germany probably can avoid a rescheduling, but the country continues to face a serious liquidity problem. Covering this year's financ- ing requirement without a reduction in reserves will require another large current account surplus and more than $3.5 billion in credits. The East Germans continued to encounter difficulties in raising loans in the first half of 1983, but the recent $400 million government-guaranteed credit from West German banks should improve prospects for covering this again stagnate this year, as opposed to the nearly 8-percent growth originally projected in the standby program. The Fund has lowered the projected current account surplus from $600 million to $500 million, but meeting this goal still requires new restraints on domestic demand. Depressed exports and continued withdrawal of short-term credits reduced reserves to less than two months worth of imports in early 1983, and the IMF now projects a $155 million decline in 25X1 reserves for the year instead of the increase originally planned. This leaves Hungary in a very weak position because Budapest faces a rising level of debt repay- ments through 1985. The Hungarians have requested a second IMF standby credit, and they will have to tighten adjustment policies, as well as continue to forge ahead with measures to improve efficiency and competitiveness if they are to avoid rescheduling. Fortunately for Budapest, many Western bankers believe they should support Hungary's reform pro- gram as an example for other East European coun- year's borrowing requirement. Even before announce- Bulgaria and Czechoslovakia. Both countries have ment of the loan, Western bankers seemed more weathered the credit crunch as a result of their ? i I I in g to provide short-term trade loans and the new financial conservatism: Since neither encountered West German credit may encourage even more lend- problems in covering obligations during the height of ing. Bankers, however, still do not anticipate an the crisis in 1982, we expect they will be able to roll increase in medium-tem r fl, l nancia credits needed to over their 1983 obligations. Their financial strength lengthen the maturity structure of E G ' t as ermany s debt. East Berlin nonetheless can draw on new government-guaranteed trade credits from France, If East Germany gets through this year's financial ',quceze, repayments on medium-term debt will be less Irr 1984-85. East Berlin still will need to roll over a large short-term debt, but further improvement in its financial position should strengthen lender confidence and case the task of refinancing. Western bankers, however, will press harder for basic economic and balance-of-payments data before increasing their ex- tx) urc. Over the medium term, the country will have to live more within its means and implement measures that improve export competitiveness and promote c`Onomic growth without heavy reliance on Western Im o p rts and credit. tfv?xary. Hungary is still on a financial tightrope dezpite some successes in raising credits in the first half of 1983. The IMF now estimates that exports will has left them with a range of options not available to the other East Europeans. They could maintain their policy of limited economic relations with the West, hold down imports, and reduce their debt even fur- ther. Or Sofia and Prague could use their financial cushion to expand hard currency imports. While there are signs that Sofia may move to expand its trade with the West, Prague apparently is committed to running current account surpluses and paying down its debt through 1985. This will contribute to a further tech- nological decline of the industrial sector and stagna- tion of the Czechoslovak economy. Legacy of the Crisis: Lessons and Perspectives Our forecast of continuing serious financial problems for some countries (Poland and Yugoslavia) and, at best, slow improvement for the rest implies that the leadership will face difficult decisions in the next few years. The problems are not new ones, but are now Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret more severe than in the past. Muddling through- tinkering, temporizing, and relying on help from the USSR and the West-has become less of an option. More than ever, the East European countries will be forced to rely on their own resources and on the ability of their economic managers and systems to adjust. Continuing financial and related problems will influence East European policy on a wide range of issues: ? Relations with the USSR, the West, and each other. ? Allocation of resources to investment, consumption, and defense. ? Economic reform-along with its politica' 54 ideo- logical implications. F___1 25X1 While East European officials instinctively blame the West for their problems, they must also recognize that their own shortcomings at least made them more vulnerable to the credit cutoff. They must be disap- pointed, for example, with the results of their decision to expand trade with the West, launched in the early 1970s. The import boom did not lead to a sustained improvement in the growth rates of their economies, implying either that the imports did not help or that their benefits were swamped by other problems. Moreover, the imported technology and equipment failed to generate enough exports to repay the loans. The regimes are likely to conclude from their experi- ences that caution should guide their economic rela- tions with the West for some time. Thus, while creditors' attitudes indicate that the supply of financ- ing will be tight, demand by the East European debtors also may be constrained by a new conserva- tism. Several East European countries apparently intend to pay off their debts to the West. At a minimum, others probably will try to be more certain that they can repay loans and will build more caution into their forecasts for the Western economies, care- fully considering the potential impact on their exter- nal accounts. At the same time, the East Europeans may conclude that they now need the West more than ever. Indeed, most still seem anxious at least to maintain their economic ties with the West. The fundamental eco- nomic problems that led them to seek Western trade and credits a decade ago are now even more pressing. Dwindling economic resources-recently aggravated by Moscow's cuts-place a greater premium on effi- ciency. With the East's relatively weak technology and research base, the West remains the preferred source of equipment and technology to boost produc- tivity. In addition, some of the countries still need debt relief, aid, and credits to relieve their financing problems. 25X1 Economic relations with the USSR will figure heavily in their decisionmaking, and Bulgaria's relative eco- nomic success in recent years is an example of the advantages of less dependence on the West and strong Soviet ties. Moscow is pressing for more balanced and possibly less subsidized trade, as well as increased CEMA integration. East European resistance has delayed the long-talked-about CEMA summit which, if and when it is held, will give a good indication of the direction of Soviet-East European relations. We do not believe that the key issues will be resolved soon. The East Europeans will continue to need Soviet energy and other raw materials and will try to minimize the political as well as economic costs of obtaining them. Most of the regimes do not regard their economic relations with East and West as an either/or proposi- tion; as in the past, they will try to get as much as pos- sible from both. The leaderships realize that one of their chief assets is their borderline position between the USSR and the West. The Soviets want to retain the strategic and military advantages that flow from domination of much of the region and the member- ship of most states in the Warsaw Pact; the West wants these countries at least to maintain traditional ties to the West and to express some independence from Moscow. Most East Europeans will be deft at playing off East against West. Within the region, the increased need for efficiency and more rational use of scarce resources are likely to give fresh impetus to reform advocacy. The capital inflows of the 1970s-together with Soviet largesse- allowed the East Europeans to get along without making fundamental changes in their economies. Without new loans, and with prospects for continuing slow or negative growth, systemic reform has become more urgent. The priority of boosting sales in hard currency markets means that East European produc- tion must be of higher quality and more flexible in Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret reacting to changing tastes and conditions. This calls for decentralization at least in the direction and operation of the external sectors. The problem is that, as the Hungarian experience shows, reforms take a long time to implement and even longer to pay off. Moreover, the present tight payments situation re- quires quick results, which would be difficult to achieve during a period of structural transition. Re- form, furthermore, can be politically unsettling in that it threatens the privileges of entrenched bureaucracies and challenges the ideological underpinnings of these regimes. Finally, the prospect of stringency in economic rela- tions with the West and the continued need for sharp domestic adjustments to the credit squeeze are likely to heighten tensions within the leaderships and be- tween the leaderships and the led. The prospect of lower capital inflows or of outflows will require reduced imports and increased exports, both of which will take resources out of the domestic economies and depress living standards. While the populations have accepted recent austerity reasonably placidly, their patience may not last as long as the tough period of austerity that lies ahead. The regimes will have to decide whether to use more repression (as in Romania) or to explain the problem and enlist public support (as in Hungary). In any case, economic deprivation will serve as a continuing, and perhaps growing, source of potential political instability in the months and years Implications for Economic Partners Eastern Europe's bleak economic prospects present problems and opportunities for both the USSR and the West. Moscow perceives economic weakness in Eastern Europe as a threat to its security interests at a time when its own problems reduce its options. The Kremlin appears ambivalent about Eastern Europe's financial problems, as reflected in apparent indecision about policy toward Eastern Europe. Moscow can gloat over Eastern Europe's misadventures-particu- larly Poland's-in buying and borrowing from the West and can cite these problems in arguing for more closely meshed economic relations within CEMA. The predicament of its client states, on the other hand, means that considerable, economic support is needed from one source or another to maintain stabil- ity in the region. The Soviets are likely to have to field more requests for aid to supplant credits and other 33 i economic constraints of their own, the Soviets will want to supply the minimum necessary to assure this stability, but will find this level difficult to estimate. Moscow's proposals to its troubled allies have focused on CEMA integration rather than on narrower trade issues. The Soviets' agenda for the CEMA summit concentrates on sweeping changes that would increase Soviet economic influence over the East European 25X1 economies and draw them more tightly into the CEMA orbit. The Kremlin may have chosen this time to exert pressure because it perceived that the East Europeans' problems left them little opportunity to resist. But such a calculation would ignore the Sovi- ets' experience in Eastern Europe since World War II and could prove dramatically counterproductive. At the same time, growing economic difficulties in East- ern Europe may persuade Western governments that they have new opportunities to weaken Moscow's influence in the region. To do so, however, would require a revival of willingness to take financial risks and to use new policy tools, such as including more East European states in the IMF, and pursuing agreements between them and the EC or assuming politically motivated aid burdens of indefinte duration The West cannot expect substantial economic gains in its relations with Eastern Europe. Financial con- straints are likely to make East European markets tough for Western exporters to penetrate. The adjust- ments of the past two years have disappointed firms- especially in Western Europe-who acquired a major stake in exporting to the region in the 1970s. Capital goods have borne the brunt of Eastern European import cutbacks, and most of the countries apparently have no plans to revive large-scale equipment pur- chases. Imports of grain also have been slashed sharply, and Western farmers cannot expect that this market will soop be as large as a few years ago.F_ Eastern Europe also will still be a source of concern 25X1 and uncertainty to creditors. Western exporters are likely to press their banks and government export credit insurers to provide financing for their sales. The banks, however, will have enough trouble getting payments on past loans and, in the cases of Poland and Yugoslavia, will be involved in protracted negoti- Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Eaahra Europe 1981 1982 Total 9 510 1 Commercial , 5 396 1,572 7 2 14,727 21,468 30,659 38,264 46,572 58,614 70,310 83,598 84 842 Official b IMF/World Bank 3 765 349 , 43 3,921 408 9,828 4,406 15,634 5,123 23,721 6,002 29,667 7,168 36,388 8,583 46,952 9,715 55,904 11,862 61,793 18,506 , 59,692 20 267 80,503 53,383 493 711 936 1,429 1,601 1,948 2,544 3,299 , 4 883 20,223 Total 743 1 009 , 6,897 Commercial 442 , 765 1,020 1,703 2,640 3,198 3,707 4,263 4,032 3,562 3 065 Official b 301 244 818 202 1,520 2,453 2,878 3,394 3,935 3,619 3,128 , 2,575 2,782 2 187 Ctechoalorakia 183 187 320 313 328 413 434 490 , 595 Total 485 630 Commercial 284 435 757 1,048 1,132 1,862 2,616 3,206 4,096 4,756 4 400 3 998 Official b 201 195 558 821 926 1,575 2,290 2,798 3,502 4,013 , 3 610 , 3 58 East-- Ml?y 199 227 206 287 326 408 594 743 , 790 ,1 840 Total 1 554 2 136 Commercial 693 , 771 , 1 348 3,136 5,388 6,292 7,828 9,666 12,312 14,089 14,680 13 077 Official b 715 783 , 788 2,243 893 4,423 965 5,217 1 075 6,528 1 8,166 10,225 11,411 11,535 , 9,642 Hungary , ,300 1,500 2,087 2,678 3,145 3 435 Total , Commercial 1,071 968 1,372 1 274 1,442 1 353 2,129 2 3,135 4,049 5,024 7,290 8,140 9,276 8,700 7 800 Official b , , ,053 3,081 3,998 4,965 7,197 8 008 9 053 8 , BIS/IMF 103 98 89 76 54 51 59 93 , 132 , 223 ,380 320 6,748 415 Poland Total 1,399 1 825 3 057 637 Commercial 420 , 856 , 1 951 5,313 8,879 12,307 14,621 17,600 21,100 24,840 25,500 24 800 Official b 979 969 , 1 3,586 6,547 9,159 10,393 12,532 15,300 14,740 15,045 , 14 340 ,106 1,727 2 332 3 148 , Romania , , 4,228 5,068 5,800 10,100 10,455 10 460 , T t l o a 1,227 1,249 1,611 2,693 2 924 2 903 3 60 Commercial 585 597 682 1,780 , 2 024 , 1 841 , 5 2 5,221 6,950 9,467 10,160 9,766 Official b 642 652 814 797 , 706 , 659 ,306 3,609 5,100 6,537 ?6,167 5,408 IMF/World Bank/ 0 0 115 116 194 402 715 800 905 1,750 1,845 1,428 CEMA banks 584 812 945 1,180 2,148 2,930 Total 3,177 3,933 4,704 5,446 6 561 7 653 C i , , 9,171 11,369 13 680 17 608 1 ommerc al 2,004 2,525 3,118 3,631 4 267 4 999 6 5 , , 8,337 18,280 Official b 824 1,000 1,208 1,220 , 1,552 , 1,628 , 12 1,642 8,715 1,518 10,150 1 931 12,911 2 578 12,380 3 11,900 IMP/ World Bank 349 408 378 595 742 1,026 1 017 1 136 , 1 599 , 2 119 ,222 3,050 11 Because of rounding, components may not add to totals shown. b , , , , 2,735 3,330 Includes Western government-guaranteed credits and direct offi- cial loans. Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Poland Warsaw's financial problems continue to mount with no solution on the horizon. While Poland's $25 billion debt is not large compared with the major Latin American debtors, Western financial experts often cite Poland's situation as the most hopeless. Martial law halted the slide of the economy but cost Warsaw the financial support of Western governments and admission to the IMF. Poland is close to a moratori- um, with no payments being made to government creditors and banks only receiving payments due under rescheduling agreements. Credit lines have been almost used up, and creditors are unwilling to lend new money to a regime that is considered harsh as well as financially bankrupt Warsaw's Projection. The Law on the Balance of Payments for 1983, approved by Poland's Parliament at the end of 1982, projects a hard currency trade surplus of $700 million, a surplus on services (except for interest) of $340 million, and $800 million in credit inflows. In our view, Warsaw's projections are unrealistic. The projected 13-percent increase in ex- ports will be hard to achieve because coal prices are down in Western Europe this year. Moreover, the projected 4-million-ton increase in coal exports to the West does not track with the expected drop in domes- tic production of 3.3 million tons. Polish plans for substantial boosts in exports of silver, copper products, and synthetic rubber also appear inconsistent with ` 25X1 The import level this year will be largely a function of the amount of credit available and the regime's decisions on how to allocate its hard currency re- sources between payments to creditors and expendi- tures on imports. The Poles project a 6.2-percent boost in imports. They intend to restrain imports of agricultural products and capital equipment while increasing purchases of raw materials for industry. F_ I 1982 bank rescheduling agreement. Warsaw's pros- pects for lining up the remainder of the $800 million projected loans are dubious; Polish officials now ex- pect to draw only $400-500 million this year. Debt Service Due. We estimate that Warsaw's obliga- tions to creditors total $14.6 billion this year, more than half of which are principal and interest unpaid from last year and payment due this year to Paris Club creditors. Under original loan contracts, Poland owes Western banks $1.3 billion in medium- and long-term principal, and an estimated $800 million in i nterest; an estimated $514 million is owed under the 1981 and 1982 bank rescheduling agreements. Final- ly, an estimated $2.4 billion in principal and interest is due to creditors outside the Paris Club and the Western bank group. Obligations to this group could be much larger because presumably very little of the $2.8 billion due them in 1982 was paid or resched- , I ul If Warsaw continues to meet obligations under the 1981 and 1982 bank rescheduling agreements, this will absorb all of its projected payments capacity of $1.04 billion. More payments can be made only if Poland earns a larger surplus or obtains credits and does not use them to increase imports. Rescheduling Negotiations. Rescheduling got off to a slow start this year. Western governments continued to refuse to reschedule Polish debt through the first half of the year, but in July they agreed in principle to begin negotiations in the Paris Club. Poland's initial proposal to the banks was so extreme that the banks did not even consider it a realistic starting point for negotiations. In February the Poles tabled a proposal to reschedule all principal and interest due under original loan contracts between 1983 and 1990 for repayment during the 1990-2002 period. The banks inisted on terms similar to the 1982 agreement. By mid-year, the Poles had moved significant) tow d a y The flow of new credits to Poland from Western governments apparently has slowed to a trickle. Data recently provided to the banks show that Warsaw obtained $145 million in new medium- and long-term credits in the first quarter of this year. Poland also has received $130 million in short-term credits under the r the banks' position, and during negotiations in Vienna in mid-August, both sides agreed to reschedule 95 percent of principal for 10 years with a five-year grace Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Poland Financing Requirement and Sources Financing requirement 10,697 10,984 13,559 -2,247 -3,258 -1,947 -433 358 a 700 c 4,971 4,974 a 5,600 c 5,404 4,616 a 4,900 c -2,293 -4,019 -2,987 Under original loan con- tracts 2,293 3,387 2,273 Paris Club 1,582 1,145 Banks 1,005 d 575 Other creditors 800 553 Under rescheduling agreements 632 714 1981 Paris Club 288 200 1981 Bank 307 228 1982 Bank 37 286 Other invisibles, net (excluding interest) 479 403 340 c Short-term debt repayments, net -839 -92 0 a Source: Report on the Economic Situation in Poland, Statistical Supplement, Warsaw, February 1982. b Projection. Polish projection: "Law on the Balance of Payments in 1983," Warsaw, 29 December 1982. d Includes $273 million due in 1982 but deferred until March 1983 under the bank rescheduling agreement. Does not include $400 million in interest arrears from 1981 paid by April 1982, which is counted as arrears. Medium- and long-term debt repayments due -7,282 -7,061 -5,013 Arrears from previous year 0 -573 -6,599 Medium- and long-term (guar- anteed) 1,481 Short-term (recycling facility- from 1982) 196 Debt relief 4,769 1,613 r 1,200 Payments received from debtors, 95 50 Aid from socialist countries 325 0 Drawdown of reserves 100 0 Arrears/gap 573 6,599 11,509 e Includes principal payments-5 percent of total-deferred until the following year under the bank rescheduling agreements for 1981 and 1982. r Includes $117 million in principal and $273 million in interest deferred until 1983 under the 1982 bank agreement. period. The banks insisted that the interest on unres- cheduled debt and the remainder of the principal be paid this year, but they agreed to relend Poland 65 percent of the interest payments as trade credits. C I 25X1 Government creditors expect to begin formal negotia- tions with Poland in October. The Paris Club has decided that arrears from 1981 must be covered before an agreement for 1982 can be signed. Despite the impatience of neutrals and some Allied countries to reschedule, these creditors have not developed terms that the Poles could meet or that would lead to a significant flow of payments. At the same time Warsaw has been tardy in providing data to the Paris Club and more aloof in seeking negotiations, possibly because of pessimism over what would result. Negoti- ations are likely to be difficult when creditors' desires for Poland to resume payments clash with Warsaw's likely request for total and long-term debt relief. With payments capacity now absorbed by payments to the banks, payments to government creditors could be made only at the expense of payments to the banks Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Longer Term Outlook. Beyond this year, the outlook is no less bleak. Because Poland is unlikely to be able to pay the interest on its debt for many years, the debt will grow by the amount of unpaid interest and creditors will involuntarily have to increase their exposure. The arithmetic of the process shows that, the longer financial recovery takes, the more difficult it will be to achieve. As long as interest is unpaid, both the debt and the interest payments required to service the debt will grow. For example, if Warsaw can pay only $1 billion in interest annually, the debt will increase to $40 billion by 1990, and the interest payments will reach $4 billion. To stem the increase in its debt, Poland must balance its current account, that is, generate net earnings equivalent to annual interest payments. Financial recovery thus requires a revival in economic growth and a regime decision to allocate more resources to support production and to repay foreign creditors rather than to continue to boost domestic consump- tion. Poland currently is allocating a very small share of its depressed output to service its debt. In Polish currency, the trade surplus in 1982-the first in 11 years-represented 2.8 percent of national income while imports represented 8.5 percent. If the 1983 foreign trade targets are achieved, the share of net exports to the West in national income will decline to 2.6 percent and cover only one-fourth of interest due Financial recovery will require a massive commitment by the regime and the people to economic growth and large sacrifices in living standards over many years. At this point there is no such commitment and the regime instead has concentrated on trying to stabilize the economy and on providing minimal levels of consumer satisfaction. Jaruzelski and his closest eco- nomic advisers appear to regard the debt problem as an obstacle to the solution of the economy's ills. The regime would like more Western credits in order to finance imports which, in turn, would be expected to increase production and exports. This policy is similar to the path followed in the late 1970s, which ended in the present crisis. This time Poland's economic pros- pects leave a creditors unwilling to risk further expo- Moreover, the regime intends to distribute the fruits of any economic recovery to the populace. The 1983- 85 plan calls for a 21 percent rebound in consumption by 1985. Because this goal is greater than projected growth in national income of 10 to 12 percent, it probably implies that a reduced share of output will be exported and that a surplus will not be available to Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret Yugoslavia By late 1982, Yugoslavia's creditors recognized that the country had no prospect of meeting this year's debt obligations, but Belgrade was adamant that it would avoid a rescheduling at all costs. The IMF urged Western governments and banks to arrange a financial rescue that would spare Yugoslavia the opprobrium of having to request a debt rescheduling. The IMF contended that a rescheduling would seri- ously undermine the federal executive's authority, compromising its ability to implement needed adjust- ment policies and structural reforms. The Fund feared that, because of the highly decentralized nature of Yugoslavia's financial system, rescheduling would be a lengthy and potentially divisive operation that could The IMF proposed a rescue plan that would roll over maturing medium- and long-term credits, halt the erosion of short-term debt, and ensure enough new credits to rebuild Yugoslavia's reserves by at least $600 million. The Fund hoped that the refinancing package, coupled with improvement in Yugoslavia's current account, would produce a strong enough revival in commercial lending that Yugoslavia would not require more help next year. The plan has grown into a complicated $6 billion package involving credits from Western governments, banks, the BIS, IMF, and W orld Bank . Banks 3,46(25X1 Completion of the rescue package proved to be a more lengthy process than any of the participants had anticipated. Progress initially was delayed by disputes between Western governments and banks over bur- densharing, with governments refusing demands to refinance all maturing loans while providing new credits. The more serious obstacle was Belgrade's resistance to banker demands for the National Bank and government to assume responsibility for the debt and in effect recentralize the financial system. After stormy debate in the Federal Assembly and the Federal Executive Council, the Yugoslavs approved a compromise wording of the bank refinancing agree- ment in early July. The Federal Republic accepted the role of guarantor for credits borrowed by Yugo- slav banks under the refinancing plan and acknowl- edged that Western creditors can sue the Republic to enforce the agreement. At the same time the Federal Yugoslavia Million US S Financing Requirements, 1981-83 1981 1982 1983 Financing requirement 6,687 5,585 5,762 Current account balance -1,821 -1,420 -750 Trade balance -4,880 -3,779 -2,750 Exports 5,720 5,858 6,200 Imports 10,600 9,637 8,950 Net invisibles 3,059 2,359 2,000 Net invisibles, excluding interest 4,649 4,319 4,000 Net interest -1,590 -1,960 -2,000 Repayment of short-term credit -2,936 -2,300 -1,810 Repayment of medium- and long- term debt -1,695 -1,690 -3,052 a Credits extended (net) - 235 -175 -150 Financing sources 6,218 4,573 5,677 1983 Western rescue package IMF 620 IBRD 450 Financial credits 200 Export credits 500 New loans 600 Short-term rollover 1,460 Medium- and long- term rollover 1,400 Net errors and omissions 589 0 0 Change in reserves 120 -1,012 -85 a Includes $500-600 million in arrears as of 1 January 1983 plus $344 million in debt service. Assembly passed legislation strengthening the Na- tional Bank's role in debt management. Despite these actions, Western banks and the Yugoslavs still had not signed the refinancing accord by late August mainly because some banks were reluctant,to contrib- ute their share of the new money. 41 Secret Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Current Account. Yugoslavia has improved substan- tially its trade and payments performance during the first months of 1983. Data provided by the Yugoslav National Bank to the US Embassy in Belgrade show a $180 million current account deficit in the first half of 1983 compared with a deficit of more than $1.5 billion in the same period of last year. Yugoslavia cut its hard currency trade deficit to $990 million from $2.1 billion in January-June 1982 on the strength of a 6-percent gain in exports and a 22-percent reduction in imports. According to Embassy reporting, the marked gains so far this year have encouraged some Yugoslav officials to believe that they will eliminate their hard currency current account deficit this year. The Yugoslav National Bank (YNB), is projecting this year's, current account deficit at $550 million. The IMF is even more cautious about the current account outlook. In its midyear review of the stabili- zation program, the Fund raised its forecast for the 1983 deficit to $750 million from its initial projection of a $500 million shortfall. The IMF actually antici- pates a somewhat smaller trade deficit than the YNB due to slightly lower imports; the main difference is that the Fund projects net invisibles will fall to $2 billion from last year's nearly $2.4 billion while the YNB estimates net earnings at $2.3 billion. The IMF's caution about the current account seems warranted. A sharp falloff in advance tourist bookings for the key summer months indicates that tourism receipts will not recover substantially from last year's low level. Net worker remittances will decline, per- haps by even more than the IMF assumes, as Yugo- slavs react to the limits placed on hard currency deposit withdrawals last year and anticipate new restrictions on the use of foreign exchange. Export growth may also fall short of the 6-percent increase projected for the year by both the IMF and the YNB. Growth in hard currency sales, in fact, declined sharply from 20 percent in the first quarter to only 3 percent in the second quarter partly because import cuts are hampering production for export The delayed disbursement of credits from the finan- cial rescue package may well hold imports below the levels projected by both the IMF and the YNB. This has led some Western bank economists to forecast that the current account deficit will be on the order of $300 million, less than both the IMF and YNB projections. These more optimistic forecasts make the strong assumption that continued tight restraints on imports do not result in a commensurate loss of exports. 25X1 Financing Sources. Even with completion of the financial rescue package, Yugoslavia will probably fall at least $300 million short of the $6 billion in credits that the IMF originally projected for 1983. The $1.3 billion credit package pledged by govern- ments is likely to yield no more than $1 billion in total credits since approximately $300 million are tied to capital goods which Yugoslavia does not plan to import; moreover, the Yugoslavs probably will draw only about $700 million of the commitments this year because of delays in negotiating bilateral agreements with donor countries. Although commercial banks pledged in the refinancing agreement to maintain most of Yugoslavia's $1.8 billion in short-term debt,25X1 the IMF anticipates some short-term capital outflow since trade credits must be repaid before new ones are drawn. some banks may be slow in anteing up their share of the $600 million in new loans. On the other hand, some of the shortfall in the rescue package has been offset by a greater amount of supplier credits provided 0125X1 )f the refinancing effort Reserves. The Yugoslav National Bank's reserves are the critical indicator of the country's liquidity situa- tion. The lack of a foreign exchange market and the tendency of the better managed banks to hoard their reserves have forced illiquid banks to depend on the National Bank for hard currency. The recently adopt- ed banking legislation has strengthened the National .Bank's central role by giving it the explicit responsi- bility of meeting the country's external obligations if enterprises, regional banks, and republics fail to cover debt service payments The IMF's upward revision of the current account deficit and the likely shortfall in credits result in a nearly $100 million decline in reserves compared with the original goal of a $600 million increase. Even if Belgrade can hold the current account deficit below the IMF forecast and obtain more credits than we assume, we would anticipate only a small increase in Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret the National Bank's cash holdings at best. Since a significant portion of reserves are not liquid, cash available to meet current obligations probably will total no more than $400-500 million by yearend. The size of liquid reserves will also depend upon compli- ance by enterprises and regional banks with regula- tions requiring contributions to the National Bank's liquidity fund and upon the level of demands to meet overdue obligations of illiquid banks in the next few months.) 25X1 First-Hall' 1984 Balance-of-Payments Outlook. Yu- goslavia's position entering 1984 will be very similar to that at the beginning of this year-stocks of imported goods and reserves will be at minimal levels and few credits will be in the pipeline to bridge the seasonal financing gap in the first half of the year. Assuming Western bankers maintain their short-term exposure, we believe that Yugoslavia probably will have a financing requirement of $2-2.3 billion in January-June 1984. The IMF projects $1.2 billion in long- and medium-term capital repayments and the extension of $100 million in net long-term loans by Yugoslavia during this period. The IMF estimates the current account deficit to be $700 million, while we believe it could run as high as $1 billion) Even if the Yugoslav National Bank exhausts its holdings of liquid foreign exchange to meet the financing requirement during the first half of the year, external financing of some $1.5-1.9 billion would be required to prevent major arrearages. The Yugoslavs should be able to draw some commercial and government-backed trade credits-including some loans remaining from this year's package-as well as World Bank-and-possibly IMF credits. skeptical that Yugoslavia can raise enough untied bank loans to cover a financ- ing gap of $500 million to $1 billion in the first half of 1984. We expect bankers to remain cautious about new lending because of: ? Yugoslavia's possible failure to reduce its current account deficit as much as originally planned. ? Belgrade's inability to curb inflation and deal with other domestic economic problems. ? Uncertainties about a new IMF stabilization pro- gram and lending facilities. ? Widespread belief that the country needs more debt i We believe some Western creditors may be inclined to force Belgrade into a formal rescheduling in 1984. Because of the problems in this year's rescue effort, commercial bankers seem increasingly convinced that rescheduling is the only way to ensure equitable 25X1 burdensharing among all creditors. the banks will resist pressures to provide more new money. Western governments that reluc- tantly accepted the "Friends of Yugoslavia" package may insist that Yugoslavia's problems be addressed in the Paris Club. If this year's problems convince the Yugoslavs to swallow their objections to a debt rescheduling, creditors can probably arrange debt relief without extended delays. But rescheduling could prove difficult if the Yugoslavs do not show more maturity and cohesiveness in dealing with their credi-25X1 ' tors than they dis ed this la year p y Is Financial Recovery Possible for Yugoslavia? Un- like Poland, Yugoslavia has some chance at financial recovery provided it regains the confidence of West- ern bankers and continues to reduce its current account deficit. But the recovery process will almost certainly require more time than for Romania, since Yugoslavia's debt repayment schedule does not im- prove soon. IMF data show over $2.5 billion in maturing medium- and long-term loans in both 1984 and 1985, and the comparatively short maturity of the government-backed trade credits offered in the rescue package will add to the debt service burden over the next few years. Furthermore, the Western bank pledge to maintain short-term credit lines will expire in 1985, and the Yugoslavs need to rebuild their reserves. Acquiring some $5 billion in credits annual- ly-whether part of a restructuring package or not- will be a formidable task in itself, leaving no room for financing current account deficits.) 25X1 Yugoslavia cannot hope for financial recovery until the leadership attacks the economy's deeply en- 25X1 trenched inflatiqpary bias. Demand restraint meas- ures had little effect in reducing inflation, and most of the improvement in the balance of payments has resulted from a forced reduction in imports caused by the drying up of credits. Belgrade must work harder to restrain increases in wages, prices, and domestic Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 credit and continue devaluing the dinar if it is to meet the IMF goals of an improving current account. But this will require gains in efficiency and competitive- ness that can be achieved only through systemic reform. Yugoslavia must abandon policies that have given primacy to regional interests over integrative market forces. The country can no longer protect jobs by shoring up money-losing enterprises and must not subordinate efficiency to political objectives in allo- cating investment resources. An efficient national foreign exchange market is needed to ensure that all producers pay the true cost of foreign exchange and those best able to use foreign resources receive hard currency Despite professions of good intentions from some officials, Belgrade's capacity to overhaul its economy is suspect. Needed adjustment policies and structural reforms may impose a higher price than society is willing to pay. The population is already grumbling about falling living standards, and resistance could intensify as consumption levels decline further. Sacri- fices are not distributed equally among regions and nationalities, making it difficult for the collective leadership to reach a consensus on policy. Moreover, greater reliance on market forces challenges official ideology and threatens the prerogatives of powerful vested interests in the republics. Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret The 1983 financial picture looks somewhat better than last year, although recent problems with the Romania Ca Million US $ IMF and continuing difficulties in lining up credits Requirements Sources could deal at best a temporary setback to Bucharest's Requents and progress. Based on incomplete and inconsistent data supplied to the IMF and Western banks, we estimate that Bucharest's sources of financing fall some $400 million short of its requirements. Failure to cover the gap would jeopardize Romania's prospects for avoid- ing rescheduling next year. The improvement stems this year mostly from Bucharest's crossing the hump in its debt maturity structure and would be greater were it not for the need to cover overdue obligations from 1982. Nearly two-thirds of the debt contracted through 1980 came due in 1981-82, but beginning this year the payments schedule stretches out considera- bly. The picture also looks brighter because debt relief negotiations were concluded by midyear, and Bucha- rest's credit needs are modest. The major uncertain- ties are whether Bucharest can meet its ambitious trade surplus target, satisfy demands made by the IMF, and roll over its short-term debt. If creditors are spooked by political problems in Romania or by developments elsewhere in Eastern Europe and choose to reduce further their short-term exposure, Bucha- rest will have difficulty in meeting its obligations. Continued Trade Adjustment. Romania is holding to its strategy of painful adjustment by forcing a net flow of resources out of the economy. In a letter to the 1981 1982 19o3 (pfJeOtC~) Financing requirement 4,215 4,268 2,566 Current account -818 655 800 Debt repayments 3,231 3,153 2,663 Medium- and long-term deb t 1,106 2,394 Short-term debt 2,125 759 Reserve buildup -77 -125 -106 Credit extensions, ,net -89 -502 -209 Arrears from previous year 0 1,143 -388 Sources 3,072 3,596 2,158 Credits, of which: 3,072 1,157 879 Commercial credits a 2,453 525 295 World Bank 297 331 250 IMF (net) 322 301 334 Rescheduling 0 2,439 963 Western banks 1,616 572 Western governments 400 136 CEMA banks 153 28 Arab banks 270 25X1 Suppliers 227 Drawdown of BIS deposit 316 Financial gap/arrears -1,143 -388 -408 Net errors and omissions -284 IMF accompanying the review of the standby a Including rollover of short-term credits. 25X1 arrangement in March, Finance Minister Gigea pledged to meet tough external account targets even at the expense of goals for growth. Bucharest projects a hard currency current account surplus of $800 Trade data through May show that exports were well million on the strength of another large trade surplus below the target rate, and Bucharest had to reduce of $1.6 billion. Not only will these targets be difficult imports accordingly. The IMF in July reduced its to achieve but they may be risky as well, given the projections of both imports and exports for the full impact on the economy of the adjustments already year by $532 million while maintaining the projected still far below the 1980 peak of $8.1 billion-with further reductions in imports of crude oil and grain Status of Rescheduling. Bucharest's effort to resched- and substantial increases in imports of machinery, ule its 1983 debt: to the banks appears to be moving equipment, and metals. Bucharest told the IMF that smoothly, especially compared with the 1982 negotia- the 6-percent growth rate projected for exports will tions. Creditors were uncertain about whether debt come largely from a 17-percent increase in sales of relief would be needed this year, but at the end of refined petroleum products, an overly optimistic tar- get given the soft ener market and Romania's own energy problems. 25X1 45 Secret Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 1982 Bucharest informed its creditors that payments due in 1983 would be suspended pending conclusion of a rescheduling agreement. In only their second negoti- ating session held in February, Romania and the nine major Western banks that led the 1982 rescheduling effort agreed on tougher terms than in 1982: only 70 percent of some $900 million in principal payments to banks is to be rescheduled instead of the 80 percent in 1982, and short-term debt is not covered. Moreover, all the unrescheduled principal is due in the second half of this year, and some of the rescheduled amount is due next year. The agreement was signed on 21 June. Several factors account for the rapid prog- ress this year: Romania Current Account ? Romanian officials have been more businesslike and cooperative, both in negotiating with the banks and in meeting commitments of the 1982 agreement. ? The amount to be rescheduled is less than half the amount of debt relief from private creditors in 1982. ? Treatment of short-term bank debt is not an issue because most of it was either paid or rescheduled last year. ? Some of the banks most opposed to the 1982 agreement have little or no debt due this year.0 The Paris Club got off to a slower start because of Romania's continuing problems in wrapping up bilat- eral accords with Western governments to conclude the 1982 Paris Club agreement. On 18 May, the Paris Club met and quickly agreed to reschedule 60 percent of principal due this year on medium- and long-term guaranteed credits. Although Bucharest's original re- quest last December called for debt relief to cover 75 percent of 1983 principal and interest, Romanian Finance Minister Gigea readily accepted the terms. Credits. The IMF also reduced the amount of credits projected for the year as a result of a shortfall in supplier credits in the first five months of the year. More serious is the regime's current disagreement with the IMF. The IMF approved Romania's perfor- mance in the December 1982 and March 1983 re- views of the three-year standby arrangement, but Bucharest failed to agree to the timetables for raising domestic energy prices and interest rates required for the July review. As a result, the IMF has withheld further disbursements. A continuation of the stale- mate could deny Romania $200 million in IMF 1981 1982 1983 (projected) Current account balance -818 655 800 Trade balance 204 1,525 1,600 Exports 7,216 6,235 6,068 Imports 7,012 4,710 4,468 Services -1,022 -870 -800 190 116 155 -1,047 -917 -805 Transportation and communications -346 -139 -220 credits, add substantially to the financing gap for this year, and complicate relations with creditors. At a minimum, Bucharest will not be able to meet its target of a $250 million increase in reserves. The problem with the IMF could deal a severe blow to Bucharest's fragile financial recovery. Outlook for 1984 and Beyond. If Bucharest manages to cover most of its 1983 financing requirement, continued gradual improvement in the financial situa- tion is possible. Although it is too early to make firm predictions, we judge that Romania's financing re- quirement next year is small enough-about $2.2 billion-that the goal of avoiding rescheduling can be achieved. According to IMF projections, more than $2 billion in principal payments is due next year. The remainder of the financing requirement is $200 mil- lion in credit extensions to support Romanian exports. Bucharest plans to cover $850 million of the require- ment by earning a current account surplus, largely on the strength of a $1.7 billion trade surplus. If draw- ings this year proceed on schedule, about $300 million will be available from the IMF under the third and final year of the standby arrangement. The Fund projects that another $400 million in loans will be Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 provided by the IBRD and suppliers. This projection for loans seems realistic, and Bucharest should have little trouble borrowing this amount, especially if it demonstrates continued success in dealing with its financial problems The breathing space associated with the rescheduling ends in 1985 when Bucharest must begin to repay obligations rescheduled in 1981. The IMF standby arrangement will have expired by 1984. Both of these factors will put pressure on the regime to continue earning large trade surpluses in order to cover exter- nal obligations and to deal with underlying economic problems that hurt competitiveness and continue to prevent sustainable and balanced growth. If creditors take into account Bucharest's success in overcoming its debt woes, access to commercial credits should improve somewhat. Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret East Germany Last year's current account surplus of over $1 billion, a healthy buildup of reserves late in 1982, and recent financial support from West Germany have dimin- ished the likelihood of an East German rescheduling in 1983. According to press reports, East Germany planned to run another large trade surplus-perhaps as much as last year's $1.5 billion surplus-and continue paying off its debts. The East Germans must have solid gains in exports to achieve their goals because the economy almost certainly needs some increase in imports after the 30-percent nominal reduction over the past two years. If East Germany were to repeat last year's 7-percent growth of exports, it could increase imports by 9 percent and maintain a $1.5 billion trade surplus. This increase in imports et interest Repayments of short-term ,4,, . -2,500 -2,350 -1,475 tories, preclude serious declines in inttv,ef-I ....,.a.. debt ... yi vuul.' tion and living standards, and ensure export growth. I OECD trade data for the first months of 1983 suggest that import growth may exceed 9 percent and that the trade surplus could be smaller than last year's. The balance with OECD countries slipped from a $175 million surplus in January-March 1982 to a $20 million deficit in the same period of this year due to a 21-percent increase in imports and 2-percent growth in exports. The surplus with countries other than West Germany actuall i d -c East Germany Financing Requirements, 1981-83 Financing requirement 5,250 4,254 3,575 Current account balance -500 1,246 1,075 Trade balance 60 1,509 1,175 Exports 6,714 7,172 7,675 Imports 6,654 5,663 6,500 Net invisibles excluding 985 950 850 interest N Repayments of medium- and long-term debt Borrowing sources Medium- and long-term credits Short-term credits Net errors and omissions Change in reserves -2,250 -3,150 -3,200 25X1 5,550 4,000 NA 3,200 2,525 NA 2,350 -265 35 1,475 33 -21 NA NA NA y rease by $5u million some undrawn Western government-backed commit- because of sizable gains in exports. The balance with ments, and France, Canada, and Austria have extend- West Germany, on the other hand, plummeted from a ed new officially guaranteed trade loans. West Ger- $130 million surplus in the first quarter of 1982 to a man banks are continuing to finance intra-German $126 million deficit this year. By midyear, East trade deals, and the East Germans have access to the Germany's deficit with West Germany widened to swing credit. East Germany's success in managing the $275 million-compared with a $106 million surplus credit squeeze has begun to encourage Western banks at mid-1982-as a result of a 33-percent jump in to offer more short-term trade credits. The main imports and a 2-percent gain in exports. Because of problem remains medium- and long-term financial easier access to trade credit in West Germany and the loans needed to cover debt service payments and to advantages of the intra-German payments mecha- refinance short-term debt on more favorable terms. nism, the East Germans are continuing the strategy of East Germany has used many of its previously undis- shifting Western imports into intra-German trade.= burled commitments with Western banks, and bank- 25X1 ers have remained cool toward a medium-term syndi- Even with healthy trade and current account surplus- cation. The late-June decision of the West German es, East Germany will still require over $3.5 billion in government to guarantee a $400 million five-year loan credits to cover its financing requirement without from West German commercial banks has provided dipping into reserves. Raising this amount of funds needed funds to cover debt service obligations. It may will not be easy, but the East Germans have some also revive other untied lensing to East Germany. financing sources. Entering 1983, East Berlin still had 49 Secret Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Nonetheless, East Berlin probably cannot return to the general syndicated market before next year. Even though an East German rescheduling seems less likely than a year ago, the country still faces a tight financial squeeze through at least the first six to nine months of this year because of a continuing high level of debt service payments. By the end of this year, East Germany will probably have surmounted the worst of its financing problem. Repayments of medium- and long-term debt will decline in 1984-85 mainly because East Berlin will have paid down a major portion of these obligations. East Germany will face the problem of rolling over a large short-term debt because lenders will remain cautious about extending new medium- term credits. Difficulties in raising loans could still force East Berlin into a debt rescheduling or default; however, solid evidence of further improvement in East Germany's balance-of-payments position would strengthen lender confidence and ease the task of refinancing maturing loans. The trade adjustment measures imposed over the past two years have addressed East Germany's immediate credit crisis, but they do not lay the basis for economic growth and balance-of-payments equilibrium. The regime may be able to ease some import restraints as economic recovery in the West leads to modest growth in exports and Western lenders become less concerned about the country's creditworthiness. A sizable por- tion of new loans, however, will have to go to covering debt service rather than to acquiring more imports, and the regime may opt to continue reducing its debt rather than to expand imports significantly. More- over, Western bankers are likely to press East Berlin much harder for basic economic and balance-of- payments data before increasing their exposure Although we see no evidence that East Berlin is rethinking its economic policy, the regime can no longer rely on a strategy that attained rapid economic growth and improvements in living standards in the 1970s through large resource transfers from the West. i The regime presumably is satisfied that its restructur- ing of economic management that began in the late 1970s has enabled the economy to cope with the credit crisis. The question remains, however, whether East Germany's strongly centralized structure is flexible enough and oriented sufficiently to efficiency to per- form well in an environment of reduced resources. Continuing financial pressures may yet force East Berlin to address the taboo question of introducing more market forces into the economy. Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 25X1 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Secret Hungary The IMF stabilization program for 1983 originally projected that Hungary would cover its $2.6 billion in debt repayments and increase its reserves by $500 million with the help of a $600 million current account surplus, $250-300 million in trade credits (primarily government-backed), $60-70 million in drawings on World Bank loans, $200-260 million in untied bank loans, $366 million in IMF credits and $1.6 billion in short-term borrowings. The Hungar- ians hoped to increase their trade surplus from nearly $770 million to over $1.1 billion by raising exports nearly 8 percent while holding imports at last year's level. The program also projected a $400 million decline in net interest costs. Adjustment Policies. The need to produce a current account surplus forced Budapest to tighten its adjust- ment policies. Beginning in 1979, Budapest shifted economic priorities from promotion of growth to gradual reduction in the country's current account deficit. The growth of demand was dampened mainly by sharp reductions in investment. Although increases in consumption slowed, the regime tried to maintain living standards. IMF statistics show that between 1979 and 1982 investment fell by more than 3 percent annually while consumption rose by 1.6 percent annu- The need to accelerate adjustment in 1983 compelled Budapest to place a greater burden on the consumer. Hungary's targets envision a 3- to 4-percent decline in real domestic demand to be accomplished by a 1.5- to 2.0-percent reduction in consumption, a 6.5- to 7.5- percent fall in investment, and a 3.5- to 5.5-percent reduction in government outlays. The Hungarians hope to hold real GDP at the 1982 level by growth in Performance. The IMF's midterm assessment has found that Hungary is falling short of the IMF goals. Domestic demand has not been dampened to the degree anticipated due to faster-than-planned in- creases in incomes and excess enterprise liquidity. The Fund now estimates that exports will grow less than 1 percent largely because of price cutting on agricultur- al exports to meet international competition, and a mediocre grain harvest will probably depress export Hungary Million US $ Financing Requirements, 1981-83 Original Revised IMF IMF Projec- Projec- tion 1983 tion 1983 Financing requirement 4,918 4,294 2,0 11 2,378 Current account balance -727 -149 600 500 Trade balance 445 766 1,142 1,062 Exports 4,877 4,876 5,252 4,920 Imports 4,432 4,110 4,110 3,858 Net interest -1,100 -976 -669 -669 Other -72 61 38 107 Repayments of medium- -826 and long-term debt -894 -936 -1,005 Repayments of short- term debt -3,261 -2,849 -1,371 -1,476 Repayments of BIS credits -210 -300 -300 Export credits, net -104 -192 -64 -97 Borrowing sources 4,292 3,375 2,571 2,223 Medium- and long-term credits 1,443 1,154 579 613 Short-term credits a 2,849 IMF credits 235 3 66 366 BIS credits 510 Change in reserves -626 -919 500 -155 a Includes net errors and omissions and change in net short-term trade credits. earnings even more. The IMF has lowered Hungary's projected current account surplus from $600 million to $500 million, but meeting this goal depends on new measures to reduce consumption and investment and to encourage savings and exports. One Hungarian banker claims the regime has approved, but not announced, new restraints on domestic demand de- signed to cut imports 6 percent below last year's level and that import restrictions will be maintained into at least 1984. Another senior Hungarian official has asserted, however, that Hungary cannot afford more Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 import reductions and needs to run a smaller trade surplus next year. Because of the worsening outlook for exports and possible resistance to more import cuts, the trade and current account surpluses may fall $100-200 million below the revised IMF projections. Borrowing. Hungary succeeded in raising credits in the first half of 1983, but Budapest probably will fall short of covering its $2.5 billion borrowing goal. ? Hungary obtained a $200 million three-year loan from a group of Western banks, including two Soviet-owned banks in the West. ? A group of Arab banks also arranged a $100 million credit early this year. ? Despite some slippage in the program targets, the Hungarians are continuing to draw on IMF standby credits. Budapest has stepped up use of guaranteed trade credits, particularly from West Germany, France, and Ja- pan, and it has a reserve of undrawn commitments. ? The World Bank has approved $239 million in project credits. he Hungar- ians have also been lining up short- to medium-term trade financing from commercial banks, particular- ly in the form of bankers' acceptances Despite these loans, the IMF estimates that Hungary will suffer a $650 million outflow on the capital account. This reflects larger outflows on export cred- its to meet competition and cover delayed payments, continuing withdrawals of short-term credits, and larger repayments on medium-term loans. Hungary lost $500 million in short-term credits during the period January to April. Some of this represented repayments to the BIS, but withdrawals of commer- cial bank lines probably totaled $200-300 million. More recent information, however, suggests that the outflow of short-term credits has stopped Reserves. The projected shortfall in Hungary's current account surplus and financing sources will preclude a $500 million buildup of reserves. Depressed exports, delayed payments from some cash-short developing countries, and withdrawal of short-term credits re- duced reserves of gold and foreign exchange by nearly $350 million in early 1983. According to press re- ports, Hungary's low level of reserves induced West- ern central bankers to grant a two-month extension on repaying $100 million of the $300 million BIS credit due in April. The IMF anticipates little rebuilding of reserves in the last half of 1983 and estimates that reserves will be down $155 million for the year. The decline could run even higher if Hungary's trade and current account performance falls below the Fund's midyear projections. New IMF Program. The gloomier outlook for Hunga- ry's financial position has prompted the IMF and Budapest to begin discussions on another standby program for 1984. Hungarian economists have told the US Embassy in Budapest they expect the IMF to press harder for more structural reforms in a second program. Indeed, the Fund commented in its midterm review of the 1983 program that Budapest's short- term adjustment measures need to be followed up by structural changes and eventual relaxation of emer- gency import restraints to ensure sustained growth. The regime has already pushed ahead this year with additional reforms which link wage incentives more closely with enterprise profitability, encourage elimi- nation of excess labor, and reduce subsidies to ineffi- cient producers. Hungarian bankers claim the leader- ship will consider additional reforms later this year. Disputes among affected interest groups, however, may well slow Budapest's actions. Outlook Through 1985. Hungary must address its fundamental balance-of-payments problems more ef- fectively because the country needs a growing hard currency trade surplus to cover rising debt service payments. According to IMF estimates, repayments on medium- and long-term debt and gross interest payments will rise to $2.3 billion in both 1984 and 1985, compared with $1.8 billion this year (see debt service payments table). Hungary will also have to roll over more than $1 billion in short-term credits each year. Because banks will probably remain reluctant to extend new medium-term credits, the Hungarians will continue to face the problem of bunched up maturities for several years. Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 25X1 25X1 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Hungary , rr Debt Service Payments, 1981-85 a r%moruzation of medium- and long- term debt Interest payments on gross debt 1981 1982 1983 1984 1985 826 894 1,005 1,610 1,606 1,014 1,004 765 750 691 a Source: IMF and National Bank of Hungary. Structural reforms, while necessary, will not be suffi- cient to ensure improved balance-of-payments performance. Hungary also needs a continued fall in international interest rates and sustained growth in its major Western markets. But even projected current account surpluses wil leave Hungary far short of covering its financing requirements over the next several years. Thus the Hungarians will have to seek large borrowings from Western banks and the IMF to meet their obligations or face the unpleasant option of 53 Secret Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Czechoslovakia Czechoslovakia plans to continue running current account surpluses and paying down its debt through 1985. The 1983 foreign trade plan called for some reduction in the trade surplus by raising imports from the West more rapidly than projected increases in Czechoslovakia Financing Requirements, 1981-83 exports, but poor export performance apparently has led Prague to co ti n nue reducing imports. During the first half of 1983, exports to the West rose only 13 percent and imports were down 8.9 percent over the same period a year ago. We estimate exports and imports will rise by about 2 percent for the year. The current account surplus will rise to $300 million this year and be on the order of $350 million in 1984 and 1985 as reduced interest costs and small growth in service earnings raise net invisible receipts. This pre- sumes Prague keeps the growth of imports in 1984-85 in line with the growth of exports. Czechoslovakia faces few borrowing problems, but it will have scarce hard currency resources as long as the leadership maintains its conservative posture vis- a-vis Western banks. The Czechoslovaks should have little problem finding adequate short-term trade cred- its to finance their restrained level of imports. The country's major financial need is medium-term finan- cial credits to build up reserves and stretch out the compressed maturity structure of debt. In mid-July, Prague obtained a $50 million loan with a maturity of four years from a small r of Western banks. the Czechoslovaks balked at emulating Hungary's example of first dis- closing more information on its debt and balance of Financing requirement 2,009 1,3s5 1,090 Current account balance -79 210 300 Trade balance 330 022 00 Exports 4 ,691 4, 029 1 3,100 Imports 4,361 5 3,537 3,600 Net invisibles excluding Net terest so -459 60 -34 70 Repayments0_fshort-term -1530 2 -1 1 -310 debt , 40 -930 25X1 R epayments of medium- and long-term debt -400 -425 -460 Medium- and long-term credits 430 190 NA Short-term credits 1,140 930 NA Net errors and omissions 57 122 NA Change in reserves -382 -113 NA continues to focus its export strategy on heavy indus- trial goods, which are falling ever further behind world standards, while neglecting light industry where it could be more competitive. Czechoslovakia's trade bureaucracy is probably the most inflexible in Eastern payments in return for a larger loan. The key question in Czechoslovakia's hard currency trade and payments outlook is whether the economy can afford a strategy that links hard currency imports to the growth of exports and will not modernize industry through hard currency borrowings. Prague's long-held financial conservatism has contributed to the technological decline of Czechoslovakia's industry and the stagnation of the overall economy. This trend can only worsen under the current policy of relying almost totally on domestic and CEMA technology in lieu of acquiring Western materials and equipment. Even with economic recovery in the West, inherent weaknesses will undermine export performance, per- mitting little if any growth in real imports. Prague Europe, and recent tinkerings with foreign trade organizations appear unlikely to make them more responsive to market opportunities. According to Em- bassy reporting, some Czechoslovak planners have been pressing for more borrowings to acquire Western goods needed to upgrade key sectors (such as electri- cal machinery, ferrous metallurgy, and coal mining). The planners argue that a judiciously planned pickup in investment-using Western resources-is needed to jolt the economy out of its doldrums. However, fear of the political consequences of reliance on Western credits and general satisfaction with its financial conservatism will most likely continue to dissuade the Husak regime from adopting a more aggressive im- port strategy Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Bulgaria Bulgaria entered 1983 in the strongest financial posi- tion of any East European country. Several consecu- tive years of current account surpluses enabled Sofia to reduce its gross debt to less than $3 billion at the end of 1982 and to build up reserves of $1 billion, enough to cover four months' worth of imports. Creditors continued to give high marks for Sofia's Bulgaria owes roughly $1.0 billion in principal on medium- and long-term debt and net interest in 1983, about the same amount of debt service due last year. Because Sofia had little problem covering its obliga- tions during the more difficult year of 1982, we expect that rolling over of maturiti will be accomplished easily this year. Sofia's financial strength allows it a range of options in managing its hard currency accounts this year. It could maintain its policy of holding down imports and reducing its debt even further. Or Sofia could use the cushion provided by the conservatism of recent years to pursue an expansion of hard currency imports. We estimate, for example, that Bulgaria could boost imports by $1 billion this year-a 40-percent gain- without incurring a rise in debt. This assumes a small (6 percent) increase in exports which is probably the best Sofia could hope for, given weak Western mar- kets for its oil products. If Sofia chooses to increase its debt or if exports rise faster, even higher imports would be feasible. I' I o is has untapped borrowing capacity. Political rather than economic factors are more apt to 1. 1 Italian commercial banks withdrew deposits placed Bulgaria .- .. Financing Requirements, 1981-83 Financing requirement 851 988 1,036 Current account balance 608 537 439 652 500 300 Exports 3,198 3,200 3,300 Imports 2,546 2,700 3,000 Net invisibles excluding interest 285 270 295 Net interest -329 -233 -156 Repayments of short-term debt -684 -750 -725 Repayments of medium- and long-term debt -775 -775 -750 Borrowing sources 960 1,290 NA Medium- and long-term credits 210 565 NA Short-term credits 750 725 NA Net errors and omissions - 48 -141 NA Change in reserves 61 161 NA According to preliminary indications, the Bulgarians may be easing away somewhat from their strict conservatism. In recent months Sofia has obtained guaranteed credit lines from several Western countries: ? In bilateral economic talks in Paris, France agreed ? Japanese Embassy officials in Sofia told US coun- terparts that they believed that a $200 million credit line for Bulgaria would replace a line that expired with Bulgaria late in 1982 for political reasons. Early this year Italy froze guaranteed export credit lines in connection with its investigation of Bulgaria's alleged role in the attempted assassination of the Pope. While the spotlight has been less intense recently, Bulgaria's international image has been tarnished and Sofia will be vulnerable to any further allegations. While banks may not choose to reduce their exposure, they may be wary about undertaking a highly visible syndication 25X1 25X1 Several reports show that Bulgaria is actively negoti- ating for Western equipment and technology-appar- ently the only East European country currently show- ing any interest. The Japanese Ambassador to Sofia reported early this year that after a year of reviewing Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3 investment plans, Bulgaria has decided to move ahead on several projects requiring Western equipment and technology, including: ? A high-technology steel mill for the Burgas metal- lurgical complex. ? A new telephone exchange system. ? Renovation of the food-processing industry to im- prove the marketability of food products in the West. ? Development of auto production, including purchase of a machine tool plant and possibly an assembly The Japanese, however, recently have been skeptical of Sofia's intentions and doubt that these projects will reach fruition. We estimate that Sofia will run a hard currency trade surplus this year of $300 million, down from the $500-600 million of recent years. Lower interest payments should help raise the current account sur- plus somewhat to $440 million Sanitized Copy Approved for Release 2010/05/26: CIA-RDP87B00342R000100200011-3