EASTERN EUROPE: BOOM MARKET FOR SYNDICATED LENDING

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP87B00342R000100200011-3
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 126
• Document Creation Date: December 22, 2016
• Document Release Date: May 26, 2010
• Sequence Number: 11
• Publication Date: October 25, 1985
• Content Type: REPORT

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