We have come a long way from the excesses of "Western economic warfare" against Eastern Europe. The past five years have seen an explosion of East-West trade and Western lending to Eastern Europe, including the U.S.S.R., with Western governments, banks, and exporters competing strenuously for East European business. In the atmosphere of détente, a wide range of political and economic forces generated opportunities for profits, which competitive capitalism exploited with characteristic alacrity and flexibility. The sum total of these diverse initiatives has been large-scale Western export of capital, both financial and real, to Eastern Europe. This new East-West economic interdependence now clearly demands the policy analysis which ideally should have preceded it.

The implications of the current situation are obscure even to many of the participants. Central planners are in principle able to use their "foreign trade monopoly" and centralized banking systems to coordinate their international trade and payments, in the light of their political and economic objectives. Even they, however, can be carried along by forces they do not fully understand. For mixed economies and their governments, the problems of international economic policy are that much greater. Neither technocrats nor politicians have yet appreciated the extent and implications of Western capital flows to Eastern Europe, and current attitudes and policies toward East-West economic interdependence could lead to consequences not desired by either side. The debtor-creditor relation can be a difficult one even with the best will in the world, and it is all too easy for miscalculations and misapprehensions to generate tensions which economic interdependence might otherwise alleviate. Whatever the ultimate form of the "new international economic order," the centrally planned economies of Eastern Europe will have an important role in it, and we should seek to ensure that the resulting East-West economic and political relations will be harmonious and mutually beneficial.

My primary concern here is therefore not with the creditworthiness of East European borrowers, although I do conclude that some countries may encounter serious debt-servicing difficulties around the turn of the decade. This problem is, however, only one of several major issues raised. Even if East European capacities for debt service were not in question, the growing volume of debt and the trade flows behind it have changed East-West relations in ways which policies have not yet begun to assimilate. One must hope that these issues may be discussed publicly without threatening market confidence. So far, Western countries have been inhibited in developing policies toward the debt not only by disagreements over the importance of the problem and lack of information on its dimensions, but also by some concern that any action might rock a rather precarious boat.

The East European debt must, of course, be viewed in the world context of rapidly growing borrowing to finance balance-of-payments deficits, but it is substantial even in comparison to the total debt of all oil-importing less-developed countries. By the end of 1976, the external debt of these non-OPEC LDCs was estimated at $180 billion, of which $75 billion was owed to commercial banks. Corresponding estimates for Eastern Europe (including the U.S.S.R.) were $46 billion and $28 billion.1 In the narrowly defined Euromarket, however, Eastern Europe accounted for $19.3 billion of the uses of Eurocurrency funds (8.4 percent of the total) at end-September 1976, while non-oil-producing LDCs accounted for only slightly more, $22.5 billion.2 The non-oil LDCs financed 58 percent of their 1974-76 current account deficits by borrowing from the commercial banking system - the corresponding figure for Eastern Europe was 57 percent. In the international financial community, many now believe that whereas the Euromarket has effectively dealt with shorter-term recycling of OPEC surpluses, in the longer run governments or international organizations will have to play a greater part, supplanting or cooperating with the commercial banks. In principle, if this view is accepted in relation to the non-oil LDCs, it should apply to East European borrowers as well.

The issues raised by the East European debt do, however, differ in several important respects from those commonly discussed in the context of the more general problem. First, although the oil price increase seriously hurt the smaller countries of Eastern Europe, the deficits of 1974-76 for the region as a whole (including the U.S.S.R.) are not oil deficits. Eastern Europe is a net oil exporter and is projected to be so at least until 1980.3 Thus the sources of the East European deficits must be examined more closely, and the adjustment problem will differ significantly from that of the non-oil LDCs.

Second, the process of assessing future prospects for trade and debt servicing capacity is different for Eastern Europe, because of the characteristics of centrally planned socialist economies and the limitations of our data on them. Similarly, the Council for Mutual Economic Assistance (CMEA or COMECON) must to some extent be viewed as a whole, i.e., as an economic and geopolitical unit dominated by a superpower, with its own internal trading arrangements, inconvertible currencies, and strategic motivations. East-West economic relations cannot simply be seen as a subset of overall international trade and monetary relations, nor can East European debt to the West be viewed merely as a component of total external debt. Indeed, as recently as 1970, say, it would have taken remarkable prescience to suggest that Eastern Europe would be willing to borrow from the West - and the West willing to lend to the East - a sum on the order of magnitude of $46 billion. And the East European countries are not fully integrated into the world financial system: only Romania even belongs to the International Monetary Fund (IMF).

Thus the important issues are not merely creditworthiness and the banks' ability to assess it, or the proper institutional form for financial intermediation between hard-currency surplus countries and East European hard-currency deficit countries. With regard to Eastern Europe, the future roles of official credit facilities and commercial bank finance and the concept of "conditionality," i.e., of finance provided subject to conditions on the borrower's economic policies - both in itself and as a key to access to bank finance - must be examined in the light of economic, political and strategic considerations often quite different from those relevant to the LDCs. The problems for Western policymakers are thus both new and special.

II

Romania started buying Western machinery on credit as early as 1961, but it was not until the 1970s that the hard-currency debts of East European countries became substantial. The indebtedness then grew much faster than East-West trade, which has been rising rapidly; trade between Eastern Europe and the OECD countries rose by 34 percent in 1973, a further 43 percent in 1974, and 15 percent more in 1975, so that its share in world trade now exceeds six percent.4 But East European imports grew much faster than their exports, and East European hard-currency balance-of-trade deficits nearly doubled in each year from 1972 through 1975, rising from $2.2 billion in 1972 to $12 billion in 1975; for 1976, the deficit is estimated at $10 billion. Given the small foreign exchange reserves and gold stocks for all but the U.S.S.R., Soviet reluctance to sell gold, and small net invisible earnings, these trade deficits generated roughly equal financial claims by the West on the East.

But the process was not automatic: it required East European need and willingness to borrow, and Western willingness - and perhaps need - to lend. One reason why East European countries found Western capital markets so open in the 1970s was their previous avoidance of debt. Two decades of rigorous financial rectitude had testified to the conservatism of their central bankers. Indeed, some of these have doubtless been uneasy about the scale of borrowing they have since had to undertake, though they manage it well.5 Under severe economic pressures, their authorities have required them to pursue what they call, with some embarrassment, an "active credit policy." By the late 1960s, the need to increase productivity in the face of a perceived technological gap led the planners to seek substantial imports of Western machinery. Not only equipment and technology, but also consumption aspirations came from the West. After many years of slow growth in real incomes, "demonstration effects" brought strong demands for more and better consumption goods. Moreover, the authorities believed that higher consumption might itself stimulate labor productivity. Finally, organizational and incentive problems made agriculture vulnerable to bad weather, and the early 1970s saw two major harvest failures.

These pressures on the import side were paralleled by problems in selling manufactures in the West. Deficient quality standards and a structure of supply too similar to goods already in surplus in Western markets were major obstacles; the recession beginning in 1974 accentuated them. The increasing agricultural protectionism of the European Economic Community (EEC) has been a further barrier to exports for countries like Hungary, Bulgaria, and Romania. And adverse shifts in terms of trade since 1973 have severely hit all East European countries except the U.S.S.R. and Poland. But although the large-scale borrowing from 1973 onward may at first have appeared to be a short-run response to harvest and terms-of-trade setbacks, the disequilibrium it reflects is more fundamental. Once the East European countries discovered they could borrow large amounts without unacceptable political conditions, it was therefore natural that they should wish to postpone adjustment.

On the Western side, the lending has come from both private banks and governments (through export credit agencies). Western bankers were impressed by the spotless previous record of East European borrowers, and their entrance into the market offered an opportunity for portfolio diversification. The new demand came, of course, against a background of increasing bank financing of balance-of-payments deficits. The Euromarket had been growing rapidly even before large petrodollar deposits began to accumulate. In the subsequent overall process of recycling of funds, East European requirements initially appeared negligible. As the recession deepened and private-sector loan demand in the West fell, Euromarket bank liquidity grew, and East European borrowers had no difficulty arranging large five- to seven-year loans on excellent terms.

The Euromarket is highly competitive, and regulation of Eurobanks is confined to "prudential supervision" through the parent banks by their national authorities. Whether or not this is adequate to safeguard the health of the market as a whole, it certainly has not prevented poor judgment by individual banks of country risk, already demonstrated for several LDCs - and there is no evidence that it has in any way restrained or controlled lending to Eastern Europe. The practice of syndicating major loans, parceling them out among many banks, reduces the risk to each. But each bank's limit on its own exposure in a given country cannot prevent the sum of a country's borrowings from all banks from reaching a total far above the country's capacity to manage in the long run.

Although Euromarket lending has accounted for the major share of the recent growth in the debt, Western governments have also been eager to extend export credits or guarantee (insure) those offered privately, and in the politically more favorable climate of détente, Western firms have aggressively sought Eastern customers. The recession stimulated a competitive search for export markets in the East, especially for capital goods, and all the major Western exporting countries except the United States have announced major loan guarantee packages covering various East European countries.6

A Marxist (but not East European) interpretation of Western behavior might suggest that regardless of détente, the mature capitalist economies required a vent for both financial and real surpluses, and Eastern Europe was just as attractive a market as the LDCs. Even if détente was a necessary condition for substantial expansion of the debt, there were strong economic motives for détente, just as for the related internal political accommodations on both sides, which could also be seen as "necessary conditions." In expanding their imports of manufactures from the West, the East European authorities have had to accept the superiority of Western technology. In allowing those exports, as well as large quantities of grain, and in taking some raw material supplies from the East, Western authorities have had to accept political and strategic consequences which had long been resisted.

Whereas it could be maintained that in the 1950s and 1960s political considerations dominated East-West economic relations, recent behavior may suggest the converse. We cannot simply conclude, however, that Western policymakers can relax and let monopoly capitalism imperialistically exploit the socialist countries, since not much could be done about it anyway. We surely can have some control over where our capital exports go, how they will affect future trade patterns, and their implications for international relations. On the other hand, policymakers will not have full autonomy, if only because of the size of the already existing East European debt to the West.

III

How does the current East European debt break down, first in terms of the amounts owed by individual countries, second in terms of the types of obligations and their public or private character, and third in terms of the Western countries which have extended official government-guaranteed export credits? The growth and country composition of East European debt are shown in Table I below. Because the East European countries do not themselves provide information on their debts, these figures and others cited below are compiled from scattered Western sources. They undoubtedly have both overlaps and omissions, but they are not inconsistent with trade figures, and however crude, they give an adequate view for our purposes of the size and structure of the debt.7

TABLE I

EAST EUROPEAN DEBT TO THE WEST

(billion U.S. dollars)

end-1970 end-1974 end-1975 end-1976*

Bulgaria n.a. 1.7 2.4 2.8

Czechoslovakia n.a. 1.1 1.5 2.1

G.D.R. (East Germany) n.a. 3.6 4.9 5.8

Hungary n.a. 2.3 3.2 3.5

Poland n.a. 4.9 7.8 10.4

Romania n.a. 2.4 2.8 2.8

East Europe (excl. U.S.S.R.) 5.8 16.0 22.6 27.4

U.S.S.R. 2.5 5.9 11.4 14.4

Country total 8.3 21.9 34.0 41.8

CMEA banks 0 2.1 2.8 3.5

Overall total 8.3 24.0 36.8 45.3

* Preliminary estimates.

SOURCES: 1970, 1974 and 1975 based on data provided by Chase Manhattan Bank. Estimate of increments in U.S.S.R. debt during 1976 from World Financial Markets, December 1976. Chase estimates of net indebtedness at end-1976 used to derive estimates for other countries.

As these figures show, the rate of growth of the total debt dropped somewhat in 1976, in keeping with the slightly reduced balance-of-trade deficit already cited. The overall totals for each year, it should be noted, do not reflect undrawn official credits, committed on signed contracts for goods not yet delivered; these amounted to roughly $10 billion at the end of 1975, by way of example. Nor, conversely, do the stated totals of debt take account of the deposits of East European countries in Western banks, which are of course an offset; at the end of 1976, these were estimated to be about $6 billion. All in all, the end-1976 net total of debt actually taken up amounted to roughly $40 billion, of which about $25 billion was attributable to the six smaller countries, about $12 billion to the U.S.S.R., and about $3 billion to the CMEA banks. At this level the annual interest obligation alone must now be approaching some $3 billion.

In terms of types of obligations, as of the end of 1975 official export credits accounted for just over 30 percent of the overall debt total. Direct credits from suppliers were about eight percent of the total, and the balance was from commercial banks. The official export credits are those guaranteed by Western governmental export credit agencies and usually have had longer maturities than the unguaranteed private medium- and long-term bank credits - 8 to 10 years, say, as compared with 5 to 7 years for the latter.8 These publicly announced, normally syndicated, Eurocurrency loans are in turn of longer maturity than the remaining Eurocurrency credits, which might run anywhere from three months to three years. The medium- and long-term Eurocurrency credits are normally variable-rate loans, the rate being set as a specified percentage "spread" over the London inter-bank offer rate (LIBOR) and changed to follow this rate every six months.

Looking at the individual countries, the U.S.S.R. and Poland at once stand out for the overall size of their debts. The Soviet debt grew particularly rapidly during 1975, when the U.S.S.R. first went into the Euromarket on a large scale, in part to finance substantial grain imports. Before 1975, most Soviet debt was in guaranteed export credits, with a correspondingly longer term maturity structure. Poland's debt rose by $3 billion in 1975 and by a further $2.5 billion last year. It is divided fairly evenly between export credits and Euromarket loans. Although Hungary led Eastern Europe into the syndicated Eurocurrency credit market, when Poland entered it in 1973, it did so on a large scale, and from then on it has borrowed about $500 million annually in this way. Its official export credits outstanding have also been growing faster than those of any other East European country.

Among the other countries, Hungary and Bulgaria are outstanding for the high proportion of their debt in Euromarket obligations; the opposite is true for Romania, which has relied on official export credits to finance its imports of machinery - in contrast to the raw materials that dominate Hungary's imports. Of the two most industrialized countries, East Germany's debt is quite high in relation to its hard-currency earnings (a measure to which we shall return), whereas Czechoslovakia has followed by far the most conservative financial policy in the bloc, with very little Euromarket borrowing until 1976 and only a modest amount of official credit obligations.

The Euromarket debt of Eastern Europe has been growing more rapidly than officially guaranteed credits: Eastern Europe's net liabilities to Western commercial banks rose from $6.7 billion at the end of 1974 to $20.7 billion at the end of September 1976, and their net liabilities in the narrowly defined Euromarket have been growing at a fairly steady rate of about 75 percent per annum since 1974. This is partly because of the need in 1974-76 to borrow for general balance-of-payments support, especially to pay higher raw material prices (as in the Hungarian case). Even to finance machinery imports, however, Euromarket terms are in some cases better than those of official credits. There are other advantages to borrowing in the Euromarket: no political concessions need be made (conversely, there are no domestic political constraints on the lenders' side) and the funds are not "tied," i.e., they can be used to purchase from any supplier country. But the Eurocurrency debts do have generally shorter maturities, and of the total Eurocurrency debt, less than one-quarter is in the longer term publicized, syndicated loans (and among these, maturities have been shortening). For short-term funds, borrowers can go to smaller banks which so far have relatively little exposure in Eastern Europe, and they are still getting good terms.

Finally, although the proportion of official export credits to total debt has been falling, the total has grown rapidly. The levels of such credits and the way they break down among lending countries as of end-1975, the last date for which reliable figures are available, are shown below:

TABLE II

OFFICIAL EXPORT CREDITS TO EASTERN EUROPE*

Bulgaria Czech. G.D.R. Hungary Poland Romania U.S.S.R. Total

(millions of U.S. dollars)

31 March 376 583 838 219 1234 1593 3877 8420

1973

31 December 737 848 1903 244 5575 1637 9920 19,948

1975

(end-1975 percentage distribution by lending country)

U.S. 0 0 0 0 2.0 4.2 4.6

Japan 10.5 6.1 2.9 0.4 6.6 12.7 8.4

Austria 2.8 21.1 14.7 2.9 11.6 2.8 3.0

U.K. 7.1 7.8 3.8 29.0 28.1 16.6 6.9

France 41.8 17.2 19.7 16.6 20.7 16.3 32.7

F.R.G. 15.3 26.7 46.3 20.7 9.9 26.9 29.7

Italy 9.8 6.6 1.8 16.6 5.1 11.0 11.0

Sweden 4.2 2.1 4.2 0.4 4.1 2.1 1.2

Other 8.5 12.2 6.6 13.2 11.6 7.5 2.0

100.0 100.0 100.0 100.0 100.0 100.0 100.0

* Export credits are government-guaranteed commitments on signed contracts. Aggregate data are from official sources. Breakdown by lending country is derived from East-West Markets, September 20 and October 4, 1976. F.R.G. "swing" credit to G.D.R. estimated at $300 million for March 31, 1973 and $917 million for December 31, 1975 (latter taken from East-West Markets). Column totals may not add because of rounding.

It will be noted at once that, whereas American banks are major holders of commercial obligations (directly or through the Euromarket), the United States holds very little of the government-guaranteed debt; this is of course the result of limitations on Eximbank lending and guarantee authority for Eastern Europe imposed by Congress in 1974 and the Soviet refusal to accept the conditions of the 1974 Trade Act (the Stevenson and Jackson Amendments).9 At present, France and West Germany are the leading official lenders, followed by the United Kingdom, with noteworthy variations in debtor country emphasis among all lenders.

IV

Let us next assess the general factors that bear on Eastern Europe's ability to handle the debt, and then move to the factors (closely related) that will affect the future debt level.

A country's debt servicing capacity depends on the maturity and interest rate structure of its existing debt, the possibilities for exports (on both the supply and demand sides), the possibilities for reducing imports, and the country's standing in international credit markets. The fundamental question is whether the borrowing country can effectively transform borrowed resources into import substitutes or exports. This involves the share of borrowed resources which actually goes into investment; the rate of return on that investment; and the ability to shift the composition of output into import substitutes and exportables, and to release exportables for sale abroad. Debt service requires both that domestic savings exceed investment by enough to cover net repayments to foreigners, and that the economy generate sufficient excess of export earnings over import costs to allow payments. In the case of Eastern Europe, the focus must be primarily on export possibilities. East European imports are predominantly raw materials and high technology goods, for which substitution will be difficult even in the medium run. Restriction of imports would probably require doing without.

Evidently there can be no simple measure of debt servicing capacity, and we shall have to consider each country and the region as a whole in some detail. For example, the most commonly used single index of capacity is the debt service ratio - here, annual interest plus amortization on hard-currency debt as a percentage of hard-currency earnings - which ignores both the productivity side of the analysis and the economy's ability to reallocate output to net exports. As a cash flow concept, however, it may be a useful indicator of possible short-run liquidity problems. The higher the proportion of export earnings already committed to debt service, the more sensitive will be the remainder (the capacity to import) to any fluctuation in exports. No matter how unlucky or temporary, a sudden drop in export earnings might make it impossible to continue even the minimum of essential imports while maintaining debt service. Much then depends on the country's credit standing; nevertheless, of countries with very high (over 30 percent) debt service ratios in recent years, only Israel and Mexico have avoided seeking debt relief, while many countries with lower ratios have had to reschedule.

We do not have the information on interest rate and maturity structures necessary to calculate debt service ratios for East European countries with any precision. An American estimate for the U.S.S.R. is 20 percent in 1975,10 and on fairly conservative calculations Poland's must now (end-1976) be at least 30 percent, but we cannot really specify the margins of error. What we do have, as a rougher measure of at least the comparative situations, is the ratio of net end-year debt principal (credits actually drawn less bank deposits in the West) to hard-currency annual export levels. Table III below shows these figures:

TABLE III

END-YEAR NET DEBT RATIO TO HARD CURRENCY EXPORTS

1974 1975 1976*

Bulgaria 2.1 3.2 3.4

Czechoslovakia 0.4 0.7 1.0

G.D.R. 1.4 2.0 2.3

Hungary 1.3 1.8 2.0

Poland 1.4 2.1 2.7

Romania 1.0 1.3 1.2

U.S.S.R. 0.3 1.1 n.a.

East Europe (Total) 0.9 1.5 n.a.

* Preliminary.

SOURCE: Chase Manhattan Bank.

The high ratios of Poland, the G.D.R., and especially Bulgaria stand out. Stressing again the roughness of the measure, one may note that on comparable definitions, the ratios for selected LDCs, as of end-1975, were 2.6 for Argentina, 2.1 for Brazil, 3.1 for Chile, 2.6 for Peru, 3.2 for Turkey (excluding sizable invisible earnings), and 0.8 for the Philippines.

The fundamental question, however, concerns the future trade balance of the East European countries with the West. If this were to show promise of achieving equilibrium, then both the management and future levels of debt would fall into place. Conversely, if deficits are likely to continue high, the management problem necessarily becomes more serious.

It has been argued that the centrally planned economies will continue to experience hard-currency deficits as long as they maintain this type of economic system. In this view certain features of the system make them "structurally" unable to produce in sufficient quantity goods demanded in Western markets and to market effectively what they could sell. They are unable to generate, use, and diffuse new technology, and even the technology they import is often already outdated. They will permanently be a step behind, and their manufactures simply will not compete. Moreover, they will consistently underestimate their future hard-currency deficits because of various "illusions."11

One may hesitate to accept this apparent denial of the basic principle of comparative advantage in international trade, or at least feel that it generalizes from only a few recent years of consecutive large deficits. The analysis does, however, tie in well with the problems Eastern Europe appears to face in different phases of the Western business cycle. When Western economies are growing slowly, they are reluctant to accept imports from the East, and price-cutting (arguably to approach an "equilibrium exchange rate") is seen as dumping. When Western growth accelerates, so does technical progress, and the technology gap widens.

The argument suggests that only decentralizing "economic reforms" will make the system flexible enough to export to the West. I believe that no far-reaching changes of this kind should be expected in the foreseeable future, whatever the economic pressures and our own policies. The Hungarian economic system c. 1971 is about as far as any East European country is likely to go toward a market economy.

On the other hand, before it was hit by sharply adverse changes in its terms of trade, the Hungarian economy was significantly improving its hard currency trade performance.12 Perhaps, therefore, the case is not proven, and limited decentralization and rationalization of the system would suffice. And even without systemic change, the substantial increase in Romanian exports to the United States after the Most Favored Nation (MFN) and Generalized System of Preferences tariff treatment were granted (July 1975 and January 1976, respectively) suggests that lowering tariffs might help significantly.

On present evidence, it seems unlikely that other East European countries will go even as far as Hungary. Certainly the 1976-80 Five Year Plans suppose no major institutional changes. They do reflect the generally tighter constraints on economic policy imposed by hard-currency debts and world economic conditions, with somewhat lower output growth rates (except in Romania) and a clear slowdown in the growth of consumption. Yet one may doubt whether the plans go far enough in this direction - or whether they could. For even if, for example, the plans could allow an increase of exports to the West by 80 percent from 1975 to 1980 (assuming the goods could be sold), as one analysis suggests, to achieve a hard-currency trade balance by then would require that imports go up only 13 percent over the same five-year period.13 But domestic pressures would make it very difficult indeed to reduce consumption growth rates any further, and investment is hard to cut in the short run, while in the longer run it is essential for the desired productivity increases. Now that foreign trade, especially trade with the West, is no longer a marginal activity involving only a small share of output, the planners' room for maneuver is much reduced.

Prospects for the debt thus involve both whether the West would buy substantially more East European goods and whether the East could supply them. In the West, market resistance and pressures for barriers to imports have already become evident over a wide range of products.14 And in the East there is little evidence so far that the output generated by imported capital and technology has gone into significant increases in hard-currency exports - on the whole, it has tended to remain within the bloc (e.g., petrochemicals, automobiles).

Straightforward arithmetical exercises make it clear that at current rates of gold sales and invisible earnings, and allowing for the rising interest burden of the debt, even its continuing rapid growth could be avoided only by a remarkable turnaround in East European trade balances. If the flows of 1976 remained unchanged through 1980, the debt would be approaching $90 billion by the end of that year. Alternatively, if imports and invisibles stayed constant at 1976 levels, then merely in order for the debt to level off by end-1980, the U.S.S.R. would have to increase its hard-currency exports by over 10 percent per annum, Poland by over 20 percent per annum, and the rest of Eastern Europe by about 8 percent per annum; the resulting stable debt levels would be about $27 billion, $20 billion, and $23 billion respectively.15 Since it seems certain that Eastern Europe's net hard-currency imports of raw materials and fuel will have to rise, any stabilization in the medium term would require both sharply reduced imports of Western capital goods and sharply increased exports of manufactures to the West.

V

The economic and foreign trade prospects of the East European countries vary considerably, just as their current debts, so the ability of each to cope with its hard-currency debt problem should be assessed individually. Yet we must recognize that developments in intra-CMEA relationships may affect each differently - and externally, debt servicing difficulties for any one would affect the credit standing of the others. The most important distinction, of course, is between the U.S.S.R. and the rest, and among the smaller countries, Poland stands out.

Recent terms-of-trade changes have substantially benefited the U.S.S.R. and Poland, as fuel and raw material exporters, and harmed the others. For example, Poland's terms of trade with the West rose 23 percent from 1970 to 1975, while Czechoslovakia's deteriorated by 11 percent from 1970 to 1974. Since intra-CMEA prices in general follow world market prices with a lag (now on a five-year moving average), this effect has operated within the bloc as well: thus Hungary experienced a 22 percent drop in its terms of trade on dollar-clearing markets in 1970-75 and a 12 percent drop on ruble-clearing markets.16 The countries with the proportionately largest hard-currency visible trade deficits have been Bulgaria, Poland, and Romania, but these countries have higher surpluses than the others on tourism (and Poland receives substantial emigrants' remittances, while Romania has some gold production).

Although we question the judgment of the Western banking community in these matters, the market's comparative credit ratings are interesting. The picture which emerges from interest rate spreads in the syndicated Eurocurrency loan market, from discount rates on commercial paper, and from discussions in banking circles is fairly consistent. The U.S.S.R. comes at the top; then Hungary, the G.D.R., and Czechoslovakia; then Bulgaria, with Romania and Poland deemed the poorest risks. Bulgaria would be thought at least as weak as Poland, but its extreme closeness to and dependence on the U.S.S.R. lead the market to believe that if the U.S.S.R. will support any country in financial trouble, Bulgaria is the prime candidate. Indeed, there is a widespread "assumption among lenders that Moscow would not allow any COMECON member to default or even reschedule, for economic, political, strategic and image reasons. . . ."17 This view has strongly influenced market interest rates, keeping them much closer together than the differences in economic circumstances between countries would apparently justify.

Bulgaria and Romania are the least developed and fastest growing East European countries. In the 1976-80 plans, the former projects net material product growth at 8 percent per annum, the latter at over 10 percent per annum. But Romania has substantial natural resources, and ever since its declaration of (limited) independence from the U.S.S.R. in the early 1960s, imports of machinery from the West have played a considerable role in its program of rapid industrialization. The share of its trade outside CMEA has been higher throughout the period than that of its partners, and the planning of this trade and its strategy have shown considerable foresight. There is some evidence of this in Romania's ability to cut imports from the West in 1975,18 while they continued to rise in all other East European countries except Hungary. Moreover, the ambitiousness of Romania's plans leaves room for some deceleration if necessary; its debt/export ratio is comparatively modest (although amortization on the earlier export credits from the West must now be running fairly high, and with it the debt service ratio); and its internal political situation is well controlled. On the other hand, Romania is the least likely to receive Soviet assistance should it encounter financial problems; moreover, the disastrous earthquake of March 1977 could reduce growth.

Bulgaria, by contrast, seems to have accumulated its very large debts almost haphazardly. Its hard-currency debt service ratio must by now be remarkably high. One can only conjecture that it intends to borrow as long and as much as it can to finance debt service and continued imports from the West, and to start worrying only if and when lenders do.19 There is certainly no evidence that it will or could mount any major hard-currency export drive.

The G.D.R.'s large debt would surely cause more concern among lenders if its citizens were not Germans. The country's reputation for sober, steady growth and production-mindedness is in fact not unjustified, and the special relationship with the F.R.G. has economic advantages, not least the interest-free "swing" credit facility for intra-German trade (now well over $1 billion). But demonstration effects in consumption are strongest here, too; Helsinki has had some effect, and there are recent signs of domestic political difficulties. Thus the economic pressures of worsening terms of trade and labor shortages leave the G.D.R. little room for maneuver in the face of a dangerously high debt/export ratio. The G.D.R. has also had to contribute increasing amounts of investment into Soviet raw material extraction, in return for future supplies. (Czechoslovakia and Hungary have also faced especially heavy demands on this account.)

Like Romania, Hungary has been borrowing to finance hard-currency imports for many years. But although its publicized Euromarket ventures have usually been identified with plant and equipment for specified projects, the borrowing has in fact been primarily for general balance-of-payments support. Hungary is very poor in raw materials and imports substantial quantities from the West; its agricultural exports have suffered from the barriers erected by the EEC's Common Agricultural Policy; and it has always had great difficulty in exporting manufactures for hard currency. Thus Hungary has not imported very large amounts of Western machinery. Since the introduction of the "New Economic Mechanism" in 1968, it has instead favored "industrial cooperation" agreements with Western firms, as a means of getting both new technology and guaranteed hard-currency export markets. The economic reforms appear to have brought some improvement in the underlying trend of the hard-currency balance of trade, but this was swamped by the deterioration of Hungary's terms of trade in 1974-75. The additional debt service burden accumulated since 1974 will now make it much harder to get back to a sustainable long-run equilibrium. But the planners at least have the advantage of dealing with a population fairly well satisfied with political, cultural and economic developments over the past decade and appreciative of their relative advantages. The eventual departure of Janos Kadar as First Secretary of the Hungarian Socialist Workers' Party, or any enforced turn away from the West into closer CMEA integration, however, might mean that efforts for long-run economic stabilization would encounter political resistance.

Czechoslovakia's debt to the West is not a cause for serious concern at present. The economy is not especially dynamic, but the planners have followed a correspondingly cautious foreign economic policy. It is nevertheless interesting to reflect that while in 1968 the proposal that Czechoslovakia should seek a $500 million Western loan was a provocation to the Soviet Union, the increase in Czechoslovakia's net hard-currency debt in 1975 was almost exactly this amount. That loan was to be used for Western machinery to reequip Czechoslovakian industry, but the 1975 borrowing was to cover the increased cost of raw materials and fuel.

The outstanding problematical case is of course Poland. Lenders belatedly realized this when the government's attempt to raise food prices in June 1976 miscarried, as urban workers again showed the strength of resistance which in similar circumstances forced the change of regime in December 1970. That a government which had originally come to power in this way could itself have acted so rashly indicates not merely political insensitivity, but more importantly, the seriousness of the underlying economic problems which motivated the proposed price increases. The economic strategy chosen in 1971-72 is clearly compromised, and with it Poland's ability to avert debt rescheduling at the end of the decade.

This strategy was a "dash for growth" based on heavy investment with Western equipment in both raw material exploitation (copper, sulphur, coal) and manufacturing, together with rapid growth of real wages (seven percent per annum) as an incentive to increase productivity. But despite the improvement in Poland's terms of trade, the planners were unable to maintain macroeconomic control, and the pressure on the economy proved excessive. At fixed consumer prices for food, with per capita money incomes growing at 12 percent per annum, consumption rose rapidly, and agricultural exports suffered; of a 32-million-ton increase in coal output from 1970 to 1975, only half went into increasing exports; and the hard-currency debt soared. The 1976-80 plan projects no growth in investment from the 1975 level and a three percent per annum growth in real wages, but both start on an excessively high base. Yet the scope for any further shift into exports is limited on both the supply and demand sides. The riots demonstrated the difficulty of restraining food consumption, and the urban housing shortage is probably the worst in Eastern Europe (so the planners were forced to allow 8 percent per annum growth in housing investment to 1980).

Poland's plan projects an 80 percent increase in total export volume from 1975 to 1980, with no increase in imports, but these targets seem highly implausible. Several of its main manufacturing exports to the West are "import sensitive" (clothing, furniture), and expansion of other manufactured exports cannot amount to much in the medium term, so the prospects to 1980 depend heavily on coal, copper, and sulphur. Domestic coal rationing was introduced in November 1976, but only a very large increase in the price of copper would offer any real hope that Poland might be able to meet its hard-currency debt repayment schedule at the end of the decade.

The U.S.S.R.'s debt is also now considerable, but so are Soviet fuel and raw material resources, gold production and reserves (estimated at 3,250 tons and valued at $13 billion at end-197620), and internal political control. The last is evidenced by the shift away from consumption growth back to heavy industry in the Tenth Five-Year Plan, belying those who saw in the 1971-75 Plan an irreversible shift of priorities toward consumers. Some of the existing debt derives from the harvest failures of 1972 and 1975 - yet predictions that these will be chronic have been followed by a record 1976 crop. Soviet hard-currency export earnings in the medium term will come primarily from oil, gas, timber, cotton, coal, copper, and armaments. I believe the U.S.S.R. will continue to borrow, as long as lenders allow, to finance Western machinery imports, and its capacity to service its debt cannot yet be doubted. The issue here is rather the leverage it derives from doubts about its will to do so and about its desire to maintain its hard-currency imports, the reduction of which would cause serious problems for some Western capital goods exporters, especially in West Germany.

VI

The common arguments which initially made lenders eager to accept East European business, and which they still use to bolster the market's confidence, appear extremely dubious in the light of the preceding discussion. The excellent repayment record of East European countries before the recent explosion of their debts can be viewed skeptically as merely a conscious, careful preparation for a major foray into Western credit markets - or at least as irrelevant to the totally transformed current situation.

Moreover, the fact that one is lending to an entire country, whose planners supposedly can at any time implement the resource shifts necessary to meet foreign obligations, is much less reassuring now that there is ample evidence of the severity of the constraints the planners face (and their own inability to foresee this, as in Poland).21 However, it is at least true that since their currencies are not convertible, the East European countries are invulnerable to foreign exchange reserve loss through speculation on their currencies and to involuntary exchange-rate changes.

And the technical management of the debt is of course much easier in a centrally planned economy, with completely centralized control over foreign exchange transactions and capital flows (disregarding some black market currency transactions). But even this has its peculiar problems. From what we can infer about the overall maturity structure from the pattern of borrowing, the recent heavy volume of five- to seven-year Euromarket loans will mature around 1980, overlapping closely with much of the somewhat earlier but longer-dated export credits. This would come at the end of a five-year plan period, when it is especially difficult for East European planners to cut down on investment and capital goods imports. It would be a bad time to encounter refinancing problems.

Next, there is the contention that no East European country could afford to miss any repayments, lest it thereby lose access to further Western credits. This appears weaker when one considers the contrary experience of various LDCs. Exporters want to continue exporting, and neither banks nor governments want to force default. If the banks can get a country to keep up interest payments provided they continuously "roll over" or even increase (cf. Zaïre) the principal, all they lose in the short run is the possible opportunity cost of being unable to redeploy the funds more profitably elsewhere, and they keep alive the possibility of repayment in the long run. There is no collateral on which they can foreclose. What might happen if the banks themselves faced a liquidity problem is of course a different story.

Possibly a stronger argument is that the U.S.S.R. would bail out any East European country in danger of sinking financially.22 It did step in to help Poland and Hungary after 1956, and again in Poland in 1971. But the numbers are so much larger now. In 1971, Poland got a $100-million loan for consumer goods imports, repayable in hard currency - this is now about two months' worth of interest payments on Poland's current debt (in inflated dollars, say three months)! And once the precedent was established for one country, others would queue up, unless the terms were seen to be onerous.

And if it is unlikely that additional credit would be completely cut off to a country forced to reschedule, a fortiori how plausible is it that the U.S.S.R. would fear its own access to credit might suffer seriously should another CMEA country fail to meet its commitments?23 The U.S.S.R. would presumably be sensitive to the political "loss of face" for the bloc as a whole if any socialist country were to signal economic weakness by rescheduling its debt. Yet, in the last analysis, the Soviet leaders might not be overly upset to see Poland, Hungary, Romania, or the G.D.R. forced to cut back drastically its trade with the West. To have external constraints curtail their independence and exposure to Western influence might suit the U.S.S.R. better than having to do the job itself.

It is also maintained that although we do not know precisely what the East European debt service ratios are, they cannot be as high as those of, say, Brazil and Mexico, which have not yet had to reschedule. Moreover, the East European debt figures include all debt, private and public, and therefore look misleadingly high in relation to many LDCs, for which some forms of commercial debt may not be reported. But the comparison with Brazil, a country of immense resources and great dynamism, or Mexico, whose currently estimated oil reserves are more than one-third those of the United States, is perhaps unhelpful - especially since several LDCs with much lower debt service ratios have had to reschedule.24 The only help here would be to match detailed debt service schedules over the next several years against equally detailed projections of hard-currency exports and imports. We simply do not have such data.

Surely 1974-76 has been an exceptional period, it is said. Harvests have been especially bad (in the U.S.S.R. in 1975 and in Poland throughout the period, among others) and the terms of trade have been especially unfavorable. It was difficult to reduce hard-currency imports in 1975, the last year of a five-year plan, and imports in 1976 reflect lags in capital goods deliveries, but cuts are undoubtedly coming.

Yet agricultural output over the whole period 1971-75 was below plan only in the U.S.S.R. and Romania. The terms of trade of the U.S.S.R. and Poland have actually improved considerably, and who in any case would predict with confidence that the adverse shift for the others will be reversed? Poland plans a tremendous export drive with little expansion of imports, but its realism is suspect; the more reliable Hungarians, for example, project a 60 percent rise in the volume of exports to non-socialist countries and a 40 percent rise in imports from them over this five-year plan, which would leave the hard-currency trade deficit in 1980 virtually unchanged from the 1975 level, in absolute terms. The OECD has projected a 1977 deficit of the same order of magnitude as the $10 billion in 1976,25 and as long as it remains possible to finance deficits of this size, it is unlikely that the trade gap will close rapidly over the next few years.

This suggests the demand for new credits will in fact continue. Will lenders supply them? Western governments show no sign whatsoever so far of cutting back the volume of their export credit guarantee support. And neither the events in Poland since June 1976 nor increasing public discussion of the East European debts have had any apparent effect on Euromarket bank lending. Total syndicated Eurocurrency credits to Eastern Europe were slightly up in 1976 over 1975 (from $2.3 billion to $2.4 billion). Meanwhile, interest rate spreads were generally falling during the year, as they were for the rest of the market.26

In the summer of 1976, a survey of the market observed: "Western bankers . . . in some cases seem to be tripping over each other in the rush to provide [money] - at rates and conditions highly favorable to the borrowers . . . one keeps hearing that these borrowers must fall into line and provide potential lenders much more information. Yet for all the caveats. . . . there remains a distinct atmosphere of euphoria surrounding this business of lending to the Communists."27 By early 1977, the brief concern caused by Poland's problems had apparently passed, relieved by the slight reduction in 1976 of Eastern Europe's hard-currency trade deficit and "a degree of familiarity and trust" between the Western banking community and COMECON.28

The banks occasionally congratulate themselves on obtaining, for a placing memorandum, more information than previously about the borrower's balance of payments and overall economic situation. But they still have much less information on debt structure than they would require of any LDC.29 They also have sought to tie loans to the financing of particular projects. But the project-lending approach ignores the internal transferability of resources. Especially in a centrally planned economy, there can be no effective distinction between "project" and "program" lending. There is only one borrower, only one project: the plan. To believe otherwise betrays a basic misunderstanding of how such economies operate.

Finally, it is suggested that industrial cooperation agreements and product repayment (buyback) arrangements ensure that exportable output really will be available to pay off loans. This too, however, is a "project loan" approach - and its converse would be that a substantial part of the most saleable output these economies will produce is already mortgaged, for practical purposes, to meet high-priority obligations. If this represents as much as 20 percent of the loans outstanding, as some estimates suggest, what will be used to repay the remainder, in particular the unsecured Eurocurrency loans? As for true East-West industrial cooperation, its expansion to any substantial scale faces severe institutional constraints.

In sum, East European hard-currency deficits must be met by some combination of adjustment and financing. The adjustment in trade required merely to stabilize the debt in the medium term seems so great as to be unlikely, except perhaps for the U.S.S.R. It would require some combination of an improvement in Eastern Europe's terms of trade, reduction in the volume of their hard-currency imports, and increase in the volume of their hard-currency exports. A significant reduction in the volume of imports would be painful and perhaps politically dangerous in the short run (if in raw materials, industrial consumer goods, or food) or economically harmful in the long run (if in machinery and equipment). On the export side, the West might be willing to take more raw materials, if they were available, but taking more manufactures would require conscious policy initiatives by Western governments against strong domestic resistance. Even then, it is not clear how much Eastern Europe could expand its supply of manufactured goods saleable at any price in the West.

The latest International Economic Report of the President (1977) sums up the situation as follows:

. . . It is evident that continuing expansion of debt cannot indefinitely finance a continuous increase in Communist country imports from the West. At some point, Communist country exports to the West must increase so significantly as to achieve greater balance in East-West trade. . . .

[But] although some success in expanding exports is likely, it seems doubtful that increases achieved will be sufficient to close the trade gap with the West in the next few years. (p. 65)

"At some point," "doubtful . . . in the next few years" - clearly the Report is suggesting that further finance will be needed. So far we can observe no constraints on the expansion of Euromarket finance. Yet without institutional developments, can we really suppose that sufficient credit will be forthcoming to finance an increase of the debt by, say, $25-$40 billion to end-1980? Would this be possible without substantial government involvement in guaranteeing commercial bank loans and in direct export financing, and would it be prudent without some international coordination, perhaps the involvement of international organizations? But could Western governments or international organizations deal with financing East European deficits in the same framework as with LDC deficits? And would overt policy initiatives harm market confidence? We cannot simply continue to ignore the debt, supposing that it will go away as quietly and rapidly as it has accumulated. We have clearly left it to the bankers for too long already.

It is unlikely that any East European country will find it impossible to borrow more in the immediate future. But unless some progress is made in reducing the overall reliance on commercial banks for financing balance-of-payments deficits, limits may be approached fairly soon. As was remarked in World Financial Markets last October, there clearly is some "danger that the current buildup of international bank credit may be followed in the next two or three years by a sharp contraction, whether because of a revival of domestic loan demand in major industrial countries, or an undue response to creditworthiness considerations." Such developments might force debt rescheduling exercises not only for a number of LDCs, but also for one or more East European countries.30

The roles of creditor governments, banks, and the IMF in past debt rescheduling operations have been complex. As Andrew Shonfield put it, the overriding consideration has been the "desire to prevent poor nations facing a crisis of external debt from dropping out of the international system altogether. . . . It is the symbolic effect of debt repudiation which is most feared. . . . Creditors do not want the conventions governing the international borrowing system to be too blatantly disturbed."31 Creditors expect a domino effect if they force one country into default, and they are in a fundamentally weak position, because the sanctions available to them are limited. The threat of an embargo is unconvincing, because debtors know that minor creditors, with little to lose, will be happy to resume selling (or lending) to them.

Thus, whether the major creditors are government export credit agencies or private banks, they have usually been willing to reschedule on relatively accommodating terms provided the IMF was called in, prescribed a "stabilization plan," and supervised its implementation. This sort of arrangement is no panacea, though - the IMF tends to impose severely deflationary policies, which debtor governments may find politically intolerable; and, unguaranteed bank credits (specifically, Eurocurrency loans) come at the end of the queue, while there are obvious limits on how far the IMF can act on behalf of private interests (cf. Argentina, Zaïre). On the other hand, when banks themselves tried to supervise stabilization policies in Peru, both they and the government found the situation politically untenable.

If the problems of recycling do become more severe, we might see a greater role developing for the IMF, or for governments or central banks through the EEC, OECD, or BIS, but how would this apply to Eastern Europe? And if the debt of an East European country were to reach unmanageable proportions, how can we envisage the complicated politics of debt working itself out? What leverage would Western creditors have over East European debtors, and what broader problems would be raised by any attempt to exert such leverage? Only Romania actually belongs to the IMF (even so, its balance-of-payments statistics are not published). Can we envisage Fund missions to Warsaw, Budapest, and Sofia, prescribing stabilization plans? And where would the Euromarket banks be then? Again, the context is clearly different for Eastern Europe than for the LDCs.

VII

The East European debt to the West has created a new dimension of East-West interdependence. The policy of détente was of course designed to create interdependence, a "web of mutual interaction" which would constrain both sides and have both economic and political advantages. The straightforward economic advantage was the potential gains from increased trade. The trade would also carry technology, and Eastern Europe would become dependent on both - at the cost to the West of helping them to grow faster, and possibly reducing internal pressures on them to divert resources from military uses. The dependence could not easily be broken because technology transfer is a long-term process, and it would create a framework for "penetration" and "linkage."

Dependence on trade with the West would bring political and cultural influence, and both political and economic stimuli for decentralizing "economic reforms," moving perhaps toward "convergence" of the two systems. More foreign trade itself, as well as diffusion of the imported technology, would require more flexibility in the system, and consumerism and further industrialization would lead to political relaxation.

"Linkage," on the other hand, referred in this context to the explicit, step-by-step use of this economic dependence as a bargaining counter for political concessions. It was always recognized, of course, that the outcome would not merely be the dependence of East on West, but interdependence. The main focus here, however, was potential Western dependence on East European raw material supplies. There was no detailed analysis of how a growing Eastern debt would affect either side.

Many of the issues associated with détente and East-West interdependence are reflected in the existing debt, the forces which generated it, and those now tending to increase it further. No matter how skeptical our current evaluation of the wider effects of economic interdependence, the debt itself now has a role of its own, however, separate from these forces. Economists distinguish between stocks and flows: although stocks are created by flows over time, once in existence stocks affect behavior independently. The current stock of debt is a striking contrast with the position of a decade ago, and one cannot help but believe that Western policymakers have regarded the process which generated it as easily reversible. But it is not so easy to reverse flows, and it is even harder, slower and more costly to liquidate stocks.

It is to be hoped that the process of gaining control of the debt, on both sides, will be more carefully monitored than its original development. It may be that the problem was simply lost from sight in the aftermath of the oil price increase, when the major concerns became the broader problems of recycling, the solvency of LDCs and some advanced countries (especially Italy and the United Kingdom), and the overall stability of international capital markets and the international monetary system. In any event its relative importance has plainly increased, and it is important to consider various aspects of the dependence it creates, for each side upon the other.

For the East European countries, policies toward the debt are constrained by their perceived dependence on imports from the West of commodities and technology. Given this, their debt levels and service obligations limit their feasible trade and production choices. How dependent they actually are on technology imports is a matter of considerable Western debate. Some argue that the measured payoff to such imports is so high that they have or will become virtually indispensable to Eastern Europe. Others suggest that even for oil and gas development in the U.S.S.R., for example, Western help is not essential (although exploitation will be somewhat slower without Western credits), and that the Soviet Union will never allow itself to become dependent on Western help. A third view (possibly consistent with either of the others) is that if a growth strategy based on imported technology succeeds and the East European countries begin to diffuse new technology and generate their own, they will become able to do without further imports; whereas if it fails, they will be unable to repay the debt.

The debt may also act as a centripetal force in CMEA. Paradoxically, if the pressures of meeting debt service obligations require East European countries to cut back on all but essential Western imports, they may thus motivate greater reliance on each other (compare the "inward" turning of West European payment union members faced by the "dollar shortage" of the early postwar period). This may also push the smaller countries into more dependence on the U.S.S.R. I conclude that centripetal forces in CMEA will be very strong indeed over the next decade, partly because the debt will limit hard-currency import capacity. Whereas some saw East-West trade as a means of separating the smaller East European countries from the U.S.S.R., the accumulation of debt (or alternatively, Western unwillingness to buy enough of Eastern Europe's exports) has now made this unlikely. Indeed, our lending may have indirectly financed investment by the other countries in Soviet raw material extraction.

Next, the debt acts as a mechanism for transmission of cyclical fluctuations from West to East. Both interest rates payable (on a substantial part of existing debt, as well as new loans) and the availability of refinancing credits will be affected by business conditions in Western countries. East European import capacities will be more tightly constrained by export demand. And by increasing Eastern Europe's vulnerability, the debt makes any move toward convertibility of their currencies (or of the transferable ruble) even more unlikely than it would otherwise have been.

Finally, Eastern Europe's debt repayment obligations will, if honored, severely constrain the geographical pattern of their exports of raw materials and higher-quality industrial goods over many years to come. For these are the goods capable of earning hard currency, and substantial quantities will have to be sent to non-socialist markets.

For the West, the creditor's fear of default is the chief source of dependence through debt. This is most obvious for the private banks which have made uninsured loans. They have "long since passed the point at which they could have cut their losses" and are "likely to make every effort to continue to lend in order to protect the loans they have previously made."32 This in turn creates some leverage for East European debtors with Western policymakers, whom the banks will seek to influence, and who in any case must be concerned with the effects on international financial markets of any large-scale East European default. There is indeed the danger that governments might go very far in supporting private sector interests: one commentator now highly placed has predicted that ". . . the U.S. government will be called upon to negotiate, to guarantee, and, to some extent, to protect the various arrangements that have been contrived even by private business."33

What governmental role would this imply in a rescheduling operation, where heretofore governments generally have not supported the interests of their banks? Governments may face the policy choice between rescuing overexposed banks and giving direct loan assistance to debtor countries. Banking regulatory authorities would favor the former, and they would limit themselves to protecting depositors, so that the banks would actually take some losses on their bad loans. Governments might see foreign policy advantages in the latter (compare American treatment of Romania and PL 480 assistance to Poland), and the big banks would lobby for it. But domestic political counter-pressures would surely be strong - "Poland but not New York City?"

The debt itself has seriously weakened governmental control over Western lending policy, given the motives of the Euromarket creditor banks and the great difficulty of enforcing any controls over the Euromarket. Whereas government policies concerning export credit guarantees and direct lending can in principle be controlled, if the Euromarket banks feel they must in consequence lend more in order to safeguard their existing loans, it will be very difficult indeed to stop them.

Finally, a different form of dependence will emerge in trade negotiations. The creditor is in the embarrassing position of appearing to hinder the debtor in his efforts to repay, should the former wish to restrict imports from the latter. This was of course one aspect of the "transfer problem" in the interwar period.

There are strong political and economic forces against Western coordination of policies toward the interdependence created by the debt, and the institutional obstacles are also formidable. The competitive desires for capital goods markets, raw material supplies, and political influence impede the development of any common trade or credit policies, and even the simple exchange of information. A year ago, Henry Kissinger warned that Eastern Europe might "play off the industrial democracies against each other."34 But their intervention is hardly necessary. France, for example, observing that the Congress has already limited Eximbank support for exports to Eastern Europe, sees a "sour grapes" reaction in any American initiative which might be interpreted as seeking a more restrictive overall Western policy. At an OECD meeting in October 1976 which discussed the debt, France simply denied there was any problem, implying that the exercise was part of a scheme to take some of its capital goods export markets. And interests differ: West Germany, although certainly concerned to maintain its capital goods exports to the East, has also consistently sought to extract political concessions as a quid pro quo.

Because of just such differences, the Berne Convention on maximum maturities for export credits (which covered loans to Eastern Europe), adopted in the late 1950s by most of the major exporters, had broken down completely by the mid-1960s. In June 1976, however, the seven largest exporting countries announced a one-year trial period for a "gentlemen's agreement" setting basic minimum terms for loans to all countries, including Eastern Europe; but by December 1976, the United Kingdom announced a major prospective deal with Poland offering "very favourable financial terms" in a framework which appears effectively to avoid the guidelines.35

As I have already stressed, the absence of information on the maturity and interest rate structures of East European countries' debts has hindered the development of government and private sector policies toward individual countries. The Berne Union (International Union of Credit and Investment Insurers) has just begun to seek information on maturity structures from its members, as has the OECD Export Credit Group, and the BIS has similarly begun to work through central banks in major countries to get their commercial banks to give a maturity breakdown of positions with Eastern Europe. But there is some (unknown) degree of overlap of coverage, which will be very difficult to sort out; and each set of data will inevitably be incomplete.

Would lenders not be far better off if they were to require this information from East European borrowers themselves? This ought to be enforceable by agreement among the major Euromarket banks (possibly under instructions from their regulatory authorities, guided by the BIS) and the Berne Union members. It is not punitive or discriminatory, since it would be demanding no more than any LDC gives to the World Bank/IMF. "Basket Two" of the Helsinki Agreement stipulates freer flows of economic and commercial information, and this is just the sort of thing that socialist planners ought to expect capitalist lenders to want to know. It would certainly become necessary in any eventual rescheduling operation.

But this is a fairly trivial policy recommendation, remarkable only because it was not implemented long ago. The question of what to do with the information if and when it becomes available is a different matter. Given the existing data, the preceding analysis suggests there is a significant probability that at least Poland, and perhaps other East European countries, will have to reschedule their hard-currency debts around 1980. If business conditions and import demand do pick up in the West, then Euromarket lending will become much tighter - if not, East European hard-currency exports to the West on the scale necessary to keep the debt manageable would encounter stiff market resistance, while an enforced drastic cutback of their imports from the West would seriously hurt both sides.

The implications are unpleasant. IMF surveillance over a stabilization program it might prescribe for Poland is difficult to envisage. But then how would rescheduling be supervised? That an East European debtor would be terribly concerned about the unsecured loans of Euromarket banks if it were forced to reschedule seems unlikely, unless Western governments were to intervene on behalf of their banks, which seems undesirable; but the consequences of default for the Euromarket would be grave.

If better data do confirm the picture outlined here, there would appear to be just two alternative policies for avoiding a nasty turn in our creditor relationship with Eastern Europe. One would be to accept a fairly rapid growth of the debt and to coordinate its financing much more actively. This might be done through international organizations, i.e., direct intervention into the recycling process. Or with a sensitive market problem of this kind, private sector coordination might be less hazardous than open governmental activity - the Euromarket banks themselves could cooperate directly, not only in sharing information, but also in setting aggregate country lending limits (as in oil allocations by the companies in 1973-74). Whether the banks would be capable of taking such an initiative before serious trouble arises, and whether Western governments would like the outcome, are open questions (so too is whether American international antitrust policy would permit such collaboration).

Alternatively, the West could adopt a policy for keeping the debt down by operating on trade flows. This might entail an agreement by major surplus countries to buy, in the framework of intercountry negotiations, much more of the manufactured goods which Eastern Europe has so far been unable to sell in the West; or to finance the export of these goods to selected LDCs.

In any case, a range of choice will arise for the West between its economic relations with Eastern Europe and with the LDCs - the two areas will to some extent compete for our markets and our financial support. There is of course a fourth actor, OPEC, and Eastern Europe could limit its hard-currency debt to the West (probably at the expense of the non-oil LDCs) by direct borrowing from OPEC and direct export sales to OPEC. There are already significant examples (e.g., partial financing of the Adria pipeline by Kuwait), but the amounts are so far relatively small. Substantial increases in such government-to-government lending would give yet a further geopolitical dimension to the problem of East European debt.

VIII

To recapitulate, we have identified some issues associated with the debt which require further analysis to provide necessary background for our overall policies toward Eastern Europe; some on which contingency planning ought to begin; and some on which action can and should be taken now. In the first category are the potential impact of the debt in reinforcing centripetal tendencies in CMEA in the medium term and the likely effects on East European economies and internal political conditions of financing problems, if they do arise. Here also, we need wide-ranging study of alternative future roles for Eastern Europe in an international monetary system from which it is no longer fully isolated. Policy planners must consider the implications of relating international agencies like the IMF to the broader economic and political problems of East-West interaction.

In the second category, prudent foresight suggests that we should begin now to consider how we would respond to any East European request for debt relief which might follow the negotiation of such arrangements for the LDCs. Indeed, this possibility should be taken into account in formulating our attitudes toward the LDCs' requests. Western central banks, bank regulatory authorities, and finance ministries should also explore various lines of approach to rescheduling the debts of an East European country or coping with the consequences of a default. Should such an eventuality arise, we may have less advance warning than for countries on which we have more debt servicing data.

Immediate action can be taken in several areas. First, on information gathering and sharing, current efforts in the lending countries should be supplemented by stronger and more coordinated attempts to require more from East European borrowers, under the rubric of Basket Two of the Helsinki Agreement. Second, attempts to coordinate export credit policies toward Eastern Europe should be reinforced, focusing perhaps on the EEC as a first step, if suspicion of American motives undercuts OECD activities along this line.

Third, the major Western industrial countries must be brought to realize that Eastern Europe will only be able to cope with its hard-currency debt by selling more manufactured goods in the West. Pressures for more protection must be resisted and, at a minimum, the remaining trade discrimination against Eastern Europe should be eliminated. (Officials responsible for implementing anti-dumping legislation should be better instructed in the ambiguities of pricing and "costs" in economies without market prices or meaningful exchange rates for their currencies.) Fourth, whether or not overall controls over the volume of Euromarket lending are deemed necessary, surely we must find some way of setting aggregate limits for East European countries which are related to their economic capabilities and governmental policies.

Finally, we should seek to bring the East European countries themselves as active participants into the current discussions of how the international monetary system will handle the increasing volume of debt. The interdependence created by the East European debt to the West requires cooperative as well as unilateral action.

Footnotes

1 World Financial Markets, January 1977.

2 Bank for International Settlements (BIS) Press Release, January 1977.

3 J. Russell, Energy as a Factor in Soviet Foreign Policy, London: Saxon House for The Royal Institute of International Affairs, 1976.

4 Based on CMEA statistics of visible trade; see Deutsches Institut für Wirtschaftsforschung, Economic Bulletin, November 1976.

5 An American banker is quoted as saying, "They may or may not be Communists, but they're damn good professional bankers." Institutional Investor, July 1976, p. 47. Both clauses are accurate.

6 At the end of 1974, Congress curtailed further involvement by the Export-Import Bank, which had been growing rapidly since mid-1972. For background and details, see P. Marer, ed., U.S. Financing of East-West Trade, Bloomington, Ind.: International Development Research Center, 1975.

7 More detailed data may be obtained from the author on request.

8 Some of the earlier Eurocurrency credits had maturities of 10 or 12 years, but there have been none of these since 1974, and indeed after 1974 there has been only a single $50-million loan of maturity over seven years.

9 See footnote 6.

11 F. Holzman, "A Theory of the Persistent Convertible Currency Shortages of Centrally Planned Economies," mimeo, 1976.

12 See R. Portes, "Hungary: Economic Performance, Policy, and Prospects," in East European Economies Post-Helsinki, a compendium of papers prepared for the Joint Economic Committee, 95th Cong., 1st Sess., Washington: GPO, 1977.

13 Deutches Institut für Wirtschaftsforschung, op. cit., footnote 4.

14 For example, the United Kingdom negotiated a comprehensive agreement with all the East European countries to raise the prices of suits they export, after the Department of Trade found evidence of "dumping." Financial Times, March 4, 1977. Clothing accounted for over 6 percent of U.K. imports from Eastern Europe in 1975. The history of this case and the full range of methods used by Western countries to restrict imports from Eastern Europe are discussed by K. Taylor, "Import Protection and East-West Trade," in East European Economies Post-Helsinki, op. cit., footnote 12.

15 At a January 1977 meeting of representatives of major banks doing East European business, their mean forecasts for end-1980 were $24 billion, $15 billion, and $21 billion respectively - uniformly lower than the outcome of the apparently "optimistic" hypothesis in the text! Either they haven't done their sums properly, or they are implicitly saying that any realistic projected accumulation of the debt could not be financed without excessively straining the present system.

16 The figures for Poland and Czechoslovakia are from Deutsches Institut für Wirtschaftsforschung, op. cit. footnote 4, and for Hungary from Portes, op. cit. footnote 12.

17 Institutional Investor, July 1976, p. 48.

18 Romania's export credit obligations were virtually unchanged from end-March 1973 to end-1975, indicating a sharp reduction in machinery imports from the West, and its net Eurocurrency liabilities (almost all of which are short-term) actually fell from end-1974 to end-September 1976; effectively, its entire debt increase in 1975 came in loans from the IMF and the World Bank.

19 In November 1976, a Bulgarian borrowing of $100 m. was "heavily oversubscribed." East-West Markets, November 15, 1976.

20 East-West Markets, January 10, 1977.

21 Yet D. Lascelles, in the Financial Times, February 23, 1977, reports "a growing feeling [in the Euromarket] that normal criteria of debt and debt service need not necessarily apply to tightly controlled and centrally planned economies."

22 The market can go to quite absurd lengths in its tendency to view the East European countries as joint borrowers, as for example in the rumors that the $200-million Czechoslovakian borrowing in 1976 was really taken on behalf of the U.S.S.R.

23 The banks would undoubtedly charge it higher interest rates, but judging by recent experience with countries which have themselves had to reschedule, the increase in "spread" would be relatively small.

24 By end-1975, Poland's debt exceeded the total (public plus private sector) debt of Argentina ($7.3 billion), Chile ($5.2 billion) and Peru ($4.5 billion), for example. World Financial Markets, September 1976.

25 OECD Outlook, December 1976.

26 In December 1976, Hungary obtained a spread of 1.125 percent over LIBOR on a $150 million 5-year loan, terms as good as those given Venezuela (which has oil and little debt).

27 Institutional Investor, July 1976, p. 44.

28 Financial Times, February 23, 1977.

29 Colorful examples abound: (1) When asked whether he could give "a more exact figure" for Poland's debt than between $6 and $9 billion, the President of the Foreign Trade Bank replied, "I cannot. Figures of indebtedness are not published; nor are figures of reserves." Euromoney, Jan. 1977, p. 33. (2) A Hungarian central banker maintains, "We give so much information that our partners [the banks] are always satisfied." Ibid., p. 14. But this tells us more about the banks than about Hungary's foreign payments position. We have no hard-currency balance of payments, a total for "international reserves" but no breakdown, and no information on the maturity structure or service payments for either export credits or the 75 percent of Hungary's Eurocurrency credits which are not publicly announced. (3) The Director of the Soviet Foreign Trade Bank recently said, "The debt figure [for the U.S.S.R.] you mention of $13 billion is too high, exorbitantly high," Euromoney, March 1977, p. 50, but he provided no alternative figures. However, an unpublished estimate by Moscow Narodny Bank (London) in February 1977 shows even higher debt figures for the U.S.S.R. than those suggested in Table I above - "net debt" at end-1975 of $10.7 billion, increasing by a further $2.8 billion to end-September 1976.

30 North Korea did default (or reschedule-its intentions are still unclear) in early 1976, but its experience has no more relation to Eastern Europe than that of any other debtor country.

32 M. Campbell and D. Lascelles, Financial Times, July 29, 1976.

33 Z. Brzezinski, "America in a Hostile World," Foreign Policy, Summer 1976, p. 80.

34 Statement to OECD, June 21, 1976.

35 Times (London), December 17, 1976.

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  • Richard Portes is Professor of Economics at Birkbeck College, University of London, and will be a Visiting Professor at Harvard in 1977-78, on a Guggenheim Fellowship.
  • More By Richard Portes