Eastern Europe: Squeezing out of Debt

EASTERN EUROPE: _______ SQUEEZING OUT OF DEBT MarkJ. Ellyne he six Eastern European countries of the Council for Mutual Economic Assistance (cmea) acquired $65 billion of gross debt during the 1970s. In 1980, however, a severe credit crunch began. In 1981, Poland virtually defaulted on its debt and Romania later followed suit. At that time, Hungary and the German Democratic Republic (gdr) looked as if they, too, might do the same. But now in 1985, Western bankers are again looking optimistically at Eastern Europe—because of stronger underlying fundamentals, or the dismal prospects elsewhere? Meanwhile , the Eastern European countries are under additional pressure from the Soviet Union to raise the quality and quantity of their exports to the Soviet Union. Since the raising of Soviet energy prices in 1975, the six Eastern European cmea1 members (ee-Síx) have suffered a rising trade deficit with the Soviet Union that they are under pressure to rectify. Eastern European borrowing is particularly interesting because of Eastern Europe's different political and economic system, and because of its political importance to the Soviet Union. What led to this credit crunch? Are the debt burdens of Eastern Europe as severe as this of major borrowers in lesser developed countries (ldcs)? How do their trade 1. The six East European CMEA members (ee-Síx) include Bulgaria, Czechoslovakia, the German Democratic Republic (GDR), Hungary, Poland, and Romania. This group and the Soviet Union are referred to as the CMEA in the context of this paper, but the organization also includes Cuba, Mongolia, and Vietnam. Mark Ellyne is a Ph.D. candidate at SAIS. Some ideas expressed in this paper have been previously published by the author in "East European Debt: A Two Sided Squeeze," DRI European Review, January 1985. 173 174 SAIS REVIEW deficits with the Soviet Union and their Western debt affect their economies? Eastern European debt originated from the rapid expansion of East-West trade at the beginning of the 1970s (see Table 1). This trade expansion emerged from the European détente of the late 1960s, initiated by the Federal Republic of Germany (frg) and followed by the U.S. détente of the early 1970s, combined with Eastern Europe's own strategy of "import-led growth." From a reasonably balanced trade sector in 1970, growing trade deficits reached unprecedented levels for Poland and the Soviet Union in 1975 and caused a five-fold rise in the net cmea debt from $5.5 billion in 1971 to $26 billion in 1975 (see Table 2). Eastern European merchandise trade deficits declined after 1975, and a substantial Soviet surplus in 1980 and 1981 gave the aggregate cmea trade balance a small surplus in 1981. Neverthless, hard currency debt rapidly continued to accumulate, reaching a peak of $86.4 billion in 1981. Why did each of these "planned economies" initiate a policy of trade deficits with the West? The buildup of foreign debt can be explained by the centrally planned economies' (cpes) response to their fear of a systemic domestic economic slowdown as in the late 1950s and early 1960s. The slowdown was caused by a number of factors. First, the cmea countries appeared to EASTERN EUROPE: SQUEEZING OUT OF DEBT 175 be running out of sources of"extensive growth" such as capital and labor. They chose a new strategy of "intensive growth," which meant raising labor productivity. Initially, this intensive growth was to be accomplished by instituting significant economic reform. A major wave of economic reform was initiated by most of the cmea countries during the period from 1964 to 1970. But the reforms met with resistance and were never fully implemented. In the early 1970s a new solution emerged: New technology would be imported from the West, thus modernizing industry and raising productivity. The search for hard currency to finance Western imports began. Between 1970 and 1980 the cmea countries ran substantial current account deficits with the West. Western governments were anxious to promote exports, Western banks were flush with money to lend, and East European countries were thought to be under the Soviet Union's "credit umbrella." Financing these deficits or refinancing the debt repayments did not seem to present a problem...