EASTERN EUROPE: FACING UP TO THE DEBT CRISIS

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP84S00895R000100010002-7
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 67
• Document Creation Date: December 21, 2016
• Document Release Date: September 16, 2008
• Sequence Number: 2
• Publication Date: September 1, 1983
• Content Type: REPORT

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Directorate of Secret
Intelligence
to the Debt Crisis
Eastern Europe: Facing Up
This paper was prepared in the Office of E can
Analysis by European
a
contribution fro Comments and
queries are welcome and may be directed to the Chief,
East-West Regional Issues Branch, EURA, on
Secret
EUR 83-10216
September 1983
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Summary
Information available
as of 1 September 1983
was used in this report.
Eastern Europe: Facet Up
to the Debt Crisis 25X1
Most of Eastern Europe has withstood the severe credit crunch that began
in 1980, but the region remains financially vulnerable. The peak of the
crisis occurred in the first part of 1982, when it seemed that several
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 loans 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
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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),
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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.
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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.
Outlookfor 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,
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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 completion 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.
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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
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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.
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.
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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.
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The Credit Crunch Begins
Poland and Romania: Coping With Rescheduling
10
Hungary, East Germany, and Yugoslavia:
Struggling To Remain Solvent
15
Czechoslovakia and Bulgaria: Conservatism
Rewarded
18
Yugoslavia
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25X1
This paper is an assessment of the financial situation and outlook of the
East European countries, including Yugoslavia.
The study reviews the
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.
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Table 1
Net Financing Flows From Western Banks a
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
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Eastern Europe: Facia Up
to the Debt Crisis
The Credit Crunch Begins Figure 1
Eastern Europe: External Debt, by
Eastern Europe's credit crunch began in 1980, well Type of Lender
before the onset of LDC financing problems, follow-
ing a decade of growing reliance on Western credits to Billion US S
finance mounting payments deficits (figure 1). Net 90
credit flows from Western banks (new credits less so-
repayments) slowed to $5.3 billion in 1980, less than
half the 1979 level (table 1).' Most of the decline can 70
be attributed to Poland and reflected growing concern
that Warsaw was headed for insolvency. The other 60
countries continued to raise credits, but the net inflow 50
was less than in 1979. Fears about Poland were
beginning to give bankers second thoughts about 40
lending to other East European countries. Other 30
factors that contributed to the slowdown in lending
were the Soviet invasion of Afghanistan and subse- 20
quent Western sanctions, Tito's death in 1980 and 10
growing doubts about the prospects for stability in
77 78 79 80
International
financial
institutions
western
gosernrnent,
- CommerctaI
hanks
Yugoslavia, and the adjustment efforts leading to less 0 1971 72 73 74 75 76
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 300309(A03236) 883
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.
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
' 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
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
rading 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 source of credit, the collapse of the aforfait
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Figure 2
Net Resource Transfer to Eastern Europe
From Western Financing'
and multilateral
institutional
financing
a New credits minus repayments of
principal and interest.
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 aforfait market's assessment of a
borrower is a very good indicator of bankers' underlying perceptions
'An undetermined share of 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
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).
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
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.
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 over three-fourths of the decline al-
though East Germany and Romania also drew down
their commitments. Statistics published by the Bank
for International Settlements (BIS) show a similar
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Table 3
Commitments of Major Western Government
Credit Insurers to Eastern Europe a b
Total
10,028
10,392
13,020
Bulgaria
737
649
688
Czechoslovakia
848
762
899
a 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.
b Sources: Berne Union of Credit Investment Insurers.
reduction-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
212
430
828
844
1,069
10,181
12,852
13,679
12,137
8,704
4,027
3,737
3,207
7,902
6,368
6,205
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).
By yearend 1981, the East European countries
showed differing degrees of financial vulnerability
(table 4):
? 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.
' There undoubtedly is some overlap between the BIS statistics on
undisbursed credit bank lines and our estimates of undisbursed
government-guaranteed credits a sizable
share of reported undisbursed bank credit lines represent commit-
ments backed by official ch commitments
are reported to the BIS.
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Table 4
Eastern Europe: Selected Financial Indicators a b
Proportion of Bank Loans With
Less Than One-Year Maturity (percent)
Reserves as a Share of Debt Maturing
in One Year (percent)
1979
1980
1981
1982
1979
1980
1981
1982
Eastern Europe
39.9
36.3
37.0
34.0
28.8
29.0
26.3
22.1
Bulgaria
41.1
36.3
48.1
51.7
31.0
53.5
55.4
68.7
Czechoslovakia
47.1
43.1
37.6
31.2
46.8
65.3
55.7
53.4
East Germany
42.7
38.6
42.6
39.0
46.7
45.2
40.7
42.5
47.4
42.9
40.4
33.2
27.2
34.0
23.6
32.0
39.1
33.1
36.1
32.8
14.7
7.5
9.7
9.0
50.5
42.7
35.3
38.9
9.6
9.4
8.9
9.5
Yugoslavia
22.6
28.1
28.4
26.7
46.3
36.9
35.5
15.9
Developing countries ex-
cluding Middle Eastern
countries
42.7
45.6
46.2
45.7
119.8
100.6
91.4
78.2
Undisbursed Bank Commitments as a
Share of Outstanding Debt (percent)
Undisbursed Government Commitments
(million US $)
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
378
4.8
4,152
3,579
1,682
Negl
9.8
1,891
1,270
953
980
7.5
3,789
3,349
1,554
1,600
Developing countries ex-
cluding Middle Eastern
countries
26.6
23.2 20.5
11.8
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.
? Czechoslovakia and Bulgaria enjoyed the most se-
cure financial positions. Both had relatively low
debt service ratios and could cover over half of
maturing credits out of their hard currency deposits
in Western banks. Bulgaria also had the highest
ratio of undisbursed commitments to outstanding
debt among the East Europeans.
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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
lending.
Table 5
Eastern Europe: Debt Service Ratios a
13
20
18
East Germany
19
46
44
Hungary
Poland
Romania
20
18 19
52 58
53 b
26 25
a Repayments of principal on medium- and long-term debt plus
interest payments as a share of earnings from exports and services. 25X1
b Reflects debt service paid. Ratio based on amounts owed equals
213 percent.
Excludes $400-500 million in arrearages.
following the imposition of martial law in Poland.
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-
ments.
Since Poland paid 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
Western governments.
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
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Table 6
Western Bank Claims, by Region a
1978
1979
1980
1981
1982
1983
First
Quarter
Total bank claims
326,987
441,667
547,569
689,660
902,979
1,110,909
1,321,919
1,549,440
1,687,522
1,689,147
Eastern Europe
11,644
17,521
23,569
29,393
40,108
50,236
55,835
54,322
47,637
45,515
Developing countries b
77,488
124,289
163,707
197,800
243,695
309,315
379,121
464,253
512,563
518,592
Developed countries
215,268
273,971
323,599
401,614
531,515
652,791
780,518
909,911
996,329
996,457
Other
22,587
25,886
36,694
60,853
87,661
98,567
106,445
120,954
130,993
128,583
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.
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
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.
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 Embassies
indicates that some governments turned down East
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Figure 3
Eastern Europe: Trade and Current
Account Balance
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-
its.
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.
imports.
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
a result of a jump in exports and a reduction in
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 diverted 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.
25X1
25X1
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Eastern Europe: Hard Currency Trade
I i I i I 1 1J 1 1 1 1 1 1 1 1 1 1 1 1
0 1971 73 75 77 79 81 82 0 1971 73 75 77 79 81 82
I I I I
0 1971 73 75 77 79 81 82
I i I i i i
0 1971 73 75 77 79 81 82
1_i 1 i I I
0 1971 73 75 77 79 81 82
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Figure 5
Eastern Europe: Trade With the Developed West,
1977 and 1981
Percent
1977
Imports
Other 1.9
Fuels 1.2----
Consumer goods 4.0
Transportation 6.4--
Raw materials 7.4 -
Foodstuffs 8.4 -
Transportation 5.4
Chemicals 5.9
Machinery 6.6
Consumer goods 18.9
-Semifinished 18.1
1981
Imports
Fuels 3.0
Consumer goods 3.7
Transportation 6.2 -
Raw materials 7.6
Transportation 4.1
Chemicals 8.2
Machinery 8.5
Fuels 20.4
Consumer goods 17.6
Semifinished 16.6
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
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 were 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.
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Figure 6
Eastern Europe: Domestic Economic Indicators
-8
I I
-10 1977 78 79 80 81 82a 83b
a Preliminary.
b Projected.
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.
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.
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
recovery.
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).
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Table 7
Rescheduling Agreements
Agreement
Date of
Agreement
Date of
Signature
1981 Paris
Club Agree-
ment
March 1981
27 April 1981
1981 Bank
Agreement
August
1981
6 April 1982
1982 Bank
Agreement
August
1982
7 November
1982
1983 Bank
Agreement
August
1983
November
1983 (planned)
Obligations
Covered
90 percent of prin-
cipal and interest
on medium- and
long-term loans in
arrears of 1 May-
December 1981
95 percent of pay-
ments on medium-
and long-term debt
due 26 March
1981-31 December
1981
95 percent of prin-
cipal on medium-
and long-term debt
due in 1982
95 percent of prin-
cipal on medium-
and long-term debt
due in 1983
Amount of
Debt
Relief
Interest
Rate
Repayment
Period
$2.2 billion
Varies with
creditor; gener-
ally 1 percent
above domestic
government
borrowing rate
January 1986-
July 1989
$2.3 billion
LIBOR plus
1.75 percent
December
1985-
December
1988
$2.2 billion
LIBOR plus
1.75 percent
September
1986-
September
1989
$1.2 billion
LIBOR plus
1.875 percent
January 1988-
July 1992
Bilateral accord
with the United
States not signed
because of $28
million arrears on
unrescheduled
payments due in
1981.
1981 interest
payments com-
pleted in March
1982.
Interest paid in
three install-
merits, November
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.
Principal repay-
ment schedule is
graduated: 10
percent due in
1988, increasing
5 percent annual-
ly to reach 30
percent in 1992.
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.
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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 Unrescheduled
ments on all debt, 1.75 percent principal paid in
including short- January and
term March 1983.
Agreement cov-
ered much less
than orginally
planned because
suppliers and
many banks re-
fused to
participate.
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 1 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.
25X1
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Despite more generous terms from commercial banks,
Warsaw only managed to cover less than half of its
$11 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
$6.6 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
the approval of an IMF standby program in June,
arrears began to mount in the summer and reached
$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
soon reached on terms, the negotiations dragged on
for 11 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.
the debt relief
from banks was worth only $1.3 billion-about $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
that he probably played the major role in deciding to
pursue more rational financial policies.
Negotiations for debt relief from Western govern-
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 25X1
delayed for months conclusion of bilateral agreements
with the 15 signators 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
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
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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 afnancial 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.
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 paid.
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
the terms
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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
$5 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 ofl:inancial and economic data.
Previously secret details on balance-of-payments per-
formance and projections, payments due to creditors
by types of creditor and country of origin, holdings of
gold and other reserves, and financial relations with
the USSR have been submitted to large numbers of
bank and government creditors, and much of the
information has appeared in the Western press.F_
Rescheduling has led creditors to try to become more
involved in the debtor countries' economies. Roma-
nia's membership in the IMF has allowed the Fund
to full this role for the creditors, but, in the case of
Poland, the creditors have been frustrated in their
attempts to encourage economic reform and policies
that would lead to economic recovery. The bank
group established an International Economic Com-
mittee 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
economy.
million at the end of the year, 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.
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.
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? 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
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 Hungary to
the brink of a liquidity crisis in early 1982.
liquid reserves fell from $1.8
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 emergency
loans.
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-
deem most of its collateralized gold. By the end of
1982, Hungary had rebuilt its foreign exchange re-
serves to nearly $1.2 billion.
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
skillful cash management.
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.' 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.
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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.
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
10 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
service payments and all currency exchanges by tourists are
convertible currency that East Berlin can use for payments to other
from banks not included in the BIS survey (for
example, Middle Eastern banks) and redepositing the
funds in Western banks
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
of undisbursed officially backed loans by nearly $320
million
East Germany's unblemished record in meeting pay-
ments led some Western bankers to conclude that the
regime received special financial help from West
German in 1982
IOf course, the roughly $1
billion obtained from West Germany through official
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
year for special credits. According to press reports
East Germany asked in late 1981 for official West
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
only some 6 percent, or $650 million, in 1982-the
smallest percentage reduction for any East European
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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.12 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.
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.
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.
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,
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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
yielded a surplus on the hard currency current ac-
count."
Bulgaria, 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-
ern firms (for example, AEG-Telefunken) and coun-
tries strapped for hard currency (for example, Iraq
and Libya).
? Sofia's perception that it could obtain free credit
unilaterally by extending payments periods.
Banks reported no .payments problems, however, and,
after a few months, the reports of arrearages to firms
stopped.
BIS statistics show another $2.1 billion fall in bank
claims on Eastern Europe during the first quarter of
1983, but more recent developments suggest some
improvement in the region's borrowing prospects:
? 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,
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business opportunities were improving
throughout Eastern Europe except for Poland and
Yugoslavia. West European bank marketing offi-
cers, in particular, have begun to press their senior
managers to look for more business in Eastern 25X1
Europe.
West German Government-guaranteed loan to East
Germany has reinforced their already improving
assessments of East Berlin's creditworthiness and
has accelerated their plans to provide new trade
credits.
the $400 million
? According to press I ]reports, Czecho-
slovakia obtained a $50 million club loan with a
four-year maturity from a group of six Western
banks in mid-July.
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
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The USSR has not provided significant 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 1983.
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 25X1
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 25X1
apparently without requesting more Yugoslav exports
this year.
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.
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Figure 7
Eastern Europe: Diminishing Economic Benefits
From Trade With the USSR
Soviet Trade Surplus With Eastern Europe
Million US S
Eastern Europe: Crude Oil Prices
Dollars per barrel
Western 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.
The region's hopes for financial recovery, however,
are fragile. Lenders who have been burned by debt
problems 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
closely 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
requests for Western aid cannot be ruled out.
Limited access to loans will force the region to
continue running trade and current account surpluses
and 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.
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.
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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 international financial 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.
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.
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
The BIS and West European central banks also aided
Hungary out of concern over the economic and
political implications of Budapest's impendingfinan-
cial crisis. According to press reporting, BIS Presi-
dent Leutwiler believed that a Hungarian financial
collapse would bring down the rest of Eastern Europe
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
$300 million credit for Hungary.
BIS decision to extend another $100 million to
Budapest in April of this year-after commercial
banks put up an additional $200 million-suggests
willingness to backstop banker's risk in Hungary.
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 IMF failed 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 1983.
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.
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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.
uling.
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
BIS probably will have to renew its credit. Yugoslav
authorities have indicated they will need another
IMF standby credit next year. Since the Yugoslavs
have made little progress in controlling inflation, the
IMF will have to press for even tighter adjustment
measures 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 refinancing 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,
$1.2 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
swamped by the tide of the bank pullout.
? The large accumulation of arrearages violated con-
ditions of the standby arrangement, and in Novem-
ber the IMF suspended further drawings.
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
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.
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 havefo-
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.
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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.
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
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.
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).'1 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
15 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
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Table 8
Net Financing Flows: a 1976-82 Actual,
1983-85 Projected
1976-80
(annual
1981-82
(annual
1983
Projected
1984-85 b (annual average)
average)
average)
-440
0
100
200
-300
0
165
330
East Germany
1,800
-505
-1,075
-700
-175
500
Hungary
1,230
-750
-500
-400
-100
375
Romania
1,305
-390
-800
-600
0
475
Yugoslavia
2,210
340
665
-500
125
500
a New credits less repayments.
b 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 1--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.
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.
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.
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Projection of Credit Flows and Exports in 1984-85
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 flows 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.
debt each year.
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.S percent fall in net debt
in 1984 and no change in 1985.
debt both years.
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
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 IMF's 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.
? 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 projects.
undercut export performance.
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
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
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Figure 8
Eastern Europe: Hard Currency Imports 1980, 1982, and
Projected 1985, Under Financing Scenarios
1980
1982
1985, Scenario I
Scenario 2
Scenario 3
1980
1982
1985, Scenario I
Scenario 2
Scenario 3
1982 1982
1985. Scenario 1 1985, Scenario 1
Scenario 2 Scenario 2
Scenario 3 > '`A Scenario 3
1_.- I I
6 8 10 12
1980
1982
1985, Scenario I
Scenario 2
Scenario 3
Romania
1980
1982
1985, Scenario I
Scenario 2
Scenario 3
1982
1985, Scenario I
Scenario 2
Scenario 3
I I I
8 1() 12
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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).
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-
creases in 1984-85.
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
Western inputs.
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 countries 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.
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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
of individual countries to respond seem likely to
diverge 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
their economies much harder than Budapest, while
the latter seems farther along in addressing struc-
tural problems. East Germany probably retains the
strongest financial safety net (particularly by ob-
taining help from West Germany), but Hungary,
and to a lesser extent Romania, are better posi-
tioned to win general Western support, including
help from the IMF.
? Thanks to their small debts 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
to make large sacrifices
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
pay.
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
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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 (ICCJ 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
1983 debt to banks and governments. The Roma-
nians, however, have balked at the IMF's demands to
establish timetables for adjusting exchange rates and
domestic energy prices, and the Fund has suspended
drawings under the standby arrangement. The stale-
mate with the Fund, combined with a continued
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-
rate share of the refinancing.
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.
shortfall in credits, could lead to a substantial finan-
cial gap this year. Bucharest has vowed that it will not
need debt relief next year and counts on a current
account surplus to cover more than half of its 1984
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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-
ing the import cuts have been.
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
year's borrowing requirement. Even before announce-
ment of the loan, Western bankers seemed more
willing to provide short-term trade loans and the new
West German credit may encourage even more lend-
ing. Bankers, however, still do not anticipate an
increase in medium-term financial credits needed to
lengthen the maturity structure of East Germany's
debt. East Berlin nonetheless can draw on new
government-guaranteed trade credits from France,
Canada, and Austria.
If East Germany gets through this year's financial
squeeze, repayments on medium-term debt will be less
in 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 ease the task of refinancing. Western bankers,
however, will press harder for basic economic and
balance-of-payments data before increasing their ex-
posure. Over the medium term, the country will have
to live more within its means and implement measures
that improve export competitiveness and promote
economic growth without heavy reliance on Western
imports and credit.
Hungary. Hungary is still on a financial tightrope
despite some successes in raising credits in the first
half of 1983. The IMF now estimates that exports will
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
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-
tries.
Bulgaria and Czechoslovakia. Both countries have
weathered the credit crunch as a result of their
financial conservatism. Since neither encountered
problems in covering obligations during the height of
the crisis in 1982, we expect they will be able to roll
over their 1983 obligations. Their financial strength
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 25X1
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
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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 political and ideo-
logical implications.
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
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
25X1
25X1
1
25X1
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25X1
J
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
ahead.
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
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
economies and draw them more tightly into the
CEMA orbit. The Kremlin may have chosen this time 25X1
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
and return.
The West cannot expect substantial economic gains in
its relations with Eastern Europe. Financial con-
straints are likely to make East European markets 25X1
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 soon be as large as a few years ago
Eastern Europe also will still be a source of concern
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-
ations on debt relief and aid.
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Appendix
Total
9,510
11,572
14,727
21,468
30,659
38,264
Commercial
5,396
7,243
9,828
15,634
23,721
29,667
Official'
3,765
3,921
4,406
5,123
6,002
7,168
IMF/World Bank
349
408
493
711
936
1,429
Bulgaria
Official'
301
244
202
183
187
320
Czechoslovakia
Total
485
630
757
1,048
1,132
1,862
Commercial
284
435
558
821
926
1,575
Official'
201
195
199
227
206
287
East Germany
Total
1,408
1,554
2,136
3,136
5,388
6,292
Commercial
693
771
1,348
2,243
4,423
5,217
Official b
715
783
788
893
965
1,075
Total
1,071
1,372
1,442
2,129
3,135
4,049
Commercial
968
1,274
1,353
2,053
3,081
3,998
Official b
103
98
89
76
54
51
BIS/IMF
Poland
Total
1,399
1,825
3,057
5,313
8,879
12,307
Commercial
420
856
1,951
3,586
6,547
9,159
Official b
979
969
1,106
1,727
2,332
3,148
IMF/World Bank/
CEMA banks
0
0
115
116
194
402
Total
3,177
3,933
4,704
5,446
6,561
7,653
Commercial
2,004
2,525
3,118
3,631
4,267
4,999
Official'
824
1,000
1,208
1,220
1,552
1,628
IMF/World Bank
349
408
378
595
742
1,026
a Because of rounding, components may not add to totals shown.
' Includes Western government-guaranteed credits and direct offi-
cial loans.
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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
production plans.
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.
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
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
interest; 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-
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 significantly toward
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
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Poland
Financing Requirement and Sources
-2,247
-3,258
-1,947
-433
358 a
700 c
4,971
4,974 a
5,600
5,404
4,616 a
4,900
-2,293
-4,019
-2,987
Under original loan con-
tracts
2,293
3,387
2,273
Under rescheduling
agreements
632
714
1982 Bank
37
286
Other invisibles, net
(excluding interest)
479
403
340
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
Banks
Other creditors
Net credit extended
Sources of financing
Credits
Medium- and long-term (guar-
anteed)
Short-term (recycling facility-
from 1982)
Payments received from debtors,
net
-7,282
-7,061
-5,013
2,573
1,770
2,442 e
1,417 e
2,046
1,826
4,930
1,677
800 c
1,481
4,769
1,613 t
1,200
95
50
e Includes principal payments-5 percent of total-deferred until
the following year under the bank rescheduling agreements for 1981
and 1982.
t 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. F_
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.
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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
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
repay creditors.
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
this year
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 creditors unwilling to risk further expo-
sure.
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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
well end in failure.
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
World Bank.
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
Financing Requirements, 1981-83
Financing requirement
6,687
5,585
5,762
Current account balance
- 1,821
-1,420
-750
-4,880
-3,779
-2,750
5,720
5,858
6,200
10,600
9,637
8,950
3,059
2,359
2,000
4,000
-1,590
-1,960
-2,000
Repayment of short-term credit
-2,936
-2,300
-1,810
Repayment of medium- and long-
-1,695
-1,690
-3,052
term debt
Credits extended (net)
- 235
-175
-150
Financing sources
6,218
4,573
5,677
1983 Western rescue package
IMF
620
IBRD
450
Government loans
700
Financial credits
200
Export credits
500
3,460
600
1,460
Medium- and long-
1,400
term rollover
- 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
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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), nonetheless,
told Western bankers recently that it 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 billio
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.
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 25X1
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,
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
outside of 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 25X1
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
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25X1
, 25X1
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
First-Half 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
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
relief.
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
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-
tors than they displayed this year.
25X1
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
financing current account deficits.
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
Yugoslavia cannot hope for financial recovery until 25X1
the leadership attacks the economy's deeply en-
trenched inflationary 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
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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.
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The 1983 financial picture looks somewhat better
than last year, although recent problems with the
IMF and continuing difficulties in lining up credits
could deal at best a temporary setback to Bucharest's
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. F_
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
IMF accompanying the review of the standby
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
million on the strength of another large trade surplus
of $1.6 billion. Not only will these targets be difficult
to achieve but they may be risky as well, given the
impact on the economy of the adjustments already
made. Imports are set to rise slightly to $5 billion-
still far below the 1980 peak of $8.1 billion-with
further reductions in imports of crude oil and grain
and substantial increases in imports of machinery,
equipment, and metals. Bucharest told the IMF that
the 6-percent growth rate projected for exports will
come largely from a 17-percent increase in sales of
refined petroleum products, an overly optimistic tar-
get given the soft energy market and Romania's own
Romania
Hard Currency Financing
Requirements and Sources
1981
1982
1983
(projected)
4,215
4,268
2,566
-818
655
800
Debt repayments
3,231
3,153
2,663
Medium- and long-term debt
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
0
2,439
963
Western banks
1,616
572
Western governments
400
136
CEMA banks
153
28
Arab banks
270
Suppliers
227
Drawdown of BIS deposit
316
Financial gap/arrears
-1,143
-388
-408
Net errors and omissions
Trade data through May show that exports were well
below the target rate, and Bucharest had to reduce
imports accordingly. The IMF in July reduced its
projections of both imports and exports for the full
year by $532 million while maintaining the projected
surplus of $1.6 billion.
Status of Rescheduling. Bucharest's effort to resched-
ule its 1983 debt to the banks appears to be moving
smoothly, especially compared with the 1982 negotia-
tions. Creditors were uncertain about whether debt
relief would be needed this year, but at the end of
energy problems.
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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 Million US $
Current Account
1981
1982
1983
(projected)
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
-346
-139
-220
? Romanian officials have been more businesslike and communications
cooperative, both in negotiating with the banks and in Other
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.F_
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
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
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t
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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
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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
would seem the minimum necessary to rebuild inven-
tories, preclude serious declines in industrial produc-
tion and living standards, and ensure export growth.
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 actually increased by $50 million
because of sizable gains in exports. The balance with
West Germany, on the other hand, plummeted from a
$130 million surplus in the first quarter of 1982 to a
$126 million deficit this year. By midyear, East
Germany's deficit with West Germany widened to
$275 million-compared with a $106 million surplus
at mid-1982-as a result of a 33-percent jump in
imports and a 2-percent gain in exports. Because of
easier access to trade credit in West Germany and the
advantages of the intra-German payments mecha-
nism, the East Germans are continuing the strategy of
shifting Western imports into intra-German trade.
Even with healthy trade and current account surplus-
es, East Germany will still require over $3.5 billion in
credits to cover its financing requirement without
dipping into reserves. Raising this amount of funds
will not be easy, but the East Germans have some
financing sources. Entering 1983, East Berlin still had
East Germany Million US $
Financing Requirements, 1981-83
5,250
4,254
3,575
-500
1,246
1,075
Trade balance
60
1,509
1,175
Exports
6,714
7,172
7,675
Net invisibles excluding
interest
985
950
850
Repayments of short-term
debt
-2,500
-2,350
-1,475
Repayments of medium- and
long-term debt
-2,250
-3,150
-3,200
Borrowing sources
5,550
4,000
NA
Medium- and long-term
credits
3,200
2,525
NA
33
NA
some undrawn Western government-backed commit-
ments, and France, Canada, and Austria have extend-
ed new officially guaranteed trade loans. West Ger-
man banks are continuing to finance intra-German
trade deals, and the East Germans have access to the
swing credit. East Germany's success in managing the
credit squeeze has begun to encourage Western banks
to offer more short-term trade credits. The main
problem remains medium- and long-term financial
loans needed to cover debt service payments and to
refinance short-term debt on more favorable terms.
East Germany has used many of its previously undis-
bursed commitments with Western banks, and bank-
ers have remained cool toward a medium-term syndi-
cation. The late-June decision of the West German
government to guarantee a $400 million five-year loan
from West German commercial banks has provided
needed funds to cover debt service obligations. It may
also revive other untied lending to East Germany.
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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.
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.
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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-
ally.
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
net exports.
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
Financing Requirements, 1981-83
1981
1982
Financing requirement
4,918
4,294
Current account balance
-727
-149
Trade balance
445
766
Exports
4,877
4,876
Imports
4,432
4,110
Net interest
-1,100
-976
-72
61
Repayments of medium-
and long-term debt
-826
-894
Repayments of short-
term debt
-3,261
-2,849
Repayments of BIS
credits
-192
Borrowing sources
4,292
3,375
Medium- and long-term
credits
1,443
1,154
Short-term credits a
2,849
1,476
IMF credits
235
BIS credits
510
Change in reserves
-626
-919
Original Revised
IMF IMF
Projec- Projec-
tion 1983 Lion 1983
2,071
2,378
600
500
1,142
1,062
5,252
4,920
4,110
3,858
-669
-669
38
107
-936
-1,005
-1,371
-1,476
-64
-97
2,571
2,223
579
613
1,626
1,244
366
366
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.
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.
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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.
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Hungary Million US $
Debt Service Payments, 1981-85 a
Amortization of
medium- and long-
term debt
Interest payments on
gross debt
826
894
1,005
1,610
1,606
1,014
1,004
765
750
691
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
rescheduling.
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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
exports, but poor export performance apparently has
led Prague to continue reducing imports. During the
first half of 1983, exports to the West rose only 1.3
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 group of Western banks.
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
Czechoslovakia
Financing Requirements, 1981-83
Financing requirement
2,009
Current account balance
-79
Trade balance
330
Exports
4,691
4,361
Net invisibles excluding
interest
50
Repayments of short-term
debt
Repayments of medium- and
long-term debt
Borrowing sources
1,570
Medium- and long-term credits
430
Short-term credits
1,140
Net errors and omissions
57
1,355
1,090
210
300
492
500
4,029
4,100
3,537
3,600
60
70
1,120
NA
190
NA
930
NA
122
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
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-
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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
financial conservatism)
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 maturities 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
Political rather than economic factors are more apt to
hinder access to credits.
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
Bulgaria
Financing Requirements, 1981-83
Financing requirement
851
988
1,036
Exports
3,198
3,200
3,300
Imports
2,546
2,700
3,000
Net invisibles excluding
interest
285
270
295
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
to provide an unspecified amount of credit.
? 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
unused at the end of March.
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.
effort on Sofia's behalf
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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
plant.
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
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