Former Soviet Union: Creditworthiness of Successor States and U.S. Export Credit Guarantees
Released: 1995-03-24T00:00:00

Letter

Introduction

Two Department of Agriculture (USDA) programs—the Office of the General Sales Manager (GSM)-102 and GSM-103 export credit guarantee programs—are intended to promote the export of U.S. agricultural commodities. The programs’ goals—under the 1990 Food, Agriculture, Conservation, and Trade Act, also known as the 1990 Farm Bill—are to develop, expand, or maintain U.S. agricultural markets overseas by facilitating commercial export sales of U.S. agricultural commodities.However, the statute also provides that the Secretary of Agriculture may not issue credit guarantees in connection with sales of agricultural commodities to any country that the Secretary determines cannot adequately service the debt associated with such sale. The law also prohibits issuing the credit guarantees for foreign aid, foreign policy, or debt-rescheduling purposes.

More than $16 billion in export credit guarantees were provided by the GSM-102/103 programs during fiscal years (FY) 1990 through 1992. The former Soviet Union (FSU) and two of its successor states, Russia and Ukraine, received 43 percent of the guarantees that were made available in fiscal year 1992. During fiscal year 1991 and fiscal year 1992, the FSU obtained more GSM credit guarantees than any other country in the world.

In deciding whether to extend GSM export credit guarantees to any country, USDA considers the prospects for developing and maintaining U.S. markets in that country, on the basis of our review of USDA documents and interviews with agency officials. Before providing guarantees, USDA also assesses the country’s overall creditworthiness. Creditworthiness, in the context of this report, concerns a country’s ability and willingness to service or make timely payments on its current and future foreign debt obligations.

Assessing the creditworthiness of nations generally involves a technical analysis of economic and financial indicators of the risk of nonpayment due to insufficient foreign currency and the likelihood that political or other nonfinancial events may disrupt payments. Some of the factors that affect creditworthiness are a country’s level of indebtedness relative to its economic and financial resources, the ability of the country’s government to effectively manage the domestic economy, and the general economic and political situation in the country. Creditworthiness also involves temporal considerations. For example, some debtors may be judged not creditworthy over the short run due to a lack of readily available foreign exchange but may be considered capable of servicing their debts if additional time is allowed for them to organize and marshal their resources.

GSM Export Credit Guarantee Programs

The Department of Agriculture’s GSM-102 and GSM-103 programs are aimed at facilitating the export of U.S. agricultural commodities to developing countries and middle-income countries with hard currency shortages. They are intended to help importing nations make a transition from concessional financing to cash purchases, as well as to maintain import levels during periods of financial difficulties.

Under the two programs, the U.S. government agrees to pay U.S. exporters or their assignees—U.S. banks or U.S. subsidiaries of foreign banks—in the event that a foreign buyer defaults on its loan obligation. By reducing the risk involved in selling U.S. agricultural products, USDA encourages exporters to explore new foreign market opportunities.

The USDA’s Commodity Credit Corporation (CCC), which administers the GSM programs, attempts to share some of the credit risk with the exporter or the exporter’s assignee (a bank or other financial institution). It does so usually by guaranteeing 98 percent of the value of the sale plus a portion of the interest payable. The exporter or the exporter’s assignee is at risk for 2 percent of the principal and a portion of the interest payable. However, CCC has flexibility to adjust the amount of guarantee coverage it provides. USDA considers the GSM programs to be fully “commercial” in that they assist sales that are made by the private sector, and the interest rates are at “prevailing market levels.” However, there is an important element of concessionality in the programs because recipient countries could not make the purchases without credit and loan guarantees. Furthermore, if the countries were able to obtain financing on commercial markets, they would have to pay a premium above the rates that they obtain from the GSM programs, since a U.S. government guarantee reduces the risk to the lender.

Debt-Servicing Requirements and Possible Budgetary Impacts

Section 202(f) of the 1990 Food, Agriculture, Conservation, and Trade Act prohibits the Secretary of Agriculture from issuing export credit guarantees in connection with sales of agricultural commodities to any country that the Secretary determines cannot adequately service the debt associated with such a sale. The provision was established in response to a situation that developed in the late 1980s and early 1990 when creditworthiness considerations were minimized for foreign policy objectives in order to provide Iraq with GSM export credit guarantees. Following the allied response to Iraq’s invasion of Kuwait in 1990, Iraq defaulted on outstanding guaranteed GSM loans. As of August 17, 1994, CCC had received claims from 10 banks regarding Iraq’s defaults. These claims totaled about $2.2 billion, and CCC had paid claims to nine of these banks, totaling $1.7 billion.

Section 202 (f) requires USDA to determine whether a country is capable of servicing the debt that would result from providing export credit guarantees for agricultural commodities. If a determination is negative, the provision prohibits USDA from making credit guarantees available to that country. USDA advised us that before making any loan guarantee commitments, it assesses the creditworthiness of intended recipients of guaranteed sales and uses the information in deciding whether to provide guarantees to specific countries.

In contrast to a direct loan, a credit guarantee does not involve dollar outlays to either the lender or the borrower when the loan is made. Nonetheless, budgetary outlays are required for loan guarantees when defaults occur and claims are made. To better account for the costs of federal credit programs, the Federal Credit Reform Act of 1990 required, beginning with fiscal year 1992, that the President’s budget reflect the costs of the loan guarantee programs. To this end, new loan guarantee commitments can be undertaken only if appropriations of budget authority are made to cover their costs, including estimated payments by the government to cover defaults and delinquencies.

The act exempted all then-existing CCC credit guarantee programs from the appropriations requirement. However, CCC advised us that it is establishing what it calls an “allowance reserve” to cover its estimate of possible defaults on GSM loans. As of June 30, 1992, CCC had approximately $9.04 billion outstanding in GSM-102 and 103 guarantees on loan principal and $4.51 billion in accounts receivable from loan guarantee payouts on delinquent GSM-102 and 103 guaranteed loans. In a December 1992 report, we estimated the cumulative costs of the programs at about $6.5 billion, or 48 percent of the total $13.55 billion, if the programs had been terminated on June 30, 1992.

Foreign Policy Considerations

In the past, decisions to provide GSM loan guarantees to countries were influenced by foreign policy considerations. Principal recipients of guarantees were often countries that had significant foreign policy relationships with the United States. However, the 1990 Farm Bill stipulated that GSM export credit guarantees could not be used for foreign aid, foreign policy, or debt-rescheduling purposes. So, for example, if the Secretary of Agriculture determines under the debt-servicing requirement that a country cannot adequately service the debt that would arise from receiving agricultural export credit guarantees, no credits are to be extended—even if the president believes that such an extension would be in the national interest.

Despite the problems that arose from the Iraqi loan guarantees, as cited earlier, many Members of Congress have expressed the view that GSM credit guarantee decisions should take account of foreign policy and national interest considerations. For example, in May 1991 the Senate approved a nonbinding resolution (S. Res. 117) recommending that the administration extend another $1.5 billion in agricultural credit guarantees to the Soviet Union—assuming the administration found the country could service the debt—if certain foreign policy objectives would also be realized.

In 1991, attempts were made to provide more flexibility in granting export credit guarantees; amendments to the 1990 Farm Bill were proposed that would have allowed the president to provide guarantees when he believes they are in the national interest, regardless of the debt-servicing requirement and foreign aid/policy restrictions. However, these amendments were subsequently withdrawn. Similarly, the administration’s 1992 bill for authorizing assistance to the former Soviet republicsincluded a provision allowing the Secretary of Agriculture to take into account major economic reforms underway in those states in making a determination about the ability of the states to repay debt associated with GSM sales. However, this provision was struck from the bill that Congress passed in October 1992.

USDA officials told us that although the 1990 Farm Bill prohibits the Secretary of Agriculture from issuing export credit guarantees for foreign aid or foreign policy purposes, the law does not mean that such assistance cannot simultaneously serve foreign policy objectives. They noted that during congressional hearings held in late 1991 and in related briefings provided by USDA to congressional staff, the principal congressional focus with regard to agricultural credit guarantees was on keeping U.S. food moving to the FSU rather than on the risks associated with providing the guarantees.

GSM-102 and GSM-103 Sales by Country and Commodity, 1990 Through 1992

Table 1.1 provides information on GSM program sales by country for fiscal years 1990, 1991, and 1992. As shown, total GSM-102 credit guarantees were $4.6 billion in fiscal year 1990, $5 billion in fiscal year 1991, and $6.1 billion in fiscal year 1992. The GSM-103 program accounted for about $1 billion in guarantees during fiscal years 1990 through 1992. The table also shows that whereas the FSU received no GSM credit guarantees in fiscal year 1990, it was the major recipient in fiscal year 1991. In fiscal year 1992, the FSU and Russia, collectively, received more guarantees than any other nation.

Table 1.2 depicts the distribution of GSM-102 and 103 sales by type of commodity for fiscal years 1990, 1991, and 1992. As the table shows, wheat, yellow corn, and soybeans and soybean meal accounted for the majority of sales.

USDA Criteria for Assessing Creditworthiness

Within USDA, the Trade and Economic Information Division (TEID) of the Foreign Agricultural Service (FAS) is responsible for analyzing the ability and willingness of countries that have requested GSM-102 export credit guarantees to meet their current and future external debts, including potential GSM debt.

TEID evaluates creditworthiness in terms of whether a country is able and willing to service its current and future foreign debt obligations. Access to sufficient hard currency is seen as the key to whether a country is capable of servicing debt (principal and interest payments). TEID notes that external debt can be serviced through revenues derived from a country’s current account, from foreign exchange received from debt and investment inflows, or from a drawdown of a country’s existing stock of foreign exchange reserves. Important factors that affect a country’s ability to service its debts, TEID says, include the status of the current account balance; the volume of trade; the variability in current receipts; the size of international reserves; the country’s access to capital account inflows, either from net direct investment, foreign borrowing, or foreign aid; and the country’s ability to reduce its imports of goods and services.

TEID’s approach also includes a review of the general economic and political situation of countries. If a country’s economy is in a steep decline, its ability to earn foreign exchange from exports may be severely impaired. If the political system is unstable or if a country is subject to external threats to its sovereignty, concerns may arise about the country’s willingness or ability to meet its future debt obligations.

The 1990 Farm Bill provision restricting when GSM-102 credit guarantees can be extended does not include a general creditworthiness standard. Rather, it requires that the Secretary of Agriculture determine whether a prospective borrowing country is capable of adequately servicing the debt associated with a specific, proposed GSM-102 sale to that country before issuing a credit guarantee. However, if a country is experiencing problems in servicing its debts or is likely to in the near future, any particular debt obligation (including a GSM loan), in our view, could result in default.

A country with low creditworthiness may be able to adequately service the debt associated with a particular GSM-102 sale if the country is willing to assign a priority to repayment of that debt (i.e., to not treat other creditors equally). In fact, USDA officials told us that the U.S. decision to extend substantial export credit guarantees to the FSU during 1991 was partly based on the assumption that the Soviet government would give preferential treatment to GSM-102 debt. U.S. officials reasoned that food was a high-priority item. Without adequate supplies of food, political stability could be threatened. Moreover, Soviet and, subsequently, Russian leaders knew that if they fell into arrears on payments for GSM-102 guaranteed sales, the GSM-102 program would be suspended. Thus, they had an incentive to keep current on GSM-102 debt repayments if they wanted to secure future GSM credit guarantees.

However, even if a borrowing country is willing to give preferential treatment to particular debts, creditor nations must pay close attention to its creditworthiness more generally. For example, if a prospective borrower country has low creditworthiness and its problems worsen, it may find it necessary to reschedule its debts. Under the normal rules of international debt restructuring, all official creditors (i.e., creditor country governments) are to be treated equally. Therefore, particular debts should not receive preferential treatment.

Exposure Guidelines

In addition to evaluating the creditworthiness of potential GSM credit guarantees, TEID establishes annual and total risk exposure guidelines to provide USDA with a yardstick for limiting its risk exposure in specific countries. The total exposure guideline for a country is TEID’s recommended maximum dollar amount of GSM-guaranteed principal, rescheduled principal, interest arrears, and claims that the country should owe CCC at a given time.

Decisionmaking Process

TEID’s country risk grades and exposure guidelines are used in USDA’s decisionmaking process for allocating credits to requesting countries. However, TEID’s recommendations about whether to extend credit and, if so, how much, are not binding on the agency. USDA considers not only the risk of providing loan guarantees but also the potential for expanding or maintaining U.S. markets overseas. A Reconciliation Committee, consisting of representatives from TEID and several other USDA offices, meets and discusses both the risk of lending to a foreign country and the prospects for developing and maintaining U.S. markets in that country. A recommendation is developed in committee. According to USDA officials, decisions about which countries should receive credit guarantees and in what amounts may be made by the Assistant General Sales Manager or the General Sales Manager, but sometimes the decisions are elevated to the level of the Under Secretary for International Affairs and Commodity Programs.

The National Advisory Council (NAC) on International Monetary and Financial Policies also provides advice to USDA on GSM credit guarantee actions. USDA sends all GSM-102/103 proposals to NAC for review. Proposals are submitted after USDA has conducted its own risk analysis on a country in question. NAC’s recommendations are only advisory in nature and do not necessarily reflect fiscal risk. However, we were told that USDA does not typically challenge NAC recommendations unless the Treasury or the State Department are not in the majority when a vote on a recommendation is taken.

Objectives, Scope, and Methodology

The Ranking Minority Member of the Senate Committee on Agriculture, Nutrition, and Forestry asked us to assess the creditworthiness of the FSU and its 15 successor states. The FSU’s 15 republics became independent states between August and December 1991, as part of the historic change that swept across the Soviet Union in the late 1980s and early 1990s. This change culminated in the collapse of the Soviet empire and the demise of the Communist Party. The successor states are Armenia, Azerbaijan, Belarus, Estonia, Georgia, Kazakhstan, Kyrgyzstan, Latvia, Lithuania, Moldova, Russia, Tajikistan, Turkmenistan, Ukraine, and Uzbekistan.(See fig. 1.1 for a map showing the location of the states).

We analyzed the creditworthiness of the FSU and its 15 successor states from a variety of perspectives, including debt burden, gross financial requirements, liquidity, secondary market valuations of FSU debt, and country risk analyses. In addition, we (1) considered the general economic and political environment in the FSU and its successor states; (2) reviewed how the Soviet debt crisis developed and the relationship between debt problems, on the one hand, and economic reform and creditworthiness on the other; (3) examined how USDA assessments of creditworthiness and market considerations affected USDA’s decisions on providing the FSU/successor states with credit guarantees; and (4) estimated the exposure of the GSM-102 portfolio to default by the FSU and its successor states.

To assess the creditworthiness of the FSU and its successor states, we (1) analyzed their debt burden and liquidity situations, using historical and forecast data; (2) considered the importance of arrears, debt relief, and International Monetary Fund (IMF) arrangements as measures of creditworthiness; (3) applied USDA/TEID criteria for measuring the relative creditworthiness of countries to the successor states; (4) reviewed secondary market prices of FSU loans and bonds; and (5) analyzed several country risk ratings of the creditworthiness of the FSU and its successor states, including preparing a composite rating for each of the states.

To examine the role of U.S. agricultural exports to the FSU and its successor states and the use of GSM-102 credit guarantees to promote such trade, we analyzed USDA data and related information on U.S. agricultural exports generally and GSM export credit guarantees more specifically. To assess the development of the Soviet debt crisis, we reviewed information on debt-servicing problems and efforts by the Group of Seven (G-7) industrialized nations and international institutions to provide financial assistance to help alleviate those problems. In reviewing the economic and political situation in the FSU and its successor states, we examined data and information on economic conditions and political events during recent years and considered the views of a number of experts and U.S. government agencies. To assess the exposure of the GSM-102 portfolio to default by the FSU and its successor states, we analyzed GSM-102 data on outstanding principal owed by all GSM-102 recipients, including weighting the data according to country risk evaluations of the creditworthiness of the recipients. In addition, we used data on secondary market prices of FSU loans and country risk ratings to estimate the risk of default on external debt of the successor states. The secondary market expresses the value of a country’s loan as a percentage of its face value. The extent to which a loan’s value is discounted in the secondary market indicates how the financial market assesses the risk of default. We estimated the default risk by subtracting a country’s secondary market price from $1 and dividing the result by 100. A similar technique was used for country risk ratings.

In conducting our review, we interviewed representatives of the U.S. Departments of Agriculture, State, and the Treasury. We also conducted field work in five of the FSU’s successor states (Belarus, Kazakhstan, Russia, Ukraine, and Uzbekistan) and in Paris, Bonn, and Brussels. In the latter three cities, we met with representatives of the French and German governments and the European Union.

We also reviewed U.S. legislation relating to GSM-102/103 programs, as well as other government documents and documents of the World Bank and IMF, and private sector ratings of country risk and creditworthiness. In addition, we reviewed information on violent conflicts that have affected Russia and other successor states (see app. I) and compared the debt burden of countries to debt payment problems, IMF arrangements, and debt relief agreements (see app. II).

We obtained comments from the Department of Agriculture on a draft of this report (see app. III). We summarize and evaluate most of USDA’s comments in chapter 6, and some comments are addressed directly in other chapters of this report.

We did our work between April 1992 and December 1994 in accordance with generally accepted government auditing standards.

U.S. Agricultural Trade With the Former Soviet Union and Role of the GSM-102 Program

The FSU has been a major purchaser of U.S. bulk agricultural exports since 1972; until 1991, it usually made such purchases with cash. However, owing to its increasing financial difficulties (see ch. 3), in the latter part of 1990 the Soviets sought export credits to finance their imports of commodities and food products. The United States responded positively. Between December 1990 and September 30, 1993, the United States offered to provide up to $5.97 billion in GSM-102 export credit guarantees to the FSU and those successor states that qualified for the program. As of September 30, 1993, $5.02 billion had been provided, $0.949 billion was no longer available to the FSU, and $3.85 billion was still owed to the United States on FSU credit-guaranteed purchases.

As a result of these sizable guarantees, the GSM-102 program has become heavily exposed to default by Russia, which has undertaken the responsibility as guarantor of the debt of the FSU. Guaranteed sales to the FSU and/or its successor states accounted for 38 percent of all GSM sales in fiscal year 1991 and 43 percent in fiscal year 1992 (including Russia and Ukraine). The FSU and its successor states now hold the largest portion of all outstanding GSM-102/103 loan guarantees. In late November 1992, Russia began missing payments due on GSM-102 debt for the FSU. By the end of September 1993, Russian defaults on FSU and Russian debt totaled nearly $1.1 billion. At that time, the United States agreed to reschedule $1.1 billion of GSM-102 debt. In January 1994, Russia again fell into default on GSM-102 loans. By early June 1994, the United States had agreed to reschedule another $882 million.

Background

As discussed in our 1993 report, the FSU was the world’s largest producer of wheat and one of the world’s largest producers of grains overall. It was also a major producer of potatoes, sugar beets, cotton, and sunflowers. Despite its vast production of crops, however, the FSU was a net importer of food. Its imports averaged just under $20 billion per year, about half of which was for grains and sugar. The need for extensive imports continued following the dissolution of the Soviet Union in December 1991.

We found that extensive food imports were necessary because the states had been unable to efficiently harvest, store, process, and distribute much of what was grown. Difficulties associated with each of these steps of the food production system combined to create huge losses due to spoilage after crops were initially produced. For example, approximately 25 to 30 percent of grain and 30 to 50 percent of potatoes and vegetables produced in the FSU and its successor states were lost annually because of these problems. Moreover, in absolute terms, aggregate annual grain loss of the successor states (excluding the Baltic states) was, on average, about 30 million to 40 million metric tons (mmt), which was roughly equal to the size of their aggregate annual grain imports.

After 1985, the Soviet Union announced a series of initiatives to reform agriculture, ranging from making changes in land ownership laws to paying farmers hard currency for high-quality crops sold to the state in excess of original state-contracted amounts. However, for a variety of reasons, these initiatives did not produce substantive results. By 1991, the availability of basic food staples, such as potatoes, meat, and bread, was far worse than before agricultural reforms were initiated. As discussed in our 1993 report, following the dissolution of the Soviet Union, agricultural reforms in the successor states proceeded slowly, with varied progress among the states. Reforms considered or undertaken in these states included the liberalizing of food prices; restructuring of state and collective farms; and privatizing of food production, wholesale and retail trade, processing, storage, and transport. However, agricultural reform has been slow, in part because successor state governments fear that rapid reform might lead to significant production shortfalls and unemployment. In turn, such disruptions could cause food shortages and discontent that would threaten the political and social stability needed by these governments to proceed with reforms. Our report also found that agricultural reforms have been impeded by (1) bureaucratic resistance from some persons with vested interests in the old central command system and (2) fear of change by workers on state and collective farms.

U.S. Trade With the FSU

Since the early 1970s, the FSU was a major customer for U.S. bulk agricultural commodities, although U.S. exports fluctuated greatly from year to year. The trade relationship was fostered by a series of U.S.-Soviet long-term bilateral grain agreements. Annual sales varied in response to a variety of factors, including fluctuations in Soviet agricultural production, changes in the nature of the U.S.-Soviet political relationship, and competition from other exporters of agricultural commodities.

Table 2.1 shows U.S. agricultural exports to the FSU and its successor states as a percent of U.S. agricultural exports to the world, between 1976 and 1993 (percents were calculated on the basis of the dollar value of the exports). For the entire period, exports to the FSU and its successor states accounted for 5.5 percent (on an average annual basis) of the total value of U.S. agricultural exports to the world. For the 1991-93 period, the average annual share was 5.3 percent. Grain and soybeans/soybean products accounted for the large majority of U.S. agricultural exports to the FSU and its successor states.

Table 2.2 shows U.S. corn, wheat, and soybean/soybean product exports to the FSU and its successor states as a percent of the total value of such commodity exports to the world between 1976 and 1993. The table shows that corn and wheat exports generally accounted for 10 percent or more of total U.S. exports of the same commodities.

GSM-102 Sales to the FSU and Its Successor States

Beginning in the early 1970s, the FSU became more or less a permanent grain importer. Generally, through 1990, it was a cash customer when it purchased U.S. agricultural commodities. However, during the last months of 1990, the Soviets sought to line up export credits to purchase needed food from countries that traditionally exported agricultural commodities to the Soviet Union. The Soviets needed such credits because they had a limited amount of hard currency reserves available to purchase food and other items and to finance their continuing trade deficit with nonsocialist countries.

On December 12, 1990, the Secretary of Agriculture announced that $1 billion in GSM-102 export credit guarantees would be made available for agricultural sales to the Soviet Union. (January 1991 was the first month in which guarantees were allocated for actual commodity purchases.) The decision was made during a time of a food shortage in the Soviet Union.The U.S. response to the Soviet Union’s request for assistance took place in the context of growing western efforts to help the Soviet Union. As of December 1990, Canada, France, Germany, Italy, and Spain had announced about $3 billion in agricultural credits to the Soviet Union for purchases in the following months. The United States had also stated its support for the Soviet President’s “perestroika” (restructuring) measures and fundamental economic reform objectives. When the GSM credits were announced in December 1990, the White House Press Secretary said they reflected the administration’s desire to promote a continued positive evolution in the U.S.-Soviet relationship.

In April 1991, the Soviet Union requested another $1.5 billion in GSM-102 export credit guarantees for 1991. However, the request occurred at a time of growing concern about Soviet creditworthiness. In hearings held in May 1991, the Deputy Under Secretary for International Affairs and Commodity Programs indicated to a congressional committee that under the 1985 Farm Bill it was quite possible to consider the creditworthiness of a country suspect but still proceed with a full GSM program for the country because market development considerations outweighed the financial risk. However, he said, USDA believed that such an approach was no longer possible and that as a result, USDA’s flexibility in operating the credit guarantee programs had been considerably limited. As discussed in chapter 1, the 1990 Farm Bill added the requirement that the Secretary of Agriculture may not issue credit guarantees in connection with sales of agricultural commodities to any country that he determines cannot adequately service the debt associated with such a sale.

During May 1991, there was extensive debate in the Senate about whether to provide additional credit guarantees to the Soviet Union. The debate focused on (1) whether the Soviet Union was creditworthy, (2) what factors should be considered in assessing a country’s ability to repay GSM debt, (3) whether credit guarantees should be provided or denied to the Soviet Union because of foreign policy considerations, and (4) what the impact on the United States and U.S. farmers would be if guarantees were not provided and sales not made. On May 15, 1991, the Senate approved (by a vote of 70 to 28) a nonbinding resolution (S. Res. 117) that said that as the administration evaluates the Soviet request, it should consider in its evaluation such factors as whether the Soviets were able to service current debt and whether the absence of U.S. guarantees would jeopardize U.S. market development. Similarly, on May 31, 1991, 37 members of the House Committee on Agriculture sent the Secretary of Agriculture a letter that said the Secretary should consider, among other factors, the U.S. ability to access, maintain, and develop markets for U.S. agricultural products, including an assessment of whether the absence of U.S. credit guarantees would jeopardize the ability to access and develop such markets.

In June 1991, the President approved the Soviet request for $1.5 billion in additional credit guarantees. Subsequently, in July 1991, USDA’s Assistant General Sales Manager told us that the Senate resolution and letters that USDA had received from Members of Congress had provided helpful guidance on how to interpret the requirements of the 1990 Farm Bill. He said that without that guidance, it is not clear whether USDA would have made a determination that the Soviet Union was creditworthy. The official noted that the entire GSM program was predicated on making credit available beyond what the private sector would provide.

During the summer of 1991, increasing apprehension about the Soviet Union’s creditworthiness affected its ability to obtain financing for U.S. agricultural commodities—even for purchases backed by U.S. credit guarantees. According to an official of Vnesheconombank (VEB), the Soviet Bank for Foreign Economic Affairs, U.S. commercial banks no longer felt comfortable with the 98-percent guarantee coverage that USDA typically offers. The banks, he said, wanted CCC to provide 100-percent coverage of the principal or have the exporters absorb some of the risk.

On September 24, 1991, CCC agreed to guarantee 100 percent of principal. Between then and the end of fiscal year 1993, all of the credit guarantees to the FSU, Russia, and Ukraine included 100-percent coverage of the principal. In comparison, none of the other countries that received GSM-102 credit guarantees in fiscal year 1991 through March 4 of fiscal year 1994 were provided more than 98-percent coverage.

In November 1991, the White House announced that another $1.25 billion in credit guarantees was being made available, along with $250 million in food aid and technical assistance. The White House said that the President’s decision would help the Soviet Union, its republics, and their peoples cope with immediate food shortages and aid in the longer term restructuring of the country’s food distribution system. However, owing to concern about whether the Soviet Union would continue to exist, this commitment was not made until after Russia and the other republics agreed to “joint and several liability” for the debts of the Soviet Union. In December 1991, the Soviet Union did dissolve. At that time, a considerable portion of the November GSM credit guarantees had not been allocated. CCC announced that the unused guarantees (about $650 million) would be available for sale to any of the 12 republics. However, all sales for the unused guarantees went to the 12 states of the FSU as a group.

In April 1992, the President announced that another $1.1 billion in credit guarantees would be made available. However, because several of the successor states (particularly Russia and Ukraine) wanted separate programs, USDA indicated that the guarantees would henceforth be made on a bilateral basis. Of the $1.1 billion announced at that time, USDA said that $600 million was being designated for Russia. The remaining $500 million would be available for Ukraine and the other states provided they met GSM-102 program qualifications. Only Ukraine received any of this commitment—$109 million. According to a USDA official, the remaining $390 million is no longer available. In September 1992, USDA announced that $900 million in new guarantees was being made available to Russia for fiscal year 1993. One month later, USDA announced a commitment of $200 million for Ukraine for fiscal year 1993. Between January and September 1993, USDA announced small amounts of credit guarantees for Estonia ($5 million) and Uzbekistan ($15 million).

Table 2.3 summarizes information on all GSM-102 commitments made to the FSU and its successor states through September 30, 1993. As the table shows, U.S.-announced guarantees totaled $5.97 billion. As of September 30, 1993, $5.021 billion had been registered for export. Of this, the FSU received $3.74 billion, Russia $1.06 billion, Ukraine $199 million, and two other states a total of $20 million. The remaining $949 million in announced guarantees is no longer available because the period of time during which the guarantees could have been registered for export has expired.

Fiscal Year 1994 GSM-102 Credit Guarantees

During fiscal year 1994, USDA announced the availability of GSM-102 credit guarantees for successor states as follows: Kazakhstan, $15 million; Ukraine, $40 million; Turkmenistan, $10 million; and Uzbekistan, $15 million. In each of these cases, CCC agreed to cover only 98 percent of the principal. For Kazakhstan, Turkmenistan, and Uzbekistan, USDA required that principal repayments be made every 6 months. For Ukraine, however, USDA indicated principal repayments could be made annually.

Although USDA said it would make up to $40 million available for Ukraine, only $20 million was authorized during the fiscal year.

In addition to the above states, in September 1994, USDA announced it was authorizing $20 million in GSM-102 credit guarantees for sales to private sector buyers in Russia for fiscal year 1994. The guarantees offered to Russia were significantly different from guarantees previously made available to the FSU and its successor states, including Russia. Under the terms of the announcement, the guarantees could be effective for up to 90 days only rather than up to 3 years. The offer followed a long period during which Russia did not receive any guarantees as a result of substantial defaults on its GSM-102 credit-guaranteed loan payments (see later discussion in this chapter).

Total GSM-102 guarantees offered to the successor states in fiscal year 1994 equalled $100 million, a small fraction of the amounts offered in fiscal years 1991, 1992, and 1993. (See table 2.3 and the accompanying discussion.)

Was There a Food Shortage?

In commenting on a draft of this report, USDA said it is important to clarify that there were no food shortages in the sense that the USSR did not produce enough food. Before the breakup of the USSR, USDA said, shortages and long lines existed in state stores where prices were controlled, resulting in “surplus demand” at those locations. No shortages existed in the farmer markets where prices were relatively freely set and substantially higher than state-set prices. After the breakup of the Soviet Union, USDA said, price liberalization led to higher prices, increasing the availability of food by decreasing surplus demand.

The primary problems facing the FSU in terms of food supply, USDA said, are disruptions due to military conflict and the reduced purchasing power of consumers, which has put some groups (such as the elderly and unemployed) at risk. Humanitarian assistance could address, and in many cases has addressed, these problems. USDA also said that it would not characterize 1990 as a time of food shortages. It noted that the 1990 grain crop was one of the largest in history and reiterated that the food problems in the Soviet Union were a function of controlled prices and surplus demand, not a “shortage of supply.”

We do not disagree with USDA’s description of what caused the food problems in the FSU but believe that our use of the term “food shortages” to characterize the situation in the FSU is consistent with what both USDA and others were saying at the time. For example, on December 12, 1990, the White House issued a fact sheet that said that the GSM-102 export credit guarantees being made available at that time were a form of food assistance that “will help the Soviet authorities address current food shortages.” A Congressional Research Service report of December 3, 1990, concluded that even with bumper grain crops in the Soviet Union in the fall, food losses due to harvesting and spoilage problems and a breakdown in food processing and distribution systems had resulted in shortages of food products, particularly in the larger Soviet cities and in remote areas far from the major food producing regions. Similarly, a May 1991 USDA report on Soviet agriculture used the term food shortages several times in describing food problems in the Soviet Union.

GSM Sales Relative to Total U.S. Exports to the Region

Since the beginning of 1991, most U.S. agricultural exports to the FSU and its successor states have been financed through GSM-102 credit guarantees. For example, the United States exported $6.6 billion in agricultural commodities to the FSU during 1991 through 1993. Between January 1991 and September 30, 1993, CCC registered for export $5 billion in GSM-102 credit-guaranteed food.

Table 2.4 shows that the principal GSM-102 commodity exports to the FSU, Russia, and Ukraine have been grains (i.e., yellow corn and wheat) and soybeans and soybean products (i.e., soybean meal and soybean oil). The table also shows that the GSM commodity exports to the three countries accounted for a considerable portion of total GSM-102 and 103 commodity exports to the world during fiscal years 1991 and 1992.

USDA Assessments of FSU And successor States’ Creditworthiness and Impact on Decisions About Whether to Provide Credit Guarantees

We examined USDA documents recording the results of meetings of USDA’s Reconciliation Committee on whether to provide credit guarantees to the FSU and its successor states. We found that FSU and, subsequently, Russian and Ukrainian creditworthiness were assessed as very risky by the committee during the 2-year period when USDA’s CCC made available more than $5 billion in credit guarantees to these countries. We also found that there was considerable disagreement between those participants whose primary concern was to assess financial risk and those responsible for assessing market opportunities. The committee sought to develop recommendations that would reconcile or balance the financial risks and market development opportunities.

The Assistant General Sales Manager or the Acting General Sales Manager chaired the committee. Other participants included representatives from several offices under USDA’s Under Secretary for International Affairs and Commodity Programs. These included (1) the Financial Management Division of the Agricultural Stabilization and Conservation Service (ASCS); (2) the CCC Operations Division (CCCD); (3) the Commodity and Marketing Programs (C&MP), including its Grain and Feeds Division (G&FD); (4) the Program Development Division (PDD); and (5) the Trade and Economic Information Division.

August-December 1990

The Reconciliation Committee met on August 21, 1990, to consider a recommendation to provide GSM-102 export credit guarantees to the FSU. Members presented very strong arguments for both a $2-billion program based on market development opportunities and a limited $500-million (or less) program based on financial and political risks. The Reconciliation Committee Chairman suggested a $1-billion program as a good balance between market development and risk. However, given strongly opposing views, the committee decided to further assess the situation.

The committee met again on September 19, 1990. TEID, responsible for assessing country risk, reported that there was continued deterioration in the Soviet economic situation and a further unraveling of the political situation. It recommended a maximum exposure of no more than $500 million in credit guarantees for the Soviet Union. ASCS, responsible for establishing limits on the amount of credit guarantees that could be handled by Soviet banks, said that on the basis of bank financial risks, macroeconomic issues, and political problems, it was strongly against a GSM program higher than $280 million. It noted a rapid and major decline in Soviet creditworthiness, reports of military movements outside of Moscow, and open discussion of a coup in the Soviet Union. Both TEID and ASCS cited a plan being circulated in the Soviet Union for changing the balance of power between central authorities and the republics, and they expressed concern about who would be responsible for repayment if republics split from the Soviet Union. ASCS said that if the Soviet plan were implemented, the Soviet banking system would be decentralized and that VEB, the only Soviet bank authorized to issue letters of credit to obtain credit guarantees, might not have sufficient hard currency to repay its obligations.

CCCD asked whether the committee could even consider anything over $500 million, given the negative financial information presented by TEID and ASCS. The Reconciliation Committee Chairman agreed that based on financial information only a smaller program was warranted. However, he reminded the participants that the purpose of the committee was not only to consider financial risks but also to reconcile these risks with market development opportunities. He said the committee had the responsibility of sending forward a recommendation that was balanced between risks and market development.

C&MP, which had urged at least a $2-billion program for the Soviet Union in August 1990, again urged a large program to meet many potential market development opportunities. It said (1) the Soviet Union represented the largest market development opportunity in the world and also had the greatest future potential, (2) there were many competitors lined up to extend credit to the Soviets, (3) any loss in U.S. market share would be severely detrimental to U.S. agricultural business and producers, and (4) loss of the Soviet market would result in higher domestic program costs for CCC now and in future years. In addition, C&MP said the Soviet Union’s ability to pay should not be based solely on current market information. It noted that the country had the largest untapped resource base in the world and that even though its financial condition was bad, it was still paying its agricultural debts to the United States.

In spite of the wide differences of view, the committee recommended a $1.25-billion program for the Soviet Union—subject to certain conditions, such as releasing the guarantees in segments and securing a credit guarantee assurance letter from the Soviet federal government. In addition, the committee said it wanted reviewers of its recommendation to know that there was extreme risk in its proposal and a substantial chance that CCC would have to make outlays. The committee said it felt that CCC should accept a degree of country risk that it would refuse for another country because (1) the Soviet Union was our largest export market for grains, and the health of the American farm community was directly dependent on maintaining market share in that market; and (2) in the event of a loss of the Soviet market, CCC would also make substantial outlays under domestic programs.

According to documents provided to us by USDA, the Reconciliation Committee did not meet again to discuss the Soviet situation between the time of its September recommendation and December 12, 1990. On the latter date, the Secretary of Agriculture announced that the President had waived the Jackson-Vanik amendment to the 1974 Trade Act emigration requirements in order for the Soviet Union to purchase U.S. agriculture commodities using USDA credit guarantees. The Secretary said $1 billion in guarantees would be made available to fulfill a request made by the Soviet government.

May-June 1991

In May 1991 the Reconciliation Committee met twice to consider a Soviet request for an additional $1.5 billion in credit guarantees. In a May 2 meeting, TEID advised the members that the Soviet economic and political situation was rapidly deteriorating and questioned who would repay Soviet loans if the Soviet Union did not survive. TEID said that on the basis of a “best-case” scenario, it could propose no more than $300 million in added credit guarantees. PDD said it favored postponing any further credits. Among some of the reasons it offered were that (1) section 202 (f) of the 1990 Farm Bill stipulated that credit should not be extended to countries that cannot adequately service the debt, (2) CCC exposure was already over CCC’s guideline, (3) Soviet instability seemed likely to continue, (4) foreign exchange reserves would likely decline, and (5) there was uncertainty about implementation of the Jackson-Vanik amendment. ASCS recommended no new credits.

In contrast, C&MP told the committee that the Soviets could use all of the $1.5 billion in credit guarantees and that if the United States did not extend credit, it would be out of the market. C&MP warned that the U.S. reputation as a reliable supplier would suffer, and long-term trade repercussions would follow. G&FD questioned whether there was not room to work out a solution. It noted that the Soviet Union had huge resources and there had been no occasion of its delaying payment. G&FD warned that the President and the Secretary of Agriculture might be embarrassed if guarantees were not extended, since the Soviet state had an obligation to feed its people and the credit guarantees would be used to purchase grain, a fundamental staple. The meeting ended with the committee recommending that no further credit be extended to the Soviet Union for the time being. However, it said a reexamination should be initiated if, for example, Congress acted to clarify the interpretation of section 202(f) of the 1990 Farm Bill. As previously discussed, during May 1991 the Senate approved a nonbinding resolution, and 37 members of the House sent the Secretary of Agriculture a letter indicating that USDA should assess the impact on U.S. commodity exports if additional credit guarantees were not extended to the Soviet Union.

On May 28, 1991, the Reconciliation Committee met to review its previous position and to be briefed by the Chairman and the General Sales Manager on the results of a presidential mission that had visited the Soviet Union between May 17 and 26, 1991, and of which the Chairman and the manager were members. The Chairman reported there were no real signs of hunger or food shortages in the Soviet Union. The General Sales Manager told the committee that Soviet officials had advised USDA that they could not provide firm financial figures relative to Soviet creditworthiness. As a result, he said, Soviet figures had lost their credibility, and a Soviet request for additional credits would have to be viewed as a political rather than commercial request. TEID agreed. Although the committee noted that the Soviet Union had passed a new immigration law that would make the Jackson-Vanik requirement less of a problem in the future, the committee concluded that there was no basis for changing its previous recommendation not to extend further credit guarantees to the Soviet Union.

The committee’s recommendation notwithstanding, on June 11, 1991, the President announced his decision to extend another $1.5 billion in loan guarantees to the Soviet Union. According to the White House Press Secretary, the President’s assessment of the Soviet Union’s creditworthiness was based on the following: (1) its record of never defaulting on an official loan involving the United States; (2) its positive repayment history on several hundred million dollars in loans through the 1970s, primarily from the U.S. Export-Import Bank; (3) the judgment of the USDA team that had visited the Soviet Union in May; (4) the subsequent review by the Secretary of Agriculture; (5) the administration’s discussions with Soviet officials; and (6) the commitment of President Gorbachev to move toward a market economy.

In July 1991, the Assistant General Sales Manager told us that food was a priority item for the Soviet government, since without adequate food supplies political stability could be threatened. The government had an incentive to stay current on GSM debt payments, he said, because Soviet officials knew that if the government did not remain current, the GSM-102 program would be suspended.

August-October 1992

The Reconciliation Committee met on August 12, 1992, to discuss a possible fiscal year 1993 GSM-102 program for Russia. PDD recommended a $1.2-billion program. It noted that Russia had not missed a payment on any of the FSU’s GSM-102 debt and that VEB and Russian officials had continually said Russia would honor all of its GSM-102 obligations. C&MP said Russia’s commodity import needs greatly exceeded the $1.2-billion recommendation and that GSM-102 was essential to maintain the U.S. share of the Russian market. It warned that U.S. exports to Russia would be needed to help offset U.S. farm program costs.

TEID objected to the proposed $1.2-billion program. It advised the committee that CCC was vastly overexposed and at substantial risk of realizing large losses on the FSU and Russian programs. TEID said that Russia’s ability and commitment to resume full debt servicing in fiscal year 1993 were very doubtful and that FSU debt was likely to be rescheduled following Russian negotiation of a standby agreement with the IMF. TEID said it was impossible to establish a meaningful debt exposure guideline for additional credits, since Russia was not creditworthy for the size of its existing program. TEID recommended that Russia be extended other assistance of a more concessional nature. ASCS also objected to the proposed program level due to the substantial credit risk. It noted that the debt exposure level for VEB was well over the established bank limit now set by ASCS at $130 million, that VEB continued to fall behind on its interest payments to other creditors, and that VEB had been late on a number of GSM debt payments to banks. In addition, responsibility for the FSU debt on the part of each former republic had yet to be settled.

In the absence of a committee consensus, on August 28, 1992, the Committee Chairman recommended a $1.2-billion Russian program to the Acting Under Secretary for International Affairs and Commodity Programs. The Chairman detailed the differing views of the committee members. He noted that the proposed program might slightly reduce CCC’s total exposure and indicated that if there were no fiscal year 1993 program for Russia, there would be a highly damaging impact on farm prices and resulting outlays under U.S. domestic commodity support programs.

On August 26, 1992, the Reconciliation Committee met to discuss a fiscal year 1993 GSM-102 program for Ukraine. PDD recognized continued deterioration of the Ukrainian economy but recommended a $200-million program. It said GSM-102 financing would be needed to maintain U.S. market share and that Ukraine officials had stated they would honor all of their GSM-102 obligations. C&MP estimated Ukraine’s credit needs as closer to $300 million and said that the market would provide significant U.S. sales opportunities well into the latter half of the 1990s. In contrast, TEID recommended against a fiscal year 1993 program. It found Ukraine overexposed based on its fiscal year 1992 program and its share of repayments of the FSU program. It warned that unless Ukraine’s record significantly improved, TEID believed Ukraine would not obtain sufficient international financing and foreign exchange earnings to pay for its imports and service its foreign debts. ASCS, which had established a bank limit of $0 for the State Export-Import Bank of Ukraine, also recommended against any further CCC credits.

In the absence of a committee consensus, in September 1992 the Chairman recommended a $150-million Ukrainian program to the Acting Under Secretary. The Chairman said he was again trying to balance financial risk against market development opportunities. He said providing credits would mark the first time that USDA had made credit guarantees available to a country whose current risk rating was below grade (i.e., not creditworthy), but he also said the proposed program would represent a minimal presence in a major market where the United States had a strong interest.

On September 14, 1992, USDA announced that during fiscal year 1993 it would provide Russia with $900 million in GSM-102 credit guarantees and $250 million in food aid. On October 19, 1992, USDA announced an allocation of $200 million in export credit guarantees to Ukraine for fiscal year 1993.

Relationship Between Credit-Guaranteed Food Imports and Agricultural Reform

As we have previously reported, the progress of agricultural reform in the successor states might be hindered by the provision of export credit guarantees by the United States and other countries. Credit guarantees allow the successor states to continue to import billions of dollars of foreign grain and other food commodities. Because these commodities are generally purchased, processed, and distributed by state-owned enterprises, these structures are likely to survive longer as state monopolies than might otherwise be the case, although we were unable to quantify this effect. It is these inefficient state enterprises that successor state reformers seek to privatize or replace with alternative, nonstate structures, such as commodity exchanges and private food processors, distributors, and wholesalers. In addition, credit guarantee-assisted food imports might hinder domestic food production and the efficient processing and marketing of this food by keeping down prices offered to successor state farmers and food processors and distributors.

At the same time, however, a number of successor state officials we contacted felt that credit guarantee-assisted food imports had benefited the overall economic reform process in the states more generally. According to these officials, the food imports helped to preclude food shortages and thereby contributed to the political and social stability needed to advance the overall economic reform process.

In commenting on a draft of this report, USDA indicated that credit-guaranteed assistance has adversely affected reform in the FSU. According to USDA, although widespread dislocation in the food supply never occurred, the West continued to provide assistance (credits and food aid) to the FSU, which accepted it to the likely detriment of economic reforms (increased debt and continued state control of agricultural marketing that lowers productivity, increases waste, and possibly undercuts domestic production). According to USDA, FSU leaders figured it was in their best interest to accept western assistance since repayment, if any, would be delayed. USDA also noted that before its breakup, the Soviet Union also imported large amounts of grain rather than pay farmers more to increase domestic grain procurement and to reduce waste.

Exposure of the GSM Programs to Default on Former Soviet Union/Successor States’ Debt

In the space of 2 years, the GSM-102 program quickly became heavily exposed to debt of the FSU and its successor states. As table 1.1 showed, in fiscal year 1990 there were no GSM sales to the FSU. In fiscal year 1991, GSM guaranteed sales to the FSU were $1.9 billion, which equalled 38 percent of all GSM-102 sales that year. In fiscal year 1992, the FSU, Russia, and Ukraine together accounted for $2.6 billion, or 43 percent of all GSM-102 guaranteed sales. Not surprisingly, the FSU and its successor states accounted for the single largest portion of all outstanding loan guarantees from the GSM-102/103 programs combined. As of the end of January 1993, CCC had $8.8 billion in outstanding loan guarantees (principal only) from these programs. Of this amount, $3.6 billion, or 40.9 percent, was accounted for by guarantees provided to the FSU, Russia, and Ukraine. When the outstanding principal owed by GSM recipient countries is weighted by the risk of countries defaulting on their debt payments, we estimate that the exposure to default by the FSU, Russia, and Ukraine is even greater. See table 5.12 and accompanying discussion in chapter 5.

Table 2.5 provides the repayment schedule for the FSU’s GSM-102 loans as of the end of February 1993.

As the table shows, combined principal and interest payments due from the FSU, Russia, and Ukraine for 1993 equaled nearly $1.65 billion; in 1994, $1.62 billion; and in 1995, about $0.72 billion. The figures do not reflect, as discussed below, USDA’s April 1993 and June 1994 agreements to reschedule a considerable amount of FSU GSM-102 debt.

Since Russia is the only successor state making payments on GSM-102 debt for the FSU and since Russia accounts for nearly all credit guarantees committed since the program was converted to a bilateral mode, the GSM program is particularly vulnerable if Russia is not able or willing to make payments on GSM debt. As table 2.5 shows, Russia began defaulting on scheduled payments for both the FSU and Russia itself beginning in the fourth quarter of 1992. As a result of these defaults, USDA suspended Russia’s participation in the GSM-102 program. By March 31, 1993, FSU and Russian defaults totaled nearly $648 million (see table 2.6).

On April 2, 1993, the United States reached a provisional agreement with Russia to reschedule approximately $1.1 billion of GSM-102 debt. The agreement covered FSU principal and interest arrears, as well as payments coming due in calendar year 1993, on export contracts made in 1991. The rescheduled debt would be repaid over 7 years, with a 2-year grace period on principal repayments. Not covered by the rescheduling were $287 million in FSU arrears accumulated through March 31, 1993. Under the proposed agreement, Russia was to eliminate the arrears by June 30, 1993, and stay current on GSM-102 payments as they came due. However, rather than eliminating the arrears, Russian defaults increased. By the end of September 1993, net defaults totaled nearly $1.13 billion, and the Commodity Credit Corporation had paid out $1.1 billion in net claims to U.S. banks that had made the loans (see table 2.6.).

Nonetheless, on September 30, 1993, the United States and Russia concluded a debt rescheduling agreement along the lines of the April proposal. Under the agreement, Russia accepted responsibility for all of the GSM-102 debt of the FSU. The agreement provided for rescheduling an estimated $1.07 billion of GSM-102 debt, including a considerable amount of the arrears. In addition, Russia agreed to repay approximately $444 million in unrescheduled arrears in three installments by the end of 1993. Table 2.7 shows the schedule for Russia’s repayment of FSU and Russian GSM-102 debt following the September 1993 debt rescheduling. As the table shows, the debt was to be fully repaid by the year 2000. In addition, Russia was required to continue to make payments, as they come due, for FSU and Russian GSM-102 export contracts made after 1991. According to USDA, a determination on resumption of the GSM-102 program for Russia could not be made until the debt issues were fully resolved and all arrears were eliminated.

Russia did pay the arrears by the end of 1993. However, during early 1994, Russia again fell into default on GSM-102 debt. For example, during the first 70 days of 1994, Russia was in default about 51 days. In February, USDA agreed to reschedule $344 million in 1991 payments coming due during the January 1 through April 30, 1994, time period. On June 4, 1994, USDA agreed to reschedule another $517 million in payments due during the May 1 through December 31, 1994, period, as well as $22 million in deferred interest. Repayment terms for the principal included a 2.75-year grace period followed by an 8-year repayment period. The deferred interest on the rescheduling agreement is to be repaid over a 5-year period. Russia was still required to pay approximately $360 million owed to CCC and U.S. banks for the January through December 1994 period.

The amount of GSM-102 principal outstanding for Russia subsequent to the June 4 rescheduling agreement was $2.85 billion. This figure included principal amounts, interest, and capitalized interest due under the FSU program and the Russian program. At the time of the June rescheduling Russia was in arrears, and the rescheduling enabled Russia to become current on those arrears. The rescheduling occurred as part of a broader agreement concluded in Paris between Russia and its official creditors. The creditor countries also agreed to meet with Russia later in 1994 to discuss a longer term and more comprehensive rescheduling to address Russia’s severe financial problems.

Meanwhile, on June 2, 1994, Ukraine began defaulting on its GSM loan payments. As of August 17, 1994, its defaults totaled about $31.1 million and CCC had paid $21.6 million for claims made by lenders.

Impact of U.S. GSM-102 Exports to the FSU on U.S. Commodity Support Programs and U.S. Farmers

According to USDA, providing export credit guarantees to banks willing to extend loans to foreign purchasers of U.S. agricultural commodities increases the demand for U.S. exports. This increase, in turn, results in higher commodity prices for U.S. farmers and lower costs for U.S. government commodity support programs. Proponents of the GSM-102 credit guarantees point out that these reduced program costs offset the risk of default on the guaranteed debt. We reviewed USDA estimates of the cost savings associated with the extension of export credit guarantees to the FSU and its successor states in fiscal years 1991 and 1992. The FSU and its successor states received GSM-102 export credit guarantees for the purchase of U.S commodities and freight, and they also secured lower prices for certain commodities as a result of USDA Export Enhancement Program (EEP) bonus payments to U.S. exporters.

USDA initially provided us with two estimates of savings in commodity support programs associated with extending GSM-102 export credit guarantees to the FSU. The first estimate, which was made in conjunction with a proposed GSM-102 package in the spring of 1991, indicated that if CCC did not provide $1.5 billion in additional export credit guarantees to the FSU between January and July 1, 1991 ($1 billion in guarantees had already been extended between January and March 1991), CCC domestic support payments for wheat, corn, and soybeans could increase between $360 million and $755 million. The higher estimate was arrived at by assuming 100-percent program additionality—that is, that alternative export markets would not exist for GSM-102 guaranteed exports to the FSU.

Thus, commodities not sold to the FSU would have to be sold in the U.S. market or added to unsold carryover stocks. For the lower estimate, USDA made two different key assumptions. The first assumption was that 25 percent of the commodities could be exported to other countries. The second assumption was that $100 million of the guarantees for the FSU would be used for high-value products for which USDA does not provide deficiency payments or nonrecourse loans. Therefore, this $100 million in GSM-102 guarantees would have no impact on the costs of USDA’s domestic commodity support programs. Both of USDA’s estimates deducted the expected cost of EEP bonus payments provided for wheat exports under the proposed GSM sales.

USDA’s second estimate, made in February 1993, assessed changes in support costs for commodity programs if the United States did not export a projected 6 million tons of corn and 6 million tons of wheat to the FSU during 1993 and 1994. According to this estimate, support payments for corn would increase by $499 million and wheat payments by $685 million. Soybean costs were not included in the estimate. The estimate assumed that none of the corn and wheat would be sold into alternative export markets (i.e., 100-percent program additionality). Expected EEP bonus payments, however, were not netted out.

The USDA estimates of increased commodity support costs depend importantly on the assumption that alternative markets would not be generally available if the commodities were not exported to the FSU. USDA did not give us the basis for this assumption. If the commodities in question were exported to other nations, USDA’s estimates of farm price changes and program savings would be less than it estimated.

Questions About an Assumption of 100-Percent Program Additionality

For a variety of reasons, USDA’s assumption about 100-percent additionality is debatable: (1) special features of the GSM-102 program that were made available to the FSU and its successor states could have been attractive if offered to other importing nations; (2) competitor exporting nations may have displaced U.S. exports in other markets; and (3) CCC program costs depend on commodity farm prices that, in turn, are the result of many factors that influence global supply and demand conditions.

As previously noted, countries that participate in the GSM-102 program are able to obtain better interest rates on their credit than would be the case in commercial markets, as they are in effect using the repayment guarantee of the U.S. government to obtain the credit. In addition, most of the guarantees to the FSU and its successor states in fiscal year 1991 and fiscal year 1992 included coverage for 100 percent of the value of the commodities (rather than 98 percent, which is typical for the GSM-102 program). The 100-percent guarantee should also lower borrowing costs to prospective buyers. Also, the GSM-102 program for the FSU and its successor states included guarantees for freight costs. In fiscal years 1991 and 1992, freight coverage equaled nearly $443 million, or about 10 percent of the value of all GSM-102 credit guarantees offered the FSU and its successor states. The coverage of freight costs meant that each dollar of GSM-102 commitment to the FSU and its successor states supported only 90 cents’ worth of commodity exports. Also, EEP bonus payments to the importing countries for selected commodities lowered the cost of importing these commodities, which in turn should have resulted in additional exports. Total EEP bonus payments for GSM-102 exports to the FSU and the successor states in 1991 and 1992 were about $579 million.

We estimated that the combination of freight cost financing and EEP bonus payments alone made the additionality attributable to the GSM program for the FSU and its successor states in fiscal years 1991 and 1992 equal at most to about 77 percent. We believe that if USDA had offered GSM-102 credit guarantees to other potential buyers with similar generous terms, it is possible that the United States could have found alternative export markets for at least some of the GSM sales that were made to the FSU and its successor states.

The behavior of competitor exporters is also relevant to the question of program additionality. For example, if exporters from other nations responded to the GSM-102 guarantees that were made available to the FSU and its successor states by offering similar incentives to non-FSU importers, the exporters may have displaced potential U.S. exports to these other markets. Displaced U.S. exports would have reduced additionality resulting from increased exports to the FSU and its successor states. Alternatively, if the United States did not provide the guarantees to the FSU and its successor states but other exporter nations did, global commodity prices would presumably be about the same. As a result, there would be little or no reduction in USDA commodity support payments to farmers.

Actual support cost is also affected by commodity prices. Commodity prices are the result of many factors that influence global supply of and demand for commodities. These include, among others, the overall economic performance of the United States, as well as the global economy; the weather and growing conditions for crops in the United States and competitor nations; purchasing decisions in importing countries; the prices of competing commodities; and the production and consumption subsidies of the United States and its competitors. These factors could cause commodity prices to reach levels that would reduce or eliminate the need for additional commodity support payments to U.S. farmers—even if the United States did not export to the FSU and its successor states. However, the complexity and variety of factors that could influence commodity prices make the isolation of the effect of a single factor difficult.

Without explicit and detailed investigation of the behavior of exporters and importers and specification of other macroeconomic and microeconomic variables, discerning the additionality of the GSM-102 program is difficult. In the absence of reliable data on the additionality of GSM-102 exports, we believe that estimated savings in commodity support programs associated with extending GSM-102 export credit guarantees to the FSU and its successor states should consider a range of additionality levels.

Conclusions

USDA provided more than $5 billion in export credit guarantees to the FSU and its successor states in 1991-92. It did so when its own assessments indicated that these were high-risk countries from a creditworthiness perspective. According to documents of USDA’s Reconciliation Committee, which makes recommendations concerning whether to provide credit guarantees to specific countries and, if so, in what amounts, the committee saw a need to balance debt-servicing considerations against the need to maintain and expand overseas markets. On two occasions when the committee was unable to reach a consensus, the Chairman made recommendations that he believed balanced financial risk and market development considerations. Since the 1990 Farm Bill does not specify criteria to be used in assessing debt-servicing ability, USDA has considerable discretion and, thus, can provide large amounts of credit guarantees to high-risk countries, increasing the risk of defaults on GSM-102 loans.

Between November 1992 and the end of September 1993, Russia defaulted on more than $1.1 billion in GSM-102 loans made to the FSU and Russia. Under a September 30, 1993, agreement, the United States agreed to reschedule about $1.1 billion in GSM-102 debt, provided that Russia repaid $444 million of arrears (as of the end of 1993). Russia did repay the arrears on schedule. However, in January 1994, Russia again fell into default on GSM-102 loans. Between February and early June 1994, the United States agreed to reschedule approximately $882 million in additional payments due to CCC and U.S. banks under the GSM-102 program. Following the June 1994 rescheduling, there was approximately $2.9 billion in outstanding GSM-102 principal still owed by Russia on GSM-102 credit-guaranteed loans.

According to USDA estimates, export credit guarantees provided to the FSU and its successor states resulted in higher commodity prices and, in turn, lower costs for U.S. commodity support programs. Proponents of the credit guarantees assert that the reduced program costs help offset the risk of default on guaranteed debt. However, the estimated savings in commodity support costs depended importantly on an assumption that alternative markets would not be generally available if the commodities were not exported to the FSU. We disagree with analyses that assume only 100-percent additionality, and we believe that any estimated savings in commodity support programs should consider a range of additionality levels.

Debt Situation of the FSU and Its Successor States

During the latter part of the 1980s, a serious debt situation arose in the Soviet Union. As the situation evolved, western commercial lenders scaled back and then virtually halted lending to the Soviet Union. Western governments provided loans and credit guarantees to help fill the gap. By late 1991, the Soviet Union’s debt problem had reached crisis proportions. At the same time, the country was in the final stages of political disintegration. The debt crisis was temporarily eased in November 1991, when official western creditors agreed to a 1-year deferral of principal payments on pre-1991 debt. Eight of the Soviet republics agreed to joint and several liability for the outstanding debt of the Soviet Union and to carry out economic reforms recommended by the IMF.

Following the dissolution of the Soviet Union in December 1991, the former republics sought membership in the IMF and the World Bank. The Group of Seven (G-7) nations concluded that the international financial institutions could be used to promote economic reform in the FSU and to coordinate western financial assistance. They encouraged the new states to undertake substantial economic reforms designed to stabilize their economies. Doing so could lead to substantial new financial assistance from abroad and help the new states to improve their creditworthiness. Specifically, the G-7 nations said they would support a $24-billion financial assistance package for Russia, contingent on Russian progress in stabilizing and reforming its economy. However, Russia did not stabilize its economy, and the FSU debt arrears situation worsened. In April 1993, Russia’s official creditors (i.e., creditor country governments) found it necessary to reschedule a significant amount of Russian and FSU debts due in 1993. At the same time, the G-7 promised a new package of economic support for Russia. However, debt relief and other financial assistance have remained largely contingent on economic stabilization and reform. During the first half of 1994, Russia’s official creditors rescheduled additional FSU debt and agreed to meet later in the year to consider longer and more comprehensive rescheduling.

How Debt Became a Problem

For decades the Soviet Union was a conservative user of western credits and was regarded by western government and commercial lenders as an excellent credit risk, given its huge gold reserves and other exportable raw materials. During the first 9 years of the 1980s, the Soviets usually ran hard currency current account surpluses.

In the mid- and late 1980s, political detente and increasingly lax fiscal policies of the Soviet government led to a rapid increase in commercial lending to the Soviet Union, according to the World Bank. It estimates that the Soviet Union’s gross hard currency debt more than doubled, from $38.3 billion at the end of 1987 to $81.5 billion at mid-1993 (see table 3.1).

In 1989, the Soviet Union experienced a negative hard currency trade balance of $2.4 billion due to surging imports. The imbalance was financed by hard currency borrowing. During 1989 and 1990, a growing debt burden, debt-servicing problems, and increasing world concern about a collapsing Soviet economy and political disintegration began to affect the country’s access to the commercial financial market. According to the World Bank, the surge of imports caused a severe liquidity crisis, leading to a buildup of arrears to western banks and suppliers. The liquidity crunch was exacerbated, in part, because the government had extended authority to Soviet enterprises to negotiate overseas business.

According to a World Bank analysis, the Soviet Union was $4.5 billion in arrears at the end of 1990 (see table 3.1). In an earlier analysis, the bank estimated that about 10 percent of year-end 1990 arrears was guaranteed debt to official creditors, 30 percent unguaranteed debt to commercial banks, and 60 percent debt to others (mainly suppliers). As arrears accumulated, commercial banks reduced and then stopped new lending. The Soviet Union was faced with large net repayment obligations, which it financed to a great extent out of its deposits in western banks. As a result, these liquid reserves fell sharply, from $14.6 billion in December 1989, to $8.6 billion in December 1990, and to $6.4 billion by March 1991. At the end of 1991, estimated reserves were only about $5.1 billion, which represented less than 2.5 months’ coverage of import costs. According to one source, a 3- to 6-month coverage is generally considered adequate.

Gold reserves, the other major component of the FSU’s international reserves, were apparently either drawn down to very low levels or already at low levels. Thus, they were not available for financing the liquidity problem. According to 1991 Central Intelligence Agency (CIA) estimates, Soviet gold reserves had ranged between 1,679 metric tons in 1980 to 2,105 metric tons in 1990, with a peak level of 2,366 metric tons in 1985.However, during the latter part of 1991 an economic adviser to the Soviet President asserted that the Soviet government had been selling off large amounts of gold reserves for several years. He added that only 240 tons of reserves were left (valued at less than $3 billion). In May 1992, the U.S. Minister Counsellor for Economic Affairs at the U.S. embassy in Moscow told us that Russia had only 220 metric tons of gold. He said these amounts were minimal reserves. In early February 1993, a former Soviet prime minister said that the Soviet Union had squandered its gold reserves before President Gorbachev took over in 1985 but had managed to keep the matter secret until 1991.

Structure, Composition, and Maturity of the Debt

Due to its problems with debt servicing, by 1990 the Soviet Union had become a high-risk country for lenders. The worsening political, economic, and liquidity conditions virtually halted the flow of commercial financing. This halt in commercial financing became an impetus for western governments to undertake considerable official financing. Consequently, the structure of Soviet debt was substantially altered, as evidenced by changes in the source and maturity of the Soviet debt.

Whereas commercial banks and other private creditors had accounted for 78 percent ($44.1 billion) of the Soviet Union’s convertible currency debt at the end of 1989, they held only 41 percent ($25 billion) at the end of 1991. Conversely, Soviet official bilateral debt increased from $12.4 billion, or 22 percent of convertible currency debt, to $36.5 billion, or 59 percent, during the same period.

A substantial change in the maturity of FSU debt accompanied the change in the sources of FSU debt. As commercial lenders increased their efforts to collect on their short-term loans, western governments extended medium- and long-term credit or credit guarantees. Whereas in 1988 about 27 percent of the debt was short term, at mid-1992 short-term debt was estimated at only 17 percent.

As table 3.2 shows, in mid-1991 Germany was by far the largest creditor of the FSU, accounting for more than two-fifths of FSU external debt. However, much of the debt to Germany (about 40 to 43 percent at the end of March 1991) was owed to the former German Democratic Republic (East Germany). The United States was not among the six biggest creditors.

Table 3.3 provides information on both loans and grant assistance pledged to the FSU by the G-7 nations and the European Community during 1990 through 1992. It shows that Germany pledged the largest amounts of both loans and grants during this period—$54 billion out of $81 billion. The United States was second, with combined pledges totaling about $9.2 billion.

Soviet Debt Situation Reaches a Crisis Point in Late 1991

The year 1991 marked a turning point for Soviet debt as well as for Soviet territorial, economic, and political integrity. The hard currency situation worsened significantly as a result of capital flight and declining exports, particularly oil. According to a World Bank report, capital flight for 1991 was estimated at about $15 billion. That figure represents a staggering 88 percent of Soviet contractual debt service for the year and 61 percent of estimated merchandise exports.

According to the Wharton Econometrics Forecasting Associates (WEFA) Group, in 1991 Soviet oil exports fell by about 50 percent from the previous year’s level; iron ore, by 64 percent; steel mill products, 70 percent; timber, 50 percent; and diesel fuel, about 25 percent. Declining exports adversely affected hard currency earnings. Whereas 1990 hard currency earnings from merchandise exports were $36 billion, according to WEFA, in 1991 the earnings equaled only about $24.8 billion. According to WEFA’s figures, most of the decrease can be accounted for by reduced fuel exports. In terms of dollar earnings, the value of Soviet fuel exports to nonsocialist countries fell from an estimated $21.8 billion in 1990 to $9.2 billion in 1991. Soviet merchandise imports also declined markedly—from $39.5 billion in 1990 to $25.4 billion in 1991—due to the lack of hard currency and the unwillingness of foreign commercial banks to grant short-term credits.

Following the failed coup in August 1991, Soviet economic deterioration and political disintegration accelerated. A crisis point was reached in autumn, when the Soviet Union found itself unable to repay all of its debts and to secure new credits badly needed to purchase food imports. Owing to concern about whether the Soviet Union would continue to exist, officials of the G-7 nations indicated that additional western loans would not be forthcoming unless the various Soviet republics pledged to honor the Soviet Union’s debt, according to various Soviet media reports. On November 21, 1991, six Soviet republics signed an agreement with the G-7 nations affirming joint and several liability for the outstanding debt of the Soviet Union, based on an October 28, 1991, memorandum of understanding. Subsequently, two other republics also signed the document. (See table 3.4.) The eight also agreed to carry out economic reforms recommended by the IMF, including reducing fiscal deficits, public expenditures, and monetary growth and liberalizing prices and the foreign exchange rate.

Debt Deferral Agreement of November 1991

The hard currency crisis was temporarily alleviated on November 21, 1991. On that day representatives of the G-7 nations reached agreement with the Soviet government and governments of 8 of the 12 republics on a financial package designed to ease Soviet liquidity problems. According to the U.S. Department of the Treasury, the package included the deferral of about $3.6 billion in principal payments on medium- and long-term debt contracted before January 1, 1991, and falling due to official creditors in G-7 nations before the end of 1992; the maintenance of short-term credit lines by G-7 nations’ export credit agencies; and the possible emergency financing of up to $1 billion in the form of a loan secured by gold.

In December 1991, the Soviet Union was formally dissolved. During that month, eight republics of the Soviet Union reached preliminary agreement among themselves on how to share the external debt and assets of the FSU. (See table 3.4.) The signatory republics agreed to accept responsibility for a portion of the Soviet Union’s overall foreign debt and to set up an interrepublic debt management committee to oversee handling the Soviet Union’s debts and assets. The committee calculated preliminary debt shares for the 15 republics on the basis of each republic’s economic stature within the union. Table 3.4 shows which republics signed the agreement and the debt shares of the republics.

Also during December 1991, the Soviet Union suspended all principal payments to commercial creditor banks for loans made before January 1, 1991. An agreement between the commercial bankers and officials of a majority of the successor states stipulated that talks on the issue resume in March 1992.

On January 4, 1992, 17 principal creditor nations, including the G-7 countries, met in Paris with VEB, the designated debt manager for the 8 former republics that signed the October 28, 1991, memorandum of understanding previously discussed. The creditors agreed to defer principal payments on medium- and long-term official debts contracted before January 1, 1991, and falling due from December 5, 1991, to the end of 1992. They said the deferral would continue beyond March 31, 1992, provided satisfactory progress were made by the debtor countries in mobilizing foreign exchange and adopting comprehensive macroeconomic and structural adjustment programs, in full consultation with the IMF.

Role of International Institutions and Linkage to Economic Reform

Shortly before and following the dissolution of the Soviet Union, Ukraine, Russia, and other republics requested membership in the IMF and the World Bank. Membership in the international financial institutions could lead to substantial new financial assistance from abroad and help the new states to improve their creditworthiness. The United States and other members of the G-7 nations concluded that the international financial institutions could be used to promote economic reform in the FSU and to coordinate western financial assistance. They encouraged the new states to develop economic adjustment programs that could be supported by the institutions.

On March 31, 1992, the IMF endorsed a draft economic reform program that had been prepared by the Russian government. A suitable reform program was a condition for extension of the moratorium on debt service payments for the FSU. Among the program’s main points were that the Russian government would (1) reduce its budget deficit to 1 percent of gross national product (GNP) by the end of 1992 through cuts in military spending and subsidies to enterprises; (2) tighten central bank monetary and credit policies; (3) adopt new taxes, including restoring a 28-percent value-added tax; and (4) target social subsidies more precisely, so aid could be provided to the most needy and the unemployed. Russian officials claimed the program would slow the rate of inflation to 1 to 3 percent by the end of 1992. They also said the reform program would have to be cut back if Russia did not receive substantial foreign financial aid, including debt relief, a stabilization fund for the ruble, and balance-of-payments support.

On April 1, 1992, the United States and other G-7 nations announced support for a $24 billion international aid program for Russia. The package was to include rescheduling of $2.5 billion of official debts of the Russian government. It also was to include about $11 billion in bilateral aid (export credits and humanitarian and other foreign aid) from the G-7 nations; $4.5 billion in loans from the IMF, World Bank, and the European Bank for Reconstruction and Development; and a $6-billion fund to stabilize the ruble for Russia and other former Soviet republics that continued to use the ruble. The stabilization fund was to be funded by IMF member loans to the IMF. However, implementation of much of the aid package was seen as contingent on Russian progress in stabilizing and reforming its economy, and including IMF approval of an IMF standby program.

In mid-April 1992, the IMF Managing Director reported that the challenge involved in trying to engineer a transformation from command to market economies in the former Soviet republics would cost billions of dollars in outside aid from the IMF, the World Bank, the governments of industrial nations, and private investors over the next 4 years. After taking into account the expected level of exports, the obligation to service the debt, the need to replenish international reserves, and the allowance for a stabilization fund for the ruble (about $6 billion), the financing requirement for 1992 in Russia alone, the Director said, could be $20 billion to $25 billion. IMF projections for the other republics, he said, indicated an external financing requirement of about $20 billion in 1992. He estimated that the IMF could provide $25 billion to $30 billion over the next 4 to 5 years. Other sources indicated the World Bank might provide as much as $12 billion to $15 billion for development projects over the same period. The IMF Director noted that if the transformation is to succeed, private capital will eventually have to play the leading role.

On April 27, 1992, the IMF and the World Bank approved membership for Russia and most other republics. Russia became a member on June 1, 1992. However, most aid was held up pending further agreement between Russia and the IMF concerning the nature of the Russian reform program and the terms for an IMF standby loan to Russia. Concerns were raised about whether Russia remained committed to and would implement an adequate reform program. In fact, in the spring of 1992, the Russian reform program was relaxed in response to attacks by domestic critics, particularly in the Russian parliament. For example, the government gave miners large pay increases; promised new bank loans to help state enterprises teetering on the edge of bankruptcy; and agreed to delay until June 1992 an 80-percent increase in oil, gas, and electrical prices scheduled for April.

With final agreement on a reform package still not achieved between Russia and the IMF by June 1992, the IMF proposed a compromise approach: it would advance Russia $1 billion of a planned $4-billion standby loan before agreement was reached on the reform program. In July, the G-7 nations expressed support for the proposal. On July 5, the IMF agreed to release $1 billion to Russia; however, the $1 billion was to be retained in Russia’s international reserves.

Debt Servicing Problems Worsen

In spite of the 1991 deferrals, the successor states have not kept current on servicing the FSU debt. As table 3.1 shows, during 1992 arrears on the Soviet debt more than doubled (from $4.8 billion at the end of 1991 to $11.8 billion at the end of 1992). Capital flight continued to contribute significantly to the FSU’s liquidity problems. The World Bank estimated capital flight during the first 8 months of 1992 at $5 billion to $8 billion ($7.5 billion to $12 billion on an annualized basis).

In June 1992, Russian officials requested that the G-7 agree to a 5-year moratorium on repayments of principal and interest on all FSU debt. In July, G-7 leaders discussed a 10-year restructuring of both principal and interest payments, with a 3- to 5-year grace period. At the July 1992 G-7 meetings, they expressed support for the Russian President’s proposal to defer Russia’s share of the FSU debt. However, they also made it known that the deferral issue had to be addressed by the Paris Club. Following the G-7 meeting, the Russian President indicated that his country would also consider proposals for swapping debt relief for Russian land, buildings, raw materials, and oil and gas exploration rights.

Meanwhile, the December 1992 agreement that had deferred principal payments on commercial FSU debt through March 1992 was reextended in June and again in September 1992.

Negotiations with Russia on debt restructuring got underway with the Paris Club in late 1992. According to the World Bank, as a result of capital flight, lower gold sales, and already depleted reserves, FSU external debt servicing reached only $1.3 billion during the first 3 quarters of 1992—far short of scheduled obligations.

Differences Between Russia and Other Republics Complicate Situation and Affect Credit Standing of All

Under the G-7 Debt Allocation Treaty of December 4, 1991, Soviet successor states were to transfer foreign exchange to VEB for FSU debt payments. However, in December 1992, the World Bank reported that Russia had been the only contributor since late 1991. One reason why other republics had not contributed was a lack of agreement on the disposition of the FSU assets.

An official of the Kazakhstan bank responsible for guaranteeing foreign loans told us that none of the former republics, except Russia, were making payments on the FSU debt. He said payments were not being made because (1) Russia had not divided up the FSU assets and (2) VEB had frozen the hard currency accounts of enterprises located in the other states. Ukrainian officials also told us that the assets had not been divided and hard currency accounts had been frozen. Ukrainian officials also said it was not true to claim that the other states were not paying their debt shares because Russia might be using or might already have used hard currency from the other states’ frozen enterprise accounts to make payments on the debt.

Ukrainian officials said that Ukraine (1) had accepted responsibility for 16.4 percent of the FSU’s debt, (2) was ready and wanted to begin paying off its debt, and (3) was willing to pay 20 percent of the total debt if states other than Russia could not pay their share. However, the officials indicated Ukraine was not willing to make payments on Ukraine’s share through VEB, because there was no assurance that the latter would use the monies to pay off Ukraine’s debt: VEB might instead use the funds to pay off Russia’s debt or the debt of some other republic. Consequently, the officials said, Ukraine wanted to deal directly with its creditors.

Kazakh officials said Kazakhstan had tried to arrange to pay debt owed to Germany’s Deutsche Bank directly to the bank rather than through VEB Moscow, but Deutsche Bank had not agreed to such an arrangement.

Uzbek officials said the debt share apportioned to their country was not fair. They said Uzbekistan did not even know how much of the FSU’s debt had been expended on Uzbekistan and that Uzbekistan’s appropriate share of the old debt was still under discussion. They also said the Uzbekistan government was prepared to pay its share of debt once it was provided accurate data on how Uzbekistan’s share was calculated.

Russian officials denied that the enterprise accounts of other former republics were frozen. Rather, they said, all of the funds in the enterprise accounts (estimated at $10 billion for all republics, including Russia) had been spent by the Soviet government before the dissolution of the Soviet Union. The money was used to pay foreign debts and to purchase grain and food imports. A VEB official said that although all of the states considered themselves responsible for the FSU’s hard currency external debt, only Russia had accepted responsibility for the FSU’s hard currency internal debt. He estimated the latter at approximately $11 billion to $12 billion and said that Russia’s debt claims on the various other states would be far greater than the other states’ asset claims on VEB.

In June 1992, the Russian government launched negotiations with most of the other states aimed at assuming responsibility for their external debts if, in turn, the states agreed to forgo claims on the external assets of the FSU. As long as the issue is not fully resolved, the credit standing of all the republics could be adversely affected, we believe, owing to the previous agreement on joint and several responsibility. For example, according to the news organization Itar-Tass, on November 2, 1992, the Russian Deputy Prime Minister said that the Paris Club had indicated that the former Soviet republics would need to settle their debts fully with each other before the debt of the FSU could be rescheduled.

Toward the end of November 1992, a tentative agreement was reached between Ukraine and Russia, giving Russia the sole right to negotiate with Ukraine’s western creditors. In return, Moscow promised to negotiate a pact with Ukraine sharing remaining assets and liabilities. Each country reserved the right to renounce the agreement if either failed to agree to a bilateral pact by the end of 1992. However, an agreement was not reached by the end of 1992.

According to a State Department official, the Paris Club creditors were not willing to reschedule FSU debt unless satisfactory arrangements were reached between Russia and Ukraine concerning responsibility for the debt. During the early part of 1993, Russia and Ukraine made some progress toward reaching an agreement. On the basis of this progress, the Paris Club creditors felt sufficiently comfortable to consider Russia as primarily responsible for FSU debt, subject to conclusion of an agreement between Russia and Ukraine. The Paris Club decision means that the creditors will pursue Russia first in their efforts to secure payment of FSU debt. As of December 1993, Russia and Ukraine had still not finalized an agreement on the handling of FSU assets and debts.

According to the World Bank, by the end of 1993, nine republics had signed agreements with Russia to exchange FSU assets for debt, and Ukraine and Georgia were negotiating with Russia. Russia had also offered to sign agreements with the Baltic countries. However, according to the bank, the Baltic countries had taken the position that they were not the legal successors of the FSU and therefore could not take responsibility for servicing and paying off its debt.

Western Nations Reschedule Debt and Offer New Financial Assistance in 1993

In early 1993, western governments became increasingly concerned about a deteriorating political situation in Russia and the possibility that Russia’s commitment to democracy and economic reform might be reversed (see ch. 4). As a result, in April the G-7 nations agreed on a $28.4-billion package for providing economic support to Russia. In addition, as part of the effort to assist Russia, the United States and other western creditor governments agreed to reschedule some $15 billion in Russian and FSU debt.

Financial Assistance Package

On April 15, 1993, representatives of the G-7 nations and the European Community announced agreement on a new package for providing financial assistance to Russia. A considerable portion of the G-7’s April 1992 aid package had never been forthcoming, in part because Russia had failed to stabilize its economy and reach agreement with the IMF on a standby agreement. As table 3.5 shows, the 1993 package included renewed commitments of support from 1992, totaling $7 billion, and it included $21.4 billion in new commitments for 1993.

As was the case with the financial assistance offered by the G-7 nations in 1992, there was no assurance that Russia would receive all of the aid. While some of the assistance was expected to start flowing quickly, fulfillment of the package remained contingent on Russian progress in stabilizing its monetary situation and continuing the process of structural economic reform. In addition, much of the assistance depended on the cooperation of multilateral institutions, including the IMF, the World Bank, and the European Bank for Reconstruction and Development. Russian cooperation was also needed.

During early 1993, the G-7 encouraged the multilateral institutions to ease up on their normal standards for conditionality and to provide financial assistance earlier as a way of encouraging later reform. On April 23, 1993, the IMF approved creation of a new loan facility for this purpose—the Systemic Transformation Facility (STF) that was included in the April 15 proposal of the G-7 and the European Community. The program is designed to provide several billion dollars in low-interest loans to Russia, and possibly other former socialist countries as well, under less stringent financial conditions than is typical for IMF loans. For example, countries are not required to have a standby loan in place to receive STF loans. The loans would be approved in two segments, with the first half disbursed immediately. Although a standby loan program is not required, a commitment to achieving macroeconomic stabilization is still important for receiving STF loans. STF is a temporary facility that expires at the end of 1994; however, withdrawals can be completed as late as the end of 1995.

In early June 1993, the IMF held up approval of an STF loan that it was considering for Russia, in spite of pressure from the United States and others. However, on June 30, 1993, it approved a first drawdown of $1.5 billion on a $3-billion loan. In return, Russia committed itself to reducing its budget deficit to 5 percent of gross domestic product (GDP) and its monthly inflation level to a low, single-digit level.

In July 1993, the G-7 established a $3-billion privatization and restructuring program for Russia that was expected to distribute funds over an 18-month period. It was to be made up of $500 million in bilateral grants to be used largely for technical assistance to newly privatized companies; $1 billion in bilateral export credits and $1 billion in World Bank and European Bank for Reconstruction and Development loans to be used by Russian companies to import western goods; and $500 million in World Bank loans to be used by local Russian governments to help them make up for health, education, and other services previously supplied to employees by state-owned companies.

In late September 1993, President Clinton signed a foreign aid bill that authorized $2.5 billion of assistance for Russia.

Debt Rescheduling Agreements

On April 2, 1993, representatives of the United States and 18 other western creditor governments reached a political agreement with Russia to recommend rescheduling $15 billion in Russian and FSU debt. The agreement concerned all arrears (at the end of 1992) on medium- and long-term official and officially guaranteed debt incurred before January 1, 1991, and maturities relevant to that debt falling due in 1993. This rescheduling referred to a 10-year span, with a 5-year grace period. Other obligations were also rescheduled, including those related to medium- and long-term obligations incurred during 1991, some short-term debt obligations, and some moratorium interest falling due during 1993. These latter obligations were rescheduled over 7 years, with a 2-year grace period.

Arrears not covered by the rescheduling were to be fully paid by June 30, 1993, and Russia was required to stay current on all other scheduled payments. Under the agreement, interest would continue to accrue on deferred or rescheduled debt and would have to be repaid as it came due. However, 60 percent of the interest due in 1993 was rescheduled. Governments of the creditor countries were to work out the details in bilateral agreements with Russia. Russia committed itself to seek comparable terms from other external official creditors, banks, and suppliers.

In effect, the April agreement was a practical recognition by official western creditors that Russia could not service most of its debt in 1993. By rescheduling overdue debt and debt likely to fall into arrears in 1993, the April agreement would enable Russia to apply for new loans from western governments and other creditors.

According to a Treasury Department official, under the April agreement Russia also agreed to accept responsibility for repaying all of the official FSU debt.

According to CCC, the April agreement was concluded outside of the Paris Club. Ordinarily the Paris Club does not reschedule government-to-government debt unless an IMF economic reform program is in place. Nonetheless, the agreement required that the Russian government adopt and implement an ambitious and comprehensive macroeconomic and structural adjustment program. The Russian delegation stressed the strong determination of its government to reduce Russia’s economic monetary and financial imbalances and to conclude an IMF upper credit tranche arrangement approved by the IMF Executive Board. Signatory creditor governments could declare the agreement null and void if Russia had not concluded an upper tranche arrangement by October 1, 1993. Russia did not conclude such an agreement by that time. However, the creditor nations waived their right to terminate the agreement. According to a State Department official, the creditors considered the IMF arrangement a significant issue, but they felt it was more important to normalize relations on the debt issue.

Commercial Debt Rescheduling

As discussed earlier, in December 1991 the former Soviet Union suspended all principal payments to commercial creditor banks made before January 1, 1991. In January 1992, commercial creditors, negotiating through a bank advisory committee chaired by Deutsche Bank, granted a 3-month rollover of debt payments. It was extended for each consecutive quarter through the end of 1993. All agreements deferred payment on current principal due during the individual deferment periods. Interest was mostly unpaid, however, and as of June 30, 1993, cumulative interest arrears on commercial bank debt were $2.4 billion, excluding late interest charges.

On July 30, 1993, Russia signed an agreement in principle with the commercial banks. According to Chemical Bank, the debt at that time included $24 billion in principal and $4.5 billion in interest arrears. Russia announced that it would make a $500 million partial payment on its interest arrears by the end of 1993, and the parties agreed to seek to restructure the overall debt in early 1994.

Developments in 1994

According to PlanEcon, at the end of 1993, Russia’s total debt was about $87 billion, and it estimated that Russia’s debt had increased nearly $9 billion during 1993.

At the time of the April 2, 1993, debt rescheduling agreement between Russia and its official creditors, the latter agreed to meet again with Russia in 1994 to discuss further debt relief. According to the World Bank, the creditors’ willingness to do so depended on Russia’s having an IMF upper credit tranche arrangement in place and arranging debt relief on other obligations due in 1993 (mainly commercial bank credit). However, according to USDA, on January 20, 1994, Russia’s major official creditors agreed, in response to a Russian request, to extend the terms of the April 2, 1993, agreement through April 30, 1994. They did so even though neither of the two above conditions was in place.

In March 1994, a State Department official told us that Russia and the IMF had begun serious talks on additional debt relief arrangements. The official indicated that debt relief was no longer being made contingent on Russia’s having an upper credit tranche arrangement or concluding a debt rescheduling agreement with commercial creditors. In March 1994, the IMF Director indicated a standby agreement would not be possible until the second half of 1994, and he said that such an agreement would depend on Russia’s planned budget for 1995 and implementation of its STF program as intended. In addition, he said that the IMF must have a clear idea of how the process of disinflation was developing in 1994.

As of March 1994, the IMF still had not approved the second half of the $3 billion STF loan to Russia. According to the WEFA Group, the IMF was unhappy with Russia’s lack of progress in stabilizing its economy.Subsequently, on April 20, 1994, the IMF announced approval of the second drawdown, equivalent to about $1.5 billion. The IMF said it was approving the loan to support Russia’s 1994 economic reform and stabilization program.

The agreement was reached only after direct negotiations between the IMF Managing Director and Russia’s Prime Minister. According to the IMF Managing Director, the loan will provide foreign exchange and be part of the general financing. He noted that Russia has a lot of debt payments to make to the international community.

According to the IMF, the Russian program’s main objectives are to further reduce the rate of inflation through tighter fiscal and monetary policies and to consolidate and strengthen structural reforms and the transition to a market economy. The IMF said the monthly rate of inflation is projected to decline to 7 percent by the end of 1994, and the federal budget deficit is expected to represent about 7 percent of GDP during the year.

The IMF warned that success of the Russian program hinges critically on the strict implementation of the government’s fiscal plan. The IMF noted that various sectors would probably be reluctant to accept a reduced level of budgetary support. In addition, the IMF reported that Russia would clearly need a further comprehensive debt relief package to normalize relations with external creditors. The IMF said that external financing would also be needed by Russia and other FSU countries to help them consolidate large budget deficits in a noninflationary manner and to finance social safety nets. According to the IMF, official and private external financing would be available only in the context of strong and sustained stabilization and a reform program. Regarding the latter, as of November 1994, Russia had not concluded a standby loan agreement with the IMF.

As table 3.6 shows, the IMF, the World Bank, and the European Bank for Reconstruction and Development delivered only $3 billion of $19 billion in aid that was announced for Russia during 1992 and 1993. Total official aid delivered from all sources was only $23 billion or about 58 percent of the $40 billion announced. According to the IMF, much of the $17 billion that was promised but not received was due to Russia’s failure to implement appropriate macroeconomic stabilization policies.

Table 3.6 also shows that export credits accounted for most of the official assistance that was delivered in 1992-93. Some observers have been highly critical of the counting of export credits as financial assistance. For example, according to Jeffrey Sachs, a former financial adviser to the Russian government, most of the credits were short-term trade credits that had to be repaid in 1 to 3 years. Thus, the credits became government debt that rather quickly added to the government’s debt-financing problems.

On June 4, 1994, Russia’s official creditors agreed to reschedule about $7 billion in FSU debt payments due in 1994, including debt contracted before 1991 and during 1991. According to a Treasury Department official, the $7-billion figure includes payments that had been deferred under the January through April extension previously discussed. The rescheduling included some short-term debt and previously rescheduled interest. The agreement provided for a grace period of 2 to 3 years, with payback periods ranging between 5 and 13 years. Russia and its official creditors also agreed to meet later in 1994 to discuss longer term and more comprehensive rescheduling.

Regarding commercial debt rescheduling, on April 1, 1994, an official of Chemical Bank advised us that talks were being held between the Russian government and the bank advisory committee. According to the official, Russia had not paid any of the promised $500 million in interest during the last quarter of 1993 and had paid no interest during 1994.

In October 1994, the Russian government issued a statement saying it was prepared to assume legal responsibility for the former Soviet Union’s commercial debts. Also, in early October 1994 there were press reports that Russia had reached agreement with its foreign bank creditors on a framework for a long-term rescheduling of the commercial debt. However, a representative of Chemical Bank advised us that the terms of an agreement had still not been defined (e.g., grace period, number of years over which principal would be repaid, contractual interest rate). He said it was possible that an agreement could provide for a grace period of up to 5 years and for repayment of rescheduled debt over 10 to 15 years. He said commercial creditors hoped that the Russian government would make some kind of cash payment on the debt. There were, he said, hopes that an agreement would be reached in the near term, but an agreement was far from being wrapped up.

Conclusions

Between 1989 and 1991, the FSU experienced increasing debt problems. The situation reached crisis proportions in late 1991. Russia and many successor states eventually reached agreements whereby Russia would accept responsibility for external FSU debt in return for the other states not making claims on the FSU’s external assets. Russia has agreed with its official creditors to accept responsibility for the FSU debts. However, as of early October 1994, Russia had still not reached agreement with its foreign bank creditors on a framework for rescheduling and resuming payments on the FSU commercial debts.

Since late 1991, the United States and other official creditor nations have provided considerable debt relief to the FSU and its successor states. The United States, other official creditor nations, and the IMF have also provided important financial assistance to Russia. However, much of the promised financial assistance has not been forthcoming because of insufficient progress by Russia in stablizing and restructuring its economy. Although official creditor nations have provided considerable debt relief, additional debt relief is needed.

General Economic and Political Situation in the FSU/Successor States

During the past few years, the FSU and its successor states have experienced historic economic and political change. The process is not yet complete. The Soviet empire is gone, replaced by 15 successor states, and the central role of the Communist Party has been abolished. The region has begun to move away from the old command economy of the FSU toward market-like economies, and some progress has been made in establishing democratic institutions. However, progress varies widely across the successor states.

The successor states’ economies are in serious decline, and further deterioration is projected for most of them. Political legitimacy is an issue in a number of the new states. During 1993, Russia itself experienced a constitutional crisis concerning the respective roles of the parliament and the presidency in directing the affairs of the country, the direction and pace of economic reform, and the question of whether its leaders represented the views of the electorate. Five of the former Soviet republics have experienced significant armed conflict within their borders.

Whether efforts to create effective market-based economies and democratic polities will succeed is not clear. Also uncertain is whether the political boundaries that resulted from the breakup of the Soviet empire will survive. Such uncertainties can affect the willingness of westerners to invest in the new states. Without substantial foreign investment, the new states’ creditworthiness can be adversely affected.

Background

It is 3 years since the Soviet Union disintegrated. Shortly before the breakup, the central administrative organs of the Communist Party were dissolved, its assets confiscated, and its archives seized. The party that dominated life in the Soviet Union for decades was banned or suspended in Russia and many other successor states. Also gone are the central governmental ministries and planning system in Moscow that played major roles in directing affairs across the various republics.

Having discarded the Marxist-Leninist ideology, the successor states are trying to make a transition from command economies to free and open markets. In addition, many have made progress toward establishing democratic institutions. Nonetheless, former Communist elites continue to govern under the names of newly created parties in many of the new states, and Communist elites cling to power at regional and local levels as well. Although the old Communist Party was banned as a national organization after the 1991 coup attempt, several neocommunist parties have been formed in Russia since then. They have a strong national organization and, as discussed in the following section, experienced some success in December 1993 elections for a new parliament. Former Communists were recently returned to power in Lithuania.

All of the states are experiencing acute economic crises that stem from the general economic collapse that preceded the dissolution of the Soviet Union and that has been further exacerbated by the breakup of the empire. Common elements of the crisis have included very high levels of inflation, hard currency shortages, and failing public health systems. Many of the new states are politically unstable, not only as a result of the economic crisis but also, in many cases, because of a lack of political legitimacy. Several states have been adversely affected by intraregional and internal ethnic and civil conflicts that have turned violent, particularly in the Caucasus region (see app. I).

The Economic Situation

The economies of the former Soviet republics are in disarray. Economic deterioration was a major factor associated with the development of the debt crisis and the disintegration of the Soviet Union itself. According to WEFA estimates, Soviet GDP fell by 2 percent in 1990 and 16.9 percent in 1991. WEFA estimated that aggregate GDP for the former Soviet republics declined another 20 percent during 1992. It estimated the cumulative drop for 1990-92 at 34.9 percent.

PlanEcon, a Washington, D.C., economic forecasting group specializing in East European countries, has estimated GNP losses for each of the former Soviet republics. According to its calculations, during 1989 through 1993, three of the republics/successor states sustained GNP declines ranging from about 12 to 26 percent (Belarus, Turkmenistan, and Uzbekistan); six states experienced declines of about 31 to 37 percent (Estonia, Kazakhstan, Kyrgyzstan, Moldova, Russia, and Ukraine); five states declines of 44 to 57 percent (Armenia, Azerbaijan, Latvia, Lithuania, and Tajikistan); and one state a decline of about 66 percent (Georgia). (See table 4.1.) The GNP estimates indicate that economic decline in most republics is already comparable to or greater than that experienced by the United States during the Great Depression.

According to a Congressional Research Service analysis, the breakdown of the economies of the former Soviet republics can be attributed to the legacy of the Stalinist economic planning system combined with incomplete economic reforms that were introduced during the Gorbachev era. Under the command economy, the state owned all the means of production and controlled production and investment decisions. The result was an inefficient system that produced, with only a few exceptions, poor quality goods and services. Gorbachev’s reforms included laws to decentralize economic decisionmaking but did not go far enough. The reforms reduced the discipline of the state-run economy but left intact most of its fundamental elements—price controls, nonconvertibility of the ruble, public ownership, and the government monopoly over most of the means of production.

The economic breakdown was manifested in monetary imbalances that led to high inflation and a shortage of goods as the former Soviet government ran up large budget deficits. The central government financed these deficits primarily by printing money, thereby generating inflation as increasing amounts of rubles chased decreasing amounts of goods. In addition, the distribution system collapsed. Direct relationships between suppliers and manufacturers and between manufacturers and distributors that were to substitute for the centrally controlled system did not fully develop.

Further Economic Decline Is Projected for Most FSU States

In February 1994, PlanEcon forecast another 2 years of economic decline in Russia and 3 years of additional decline in Belarus and Ukraine. It concluded that prospects for economic recovery in Armenia, Azerbaijan, Georgia, Moldova, and Tajikistan would remain bleak until their various political, interethnic, and territorial conflicts are resolved (see app. I). It forecast another 2 years of economic decline or stagnation in Kyrgyzstan, Turkmenistan, and Uzbekistan. And it forecast another year of economic decline in Kazakhstan.

There were four bright spots in PlanEcon’s forecast. Although forecasting another year of decline in Kazakhstan, PlanEcon said it anticipated a strong recovery in 1995 and 1996. The recovery would be led, directly and indirectly, by several large projects to develop Kazakhstan’s natural resource wealth that involve a commitment of substantial resources by a significant number of major multinational corporations. However, PlanEcon said its forecast would be endangered if developments materialize that discourage the continued participation of western firms in the joint ventures. Without the imminent takeoff of these joint venture products, Kazakhstan’s recovery would be more closely tied to and possibly even lag behind Russia’s recovery.

The other bright spots were the Baltic states. PlanEcon forecast recovery would get underway in these states in 1994 and 1995—provided that macroeconomic stabilization policies were continually pursued and that industrial restructuring got fully underway. According to PlanEcon, the Baltic states have made the most progress in transition toward market economies of all the former republics. PlanEcon said that tough monetary and fiscal measures had paid off—inflation had been sharply reduced, and all three states boasted strong new currencies. According to PlanEcon, (1) all three states closed 1993 with current account surpluses; (2) their trade balances were positive (except for Estonia); and (3) sizable aid and loan transfers, combined with surpluses in services, have made the near-term external payments picture quite solid. With generally stable monetary policies in place, PlanEcon said, they have been able to increase the level of confidence in their currencies, raise their foreign exchange reserves, and maintain the convertibility of their currencies for current account transactions. However, PlanEcon said, the Baltic states are highly dependent on foreign trade, including trade with the CIS. Consequently, prospects for recovery in foreign trade over the medium term, and thus their external payments environment, will depend on developments in the CIS and particularly Russia.

Economic Reform Has a Long Way to Go

As discussed in chapter 3, during 1991 the IMF and the G-7 encouraged Russia to set certain economic goals. Of all the CIS republics, Russia had the most reform-minded leadership, and its reform program set the pace for the others, according to the CIA. It has passed many of the laws and regulations required to establish market institutions and provide the necessary guidelines for private business activity. It took the lead on price deregulation. In terms of foreign exchange, it set exchange rates at more realistic levels, reduced the number of goods requiring export quotas and licenses, and abolished import quotas. It also made some serious efforts to stabilize its economy by reducing its budget deficit, and it made substantial cuts in defense expenditures.

However, Russia still has far to go to create a market economy. Russian fiscal and monetary restraint has weakened considerably in the face of pressures from the old establishment for increased spending and easier credit. Elements of that establishment—industrial managers, farm bureaucrats, and local government officials—are resisting reforms that reduce their influence and diminish their financial support.

In addition, Russia has also fallen far short of the goals that it outlined to the IMF in March and July 1992. As discussed in chapter 3, the March 1992 program called for Russia to reduce its budget deficit to 1 percent of GNP by the end of 1992 and indicated the rate of inflation would be slowed to 1 to 3 percent by the end of the year. In July 1992, Russian officials indicated to the IMF that these goals were not obtainable. At that time, they committed to reduce Russia’s budget deficit to below 10 percent in the second half of 1992 and to lower the monthly rate of inflation to 9 percent by December 1992. According to the IMF, Russia’s budget deficit in 1992 was nearly 19 percent of its GDP (see table 4.2). Regarding inflation, PlanEcon estimated that Russia’s average annual inflation in 1992 was 1,414 percent (see table 4.3) and that it averaged about 25 percent per month during the last quarter of 1992.

According to the IMF, Russia reduced its budget deficit considerably in 1993; however, the deficit was still more than 9 percent of GDP for the year. Russia also reduced inflation significantly during 1993. Nonetheless, its average annual inflation for the year was 905 percent, and PlanEcon estimated that monthly inflation during the last quarter of 1993 averaged 16 percent.

During the first half of 1994, Russia made unexpected progress in reducing inflation as the government maintained tighter fiscal and monetary discipline than had been expected. The average monthly inflation rate fell below 10 percent. PlanEcon estimated that the federal budget deficit during the first half of the year amounted to about 10.4 percent of GDP. However, during the summer, monetary policy was relaxed, raising concerns that inflation would significantly increase before the end of the year. In early October, the ruble began to depreciate significantly. A crisis erupted when the Russian ruble lost more than 25 percent against the dollar in 1 day, October 11—raising new concerns about the effectiveness of the government’s efforts to stabilize the economy. President Yeltsin fired the Finance Minister, sought the resignation of the head of the Russian Central Bank, and appointed a state commission to investigate the situation. The day following the collapse of the ruble, Russia’s Economic Minister was reported to have attributed the ruble collapse, in part, to the government’s easing of monetary and credit policy.

Progress in stabilizing economies and implementing economic reform varies widely across the other successor states. As table 4.2 shows, 12 other states had budget deficits in 1993. For 10 of the 12 states, the deficits ranged between 6.1 percent to 52 percent of GDP. Regarding inflation, PlanEcon estimated that 12 other states had average annual inflation rates in 1993 ranging between 410 percent and 10,000 percent. Estonia and Latvia, the countries with the lowest inflation, had annual rates of 55 and 108 percent, respectively. (See table 4.3.)

According to PlanEcon, little progress on economic reform has been made in many of the successor states. For example, Armenia, Azerbaijan, Georgia, Moldova, and Tajikistan have been sidetracked by war, civil conflicts, and/or trade embargoes. Kyrgyzstan, Tajikistan, Turkmenistan, and Uzbekistan continue to adhere to many features of the old centrally planned systems, including state orders, price controls, and trade regulation through permits and quotas. Belarus has failed to undertake any significant economic reform, partly because of a parliament dominated by old-style Communists. Kazakhstan hesitated in introducing market reforms during 1992 and 1993. Since then, it has begun to accelerate the transition, yet is still struggling to set up the institutions needed to manage the economy of an independent state. Ukraine made some progress on economic stabilization and reform during later 1992 and early 1993, but meaningful reform was then largely abandoned in favor of a return to greater central control. According to PlanEcon, the members of the old Communist Party continue to dominate that country.

Recent IMF Assessment

According to an IMF May 1994 assessment, most FSU successor states had not yet achieved a reasonable measure of macroeconomic stability.

Exceptions cited were the Baltic states. High inflation and budget deficits, the IMF said, are contributing to economic uncertainty and inefficiency, the impoverishment of vulnerable groups of people, capital flight, and a protracted adjustment period. The high inflation and budget deficits are also discouraging needed foreign investment. According to the assessment, states that have pursued very expansionary monetary and fiscal policies (Belarus, Russia, and Ukraine are cited as examples) have not significantly mitigated the large declines in output associated with the transition to market economies.

In those countries where macroeconomic stability has not been achieved, the IMF said, the first priority should be to eliminate the underlying sources of inflation—by sharply reducing budget deficits and reining in credit growth. Tax reform is required to enhance revenues and reduce distortions. Expenditure reform is required to reduce subsidies and to target social assistance more effectively. Eliminating excessive credit growth requires allowing financial markets rather than central banks to allocate credit at market-determined rates.

The IMF found that most countries in transition have made substantial progress in structural reform. In particular, it said, prices are now largely market determined, and international trade has been liberalized in many countries. Privatization has also proceeded rapidly in some—but not all—countries. However, the IMF also found that the reform process has been significantly delayed in most FSU countries because the large declines in economic output, high inflation, and erosion of the financial position of vulnerable groups have resulted in severe economic and social strains. In some cases, the IMF said, the strains threaten to derail the reform process. As a result, it said, all countries in transition still face a daunting agenda of structural reform, which is crucial to the medium-term prospects for economic growth. A priority for the FSU countries (except the Baltics) is the elimination of the system of state orders, bilateral trading arrangements, barter agreements, and export controls and tariffs. These distortionary measures should be replaced, the IMF said, with more uniform tariff structures at low rates, a workable interstate payments system, and a trading system based on the most-favored nation principle.

According to the IMF, privatization and enterprise reform are central to the establishment of market economies but are proceeding more slowly in most FSU countries than had been anticipated. As a result, it said, the pace and scope of privatization need to be strengthened, particularly to include the large enterprises. Land reform, including liberalized real estate markets and the privatization of agricultural land, should be speeded up in most countries. In addition, there is an urgent need in most of the countries to strengthen the financial sector and put in place a legal framework of property rights and effective bankruptcy procedures.

According to the IMF, the decline in FSU and its successor states’ output has put great strain on social, economic, and public institutions. It said the old, the unemployed, and the unskilled have been exposed to severe hardship as inflation has eroded the real value of pensions, unemployment benefits, and minimum wages. In general, the patchwork of enterprise-provided social services that prevailed under central planning has not been replaced by adequate alternatives, and the absence of a social safety net has deterred firms from shedding labor. IMF said that there is an urgent need to maintain the purchasing power of many benefits in the face of inflation and to better target benefits by overhauling eligibility criteria and benefit structures, while keeping expenditures at levels consistent with sustainable budgetary positions.

The Political Situation

The FSU’s political situation is characterized by great uncertainty, with the economic depression that has swept across each state a major destabilizing force. Between the latter part of 1992 and the end of 1993, Russia experienced a political and constitutional crisis that pitted the powers of the Russian presidency against the parliament. The conflict also included a struggle between those who supported the government’s western-oriented market reforms, democratization, and foreign policies against those who wanted to moderate or reverse one or more of these policies.

Conflicts have arisen among the republics over the disposition of the FSU’s armed forces, nuclear weapons and other assets, and foreign debts. Finally, historic ethnic rivalries that were largely suppressed during decades of Soviet rule have broken out into the open. They have already led to serious armed conflicts in five of the former republics—Armenia, Azerbaijan, Georgia, Moldova, and Tajikistan. Each conflict has affected Russian minorities living there, and Russia has employed military forces in some of the conflicts to protect its minorities and other interests. Russia has also deployed troops within its own borders in an effort to separate ethnic combatants and prevent a further spread of violence. (See app. I.)

Developments in Russia19

Russia is the most important of the republics, because it accounts for the large majority of the area, population, and resources of the FSU, and because it has been in the forefront of CIS republics attempting to institute economic and political reforms. Russia includes several highly disparate regions, each of which has an economy larger than nearly all of the other former Soviet republics.

Russia’s population of more than 148 million includes over 150 ethnic groups. Several ethnically based groups have declared themselves sovereign entities and are practically self-governing. These include the Chechen and Tuva Republics and Tatarstan. One concern is whether some of the larger ethnically based groups will be content to remain a part of the Russian Federation or will prefer to seek full independence. Russia’s integrity and viability could be threatened if certain groups seek to leave the country. A related concern is that conflict between minorities could become violent and challenge the Russian government’s ability to maintain order. As discussed in appendix I, Chechens declared independence in 1991, but Russia did not recognize Chechnya’s claim to independence. In late 1994, the Russian government sent large military and police forces into Chechnya to disarm the Chechens and restore Russia’s authority. Chechens fought back fiercely. The conflict could seriously affect Russia’s transition to democracy and a market economy.

For additional information about several of the other republics, see appendix I.

successor states as a pretext for intervention and possible territorial aggrandizement.

As discussed previously, in early 1992 Russia embarked upon a serious economic reform program. During that year, the Russian President governed largely by use of special emergency powers that allowed him to enact changes by executive decree. However, his government found it increasingly difficult to implement its program because of the rise of a powerful industrial lobby that established considerable influence with the Russian parliament. The lobby included large enterprise managers, trade union leaders, and other conservatives who wanted to roll back the government’s economic reform program. The program threatened to restrict the lobby’s powerful role in the Russian economy by decentralizing economic decision-making and holding firms accountable for their actions. During 1992 the lobby demanded and received hundreds of billions of rubles worth of easy credits. It was aided by the Russian central bank, which controlled the printing of money and was responsible to the parliament rather than to the President. The bank’s policy of printing rubles and making large credits available to state-owned industry and farms undermined the government’s monetary and credit policy, threatening hyperinflation. As a result, the budget deficit became much larger than planned, and high inflation rates continued unabated.

Toward the end of 1992, a full-blown constitutional crisis developed. In November 1992, the President told the British Parliament that a cabal of militant nationalists and former Communist officials were plotting to overthrow him and sweep aside the economic and political reforms that his government had pursued. The President vowed to do whatever was necessary to prevent their success. In December, Russia’s supreme legislative body, the Congress of People’s Deputies, convened. As the Congress got underway, estimates indicated that only a minority of its members was committed to the government’s reform program; a larger minority was opposed. A crisis occurred when the Congress voted to not approve making the Acting Prime Minister, Yegor Gaidar, Prime Minister. He had spearheaded the government’s radical economic reform program. Following his rejection, the President declared that it had become impossible to work with the Congress. He called for a national referendum, to be held in January 1993, in which the public would be asked to choose between the Congress’ or the President’s ideas for leading Russia out of its economic and political crisis. The President said he would resign if he did not win the vote. The proposal was threatening to members of the Congress, since their terms were not due to expire until 1995 and a vote against the Congress could lead to early elections.

The crisis was temporarily defused in mid-December 1992 when the President and the parliament agreed instead to hold a referendum in April 1993 to approve the basic principles for a new constitution, such as whether Russia should have a presidential or parliamentary system of government. However, in January the parliament began to try to back away from holding a referendum. In February the President and the parliament explored possible compromise power-sharing formulas that would allow them to postpone or call off the planned April referendum. At issue, in part, were concerns that a referendum would contribute to separatist tendencies in Russia’s regions and to political and economic instability more generally. In March the Congress met in emergency session to decide whether to pursue a referendum or approve a power-sharing arrangement between the parliament and the presidency. Instead, the Congress chose to cancel the referendum and reduce the President’s powers. It gave itself authority to suspend the President’s decrees, made it easier to remove him from office for unconstitutional conduct, and indicated it would act to further reduce the President’s powers and dismantle many of his reforms.

In a televised address to the nation on March 20, 1993, President Yeltsin announced he was assuming temporary special powers to rule by decree and indicated he intended to hold a referendum on a new constitution and to secure a vote of public confidence in his leadership. Such measures were necessary, he said, to prevent restoration of Communist power. President Yeltsin also said that he had ordered the Prime Minister to speed up the economic reform process, including introduction of private land ownership, and to assume control over Russia’s central bank. A few days later, Russia’s constitutional court ruled that the President had violated the constitution by assuming special powers (even though the court had not yet received a copy of a presidential decree ordering an assumption of special powers). On March 23, the speaker of the parliament called for President Yeltsin’s impeachment.

This crisis eased somewhat when the President’s decrees were published, since they backed away from the assumption of special powers. Even so, on March 28, 1993, nearly 60 percent of the members of the Russian Congress voted to impeach the President. However, the vote fell short of a required two-thirds majority. (Only a quarter of the legislators opposed the proposal to oust the President.) The Congress also rejected a proposal that called for elections for both the President and the parliament in November 1993. The Congress then passed a resolution calling for a referendum on April 25, with four questions to be put to the voters. They were whether the voters (1) had confidence in the President, (2) approved of the social and economic policies conducted by the President and the government since 1992, (3) considered it necessary to hold early elections for the presidency, and (4) considered it necessary to hold early elections for the Congress. The Congress did not approve questioning, as had been agreed upon in December 1992, the electorate on the basic principles for a new constitution.

The Congress stipulated that a majority of the electorate would have to approve any question put to the voters before a decision would be accepted. The standard exceeded the normal condition for referendums that 50 percent of the electorate simply vote. The higher standard was considered difficult to achieve, given an apathetic electorate. However, on April 21, 1993, Russia’s Constitutional Court ruled that the President need secure only a majority of votes by those actually voting on the issues of (1) confidence in the President and (2) approval of the President’s socio-economic policy.

In the April 25 referendum, a majority of those voting expressed confidence in the President, his handling of the economy, and early elections for the legislature. Nearly a majority (49.5 percent) voted for early presidential elections. However, the referendum did not bring an end to political gridlock or the constitutional crisis that had gripped Russia for many months. Less than a majority of the total electorate voted for early elections to the legislature and the presidency; consequently, early elections were not mandatory. Although there was a large voter turnout, key opponents of the President sought to discredit the election results before the vote counting had been completed and warned that the President might resort to unconstitutional measures to further his objectives.

Between then and September 1993, relations between President Yeltsin and the parliament deteriorated further. As a result, on September 21 the President announced that he was disbanding the parliament and decreed that elections for a new legislature would be held in December. The lower tier of the parliament responded by voting in favor of impeaching the President and declaring Vice President Alexander Rutskoi as Acting President. The latter said he was nullifying Yeltsin’s decree and named new ministers of defense, interior, and security. However, Yeltsin won support from the existing defense, interior, and security ministries.

On September 28 and 29, the Interior Ministry sealed off the White House (the building that housed the Russian parliament) with armored personnel carriers and barbed wire and ordered remaining armed parliamentary deputies to surrender their arms and leave the building. On October 3, thousands of anti-Yeltsin demonstrators overran police forces surrounding the parliament and seized control of several key facilities. There were many casualties, and the government launched a counteroffensive. The rebellion collapsed on October 4 when army troops subdued the opposition, including using armed force to retake the White House. Rutskoi and other hardliners were arrested.

Following the collapse, President Yeltsin, in a televised address to the nation, warned that conditions in the nation remained dangerously unstable and said that quick action was needed to eliminate the remnants of the old system and put a new democratic structure in place. To this end, he called for (1) a new constitution, (2) elections for a new parliament in December and possibly for new local legislatures as well, and (3) unswerving commitment to continuing economic reform.

Elections were held in mid-December 1993 but yielded mixed results. Voters did approve a new constitution for Russia, but progovernment parties fared poorly in the parliamentary elections. Hardline opposition parties won more than 40 percent of the popular vote and elected more deputies than those elected by the reformist parties. Ultranationalists, Communists, and their allies won the upper hand in the Duma, the more powerful legislative chamber. The significant representation that they achieved reflected widespread economic distress and increased opposition to President Yeltsin’s policies. Nonetheless, during the first half of 1994, Russian political developments were surprisingly favorable, according to PlanEcon, as the new parliament demonstrated greater professionalism and the President, Prime Minister, and parliament achieved more stability in their interactions with one another. However, as previously discussed, in late 1994 Russian military and police forces became involved in a major conflict in Chechnya, and the conflict could adversely affect Russia’s transition to democracy.

Political Reform in the Other States

As with economic reform, progress on political reform varies widely across the other successor states. According to PlanEcon, the Baltic states have established viable democratic institutions capable of managing the economic transition and relations with their neighbors, especially Russia. However, all of the other states remain considerably or even far behind. For example, owing to armed conflict and civil strife, Armenia, Azerbaijan, Georgia, Moldova, and Tajikistan have not even been able to achieve political stability. As a result, according to PlanEcon, none of the countries seems close to establishing the political stability necessary to promote economic recovery and attract foreign investment.

In Belarus, there was little political change until recently. According to PlanEcon, since January 1994, the chief of state resigned under allegations of corruption, the parliament adopted a new constitution, and the country elected a new president. However, the new president’s positions on major issues remained unclear. In addition, parliamentary elections have not been held since 1990, and the legislature is dominated by a faction that consists largely of holdovers from the old Communist regime.

In Central Asia, the political leaders of Tajikistan, Turkmenistan, and Uzbekistan have not strayed far from their Communist roots, according to PlanEcon. The President of Kyrgyzstan is characterized as somewhat of an exception. According to PlanEcon, he seems genuinely committed to change. However, he has been discouraged by corruption and resistance to reform and recently indicated that the people are not yet prepared for democracy. In Kazakhstan, the other successor state in Central Asia, policies have largely been decreed by its executive branch, headed by President Nursultan Nazarbayev. A new constitution was adopted in January 1993 that provided for a strong president (elected for 5 years), a legislature, and a quasi-independent judiciary. The country held its first parliamentary elections in March 1994, with the President’s political supporters securing a large majority. However, according to PlanEcon, both the candidate selection process and voting were not fair.

In Ukraine, the first post-independence parliamentary elections were held in March and April 1994. Ukraine also elected its second post-independence president in July. However, according to PlanEcon, the country is still governed by a Soviet-era constitution and a small cadre of bureaucrats, driven by greed and heavily influenced by industrial bosses, controls the levers of both legislative and executive authority.

Uncertain Future

As the prior discussion indicates, the economic and political situation in the FSU has changed dramatically, and there is much uncertainty about its future. As the CIA has noted, “an empire has collapsed, the dust has barely begun to settle, and the forces that will both buffet and propel reform are epic in proportion. The elements of uncertainty and unpredictability in this part of the world are greater than at any time since the Bolshevik Revolution of 1917.”

At issue is whether attempts to establish democratic and market-based systems will succeed. Also at issue is whether the political boundaries that resulted from the breakup of the Soviet empire will survive. According to one observer, possible outcomes for the area during the next decade include (1) splintering the empire into different groupings, with widely divergent foreign policies and cultures; (2) instability and possibly even civil war; (3) restoration of the Russian empire under an authoritarian, xenophobic, anti-Western regime; or (4) the emergence of truly independent democratic nations united by some form of a common market and collective security framework.

Regarding the latter two possibilities, PlanEcon recently concluded that a few of the new states have already begun to trade some of the normal attributes of sovereignty for closer ties with Russia. In support of this conclusion, it noted the following developments. During 1993, Russia muscled three recalcitrant countries into joining or promising to become full members of the CIS. Georgia had resisted membership since the collapse of the Soviet Union, but in 1993 the Georgian President asked for military assistance to prevent the overthrow of his government; simultaneously, he brought Georgia into the CIS. Azerbaijan, faced with a series of military defeats by the Armenians, turned to Russia for military support and, in exchange, began to participate more actively in the CIS. Moldova’s parliament had not ratified an agreement to participate in the CIS until Russia pressured it to do so in the fall of 1993. In addition, PlanEcon said, Tajikistan and Belarus have abandoned some of the normal attributes of sovereignty for closer integration with Russia. Tajikistan’s ruling group lost the initial rounds of a civil war and needed Russian assistance to reestablish control. The current government relies on Russian economic and security assistance to stay in power and has agreed to follow Russian security and economic policies. Belarus has said it will subordinate its economic, foreign, and security policies to Russia. According to PlanEcon, Kazakhstan and Ukraine are major question marks; if they relinquish the same powers as Belarus, Russia will have reestablished the heart of the former Soviet Union.

Some observers believe the successor states lack the necessary political and economic preconditions for undertaking large and instant reforms. For example, Peter Reddaway, a professor of political science and international affairs at George Washington University in Washington, D.C., has concluded that Russia’s deeply Sovietized political culture is highly unsuited to free markets, entrepreneurism, privatization, and the rule of law and will remain so for a decade or two, even with sustained western assistance. According to Reddaway, Russians have reached the limits of their stoicism after the demoralizing traumas of loss of empire, ideology, and familiar institutions, and with severely diminished real incomes.

Zbigniew Brzezinski, a former national security adviser to President Carter, has also indicated that the former Soviet republics enjoy little prospect of a successful transition to market-based democracies in the foreseeable future. According to him, the more realistic scenarios for the future of the FSU include (1) continued fragmentation of Russia itself—splitting perhaps into two or three states, with Moslem Central Asia going its own way; (2) emergence of an inward-oriented and rather authoritarian but modernizing Russian national state; or (3) establishment of an authoritarian and nationalist Russian state that seeks to recreate its imperial status. Brzezinski also said that the reforms demanded by the IMF and the West as part of the privatization process would force the post-Communist countries to accept prolonged, massive, and painful unemployment. This situation, he said, is politically and morally unacceptable; rather, the West should, at a minimum, help create some temporary safety nets for the victims of the transition process.

In June 1992, the CIA said that it expected the reform process to continue in Russia and elsewhere but believed the process would be contentious and marked by recurring crisis. The CIA said the process would probably last a decade—during which the downside risks would be enormous and the range of possible outcomes wide, including extended political deadlock and instability so serious that it could derail reform in both the economic and political spheres. In early 1993, the CIA reported that there were reasonable prospects that Russia would continue its positive internal transformation and integration into the western system of values, but inevitably with continued great travail. Moreover, it said, there remains the possibility that Russia could revert to dictatorship or disintegrate into chaos, with immediate disastrous consequences for the world.

In January 1994, the U.S. Ambassador responsible for coordinating U.S. assistance to the NIS advised Congress that a titanic struggle was underway in Russia over the future of the country. He said the struggle involved a long-term process that could take a generation or more to resolve. In March 1994, the Secretary of Defense said the struggle could lead to a fully democratic and market-oriented Russia, which he characterized as the best possible outcome imaginable or, in the worst case, an authoritarian, militaristic, imperialistic nation hostile to the West. The latter case, he said, could see a renewal of some new version of the old Cold War.

Economic and Political Situation Can Adversely Affect Foreign Investment

As discussed in chapter 1, one of the factors that affects the creditworthiness of countries is their ability to attract foreign exchange to finance new investment within their borders as well as their external debt. As discussed in chapters 3 and 5, estimates are that Russia and the other new states will require billions of dollars in outside financing over the next several years to engineer a transformation from command to market economies. However, as WEFA recently noted, the amount of direct foreign investment already in Russia is meager. It noted that estimates by Russian officials vary widely, citing figures ranging between $2 billion and $7 billion. Even the latter figure, WEFA said, is small relative to the size of the Russian economy and Russia’s professed desire for foreign investment. In April 1994, a Commerce Department official told us that most observers agree that total foreign investment in Russia is not more than $4 billion. According to a recent report to Congress, total U.S. companies’ investment in Russia is estimated at about $1 billion.

The willingness of foreigners to invest in the various new states depends importantly on their assessments of each state’s (1) political stability; and (2) willingness to pursue the economic reforms needed to establish viable market economies, according to PlanEcon and WEFA. Consequently, to the extent that there is considerable uncertainty about the future of economic reform and political stability in the new states, foreign direct investment is likely to be adversely affected.

Conclusion

Severe economic problems and political and ethnic tensions make the future political and economic situation of the FSU highly uncertain. As long as such uncertainty persists, the FSU successor states will be less likely to attract needed foreign investment, thus adversely affecting their creditworthiness.

Financial, Country Risk, and Other Assessments of the FSU/Successor States’ Creditworthiness

Before 1992, all of the successor states had a relatively small debt compared to their economic output. Since then, all would be classified as severely indebted if held responsible for their respective shares of the FSU debt. Many of the FSU states have agreed to give up their claim on FSU assets in return for Russia’s accepting their share of the FSU debt. This situation would reduce their debt burden but increase Russia’s. Most of the new states have experienced severe liquidity problems. Russia’s serious and growing arrears in debt payments, its inability to meet current and future debt payments, and its need to reschedule its debts demonstrate weighty creditworthiness problems. The secondary market for trading country debt has deeply discounted FSU securities. Since Russia has been commonly perceived as having major responsibility for the FSU’s debt, the discounting shows that commercial investors do not perceive Russia as creditworthy. In addition, several major, private-sector assessments of country risk have rated Russia and all other successor states as high-risk or low on creditworthiness. The lack of creditworthiness of the successor states exposes the GSM-102 program to a high level of risk. For example, GSM-102 credit guarantees on the outstanding principal for the FSU and to Russia and Ukraine equaled about 44 percent of the GSM-102 portfolio. Moreover, these guarantees represented nearly 60 percent of the program’s portfolio risk exposure, according to our calculations.

Debt Burden and Creditworthiness

The amount of a country’s debt burden can be an important indicator of its solvency—the ability to fulfill its obligations in the long run. All other things being equal, a country with a high debt level poses a greater risk of default than one with a low debt level. The burden that debt poses depends, in part, on its relationship to a country’s economic output and its capacity to earn foreign exchange. One method used for analyzing country debt burden was developed by the World Bank. The bank used four indicator ratios to assess whether developing countries are less, moderately, or severely indebted. The ratios are (1) debt to GNP, (2) debt to exports of goods and services, (3) debt service to exports of goods and services, and (4) interest payments to exports of goods and services. The World Bank established thresholds for each of the ratios to use in classifying whether a country has a low level of indebtedness or, alternatively, is moderately or severely indebted. For each indicator, the bank’s moderate threshold represents 60 percent of the value of the severe threshold. A country is classified as “moderately” or “severely” indebted if three of its four ratios exceed the corresponding thresholds shown in table 5.1.

The Debt Ratios

Debt-to-GNP Ratio. This is the broadest measure of the solvency of a country and its ability to fulfill its debt obligations. A low debt-to-GNP ratio suggests good creditworthiness, since it shows that a nation’s output is large relative to its debt obligations.

Debt-to-Exports Ratio. For countries that lack or are limited in their ability to draw upon foreign exchange reserves, exports are the principal means for obtaining foreign exchange needed to pay off loans. Countries with large export revenues relative to their debt are likely to be less vulnerable to foreign exchange crises and thus are less likely to default on their foreign loans.

Debt Service-to-Exports Ratio. Debt service ratios relate principal and interest payments to revenues received from the exports of goods and services. They indicate a country’s ability to service its debt from hard currency export earnings.

Interest-to-Exports Ratio. The interest-to-exports ratio indicates a country’s debt burden from the perspective of interest payments alone. Creditors generally do not reschedule interest payments on outstanding loans. If a country needs to reschedule its debt, creditors will want the country to at least stay current on its interest payments. The increasing frequency with which countries with debt service problems are rescheduling their principal payments has increased the relative importance of this indicator.

Debt Burden of the Successor States

Prior to 1992, the FSU and its successor states were not included in the World Bank’s debtor reporting system. Therefore, we used historical and forecast data for the FSU and the successor states to calculate their debt burden ratios and thus classify their overall debt burden.

For a variety of reasons, economic forecasts for the former Soviet Union and its successor states are difficult to make because of major uncertainties associated with their transition from command to market economies. These uncertainties include the form and pace of economic restructuring that will be attempted, the amount of external assistance they might receive, and the extent to which they will cooperate with each other. In addition, official statistics of the FSU and the new states are difficult to obtain and do not adequately capture the growing nonstate sector. Consequently, although we have attempted to minimize these data problems by using relative indicators such as ratios instead of absolute values, the forecast, as well as our analysis, should be used with caution.

Data were obtained from the WEFA Group. WEFA did not provide disaggregated data for the external debt of the successor states. We estimated the states’ individual debts by allocating total FSU debt according to a fall 1991 agreement among the successor states that assigned preliminary debt shares for each of the states. Other economic variables necessary for calculating the ratios were obtained from state level data as reported by WEFA. Although WEFA stopped making detailed forecasts for the FSU as an entity in October 1992, it continued publishing forecasts for each former republic. Its forecasts for the former republics were denominated in rubles. When there was a need to convert them to dollar values, we used PlanEcon data on historical or forecast market exchange rates to convert the republic data to their dollar equivalents (see below). The extraordinarily severe depreciation of the ruble relative to the dollar, however, may cause an undervaluation of the data for the former republics.

We made our analysis using historical and forecast data made by WEFA in January 1993. We were not able to obtain compatible, more recent data to update the forecast data. Nonetheless, we believe the underlying economic conditions for the forecasts have not been significantly altered for most of the successor states. Important problems being faced then are still being confronted by the states. Examples include large government budget deficits, decreasing economic output, and high levels of inflation.

Table 5.2 summarizes the results of our analysis, using the World Bank’s old methodology, in terms of whether and when each country is considered to have low, moderate, or severe indebtedness during 1988 through 1997.

As table 5.2 shows, before its dissolution in late 1991, the Soviet Union was a less-indebted country. If the outstanding 1988 through 1991 FSU debt were to be distributed among the republics according to the formula agreed upon in 1991, Belarus and Russia would be classified as less-indebted republics. In contrast, Armenia, Azerbaijan, Estonia, Georgia, Kyrgyzstan, Latvia, and Moldova would fall into the severely indebted category. For 1992, and for the 1993 through 1997 period, all of the states are classified as severely indebted.

As earlier indicated, we arrived at the debt classifications in table 5.2 by allocating the total FSU debt among the various republics. As discussed in chapter 3, many of the former republics have now reached agreement with Russia to give up their claims on FSU assets in exchange for Russia’s assuming their shares of FSU debt. Successor states that do this will have reduced their debt burden and thus may no longer be classified in the same category for the forecast years. At the same time, Russia will have increased its debt burden.

While a number of successor states have benefited from Russia’s assuming responsibility for all of the FSU’s debt, they have been hurt by a reduction in transfers received from Russia. According to the IMF, most FSU countries have experienced a steep decline in large explicit and implicit transfers, including fiscal transfers from the former Soviet Union budget, which disappeared in 1992, and the subsidy implicit in the underpricing of energy and raw material exports (relative to world prices). This subsidy was reduced significantly as interstate prices for these goods were raised. The IMF estimated that between 1992 and 1994, the loss of official transfers from Russia and the rise in the import bill—on the assumption that energy and materials prices rise to world levels—may cost the other FSU countries $15 billion, or about 15 percent of their estimated 1994 GDP (at market exchange rates).

In addition, a number of successor states have fallen into serious arrears as a result of trade deficits with other FSU countries. For example, PlanEcon estimated that Ukraine had a 1993 trade deficit with CIS countries of about $2.5 billion and that it owed Russia more than $1 billion for energy resources while having substantial arrears with Turkmenistan for gas deliveries. As a result, creditor states were refusing to deliver new supplies until old arrears were paid for. Turkmenistan has cut back on gas deliveries to Georgia because of the latter’s inability to pay for supplies. Armenia and Moldova have had large trade deficits with other CIS countries, especially Russia and Turkmenistan. Uzbekistan reduced gas deliveries to Kyrgyzstan and threatened to cut off all supplies if the latter did not pay its debts. Tajikistan has accumulated large deficits with Russia.

Liquidity and Creditworthiness

“Liquidity,” as used in this report, refers to a country’s ability to secure foreign exchange over the short- and medium-term future sufficient to meet its debt service payments. We used two different methods to measure the liquidity of the successor states: (1) We examined the gross financial requirements of a country, defined as the amount of financial resources needed to meet its debt service obligations and international payments, including imports of goods and services. (2) We constructed liquidity ratios that parallel the World Bank’s old method for measuring debt burden to assess the liquidity of the successor states.

Gross Financial Requirements of the Successor States

Table 5.3 provides recent historical and forecast data for the hard currency financial requirements for the former Soviet Union. Figures for 1992 and the forecast years of 1993 through 1997 treat the 15 independent states as a single aggregate. The data are from the WEFA Group.

WEFA’s forecast indicates that as an aggregate, the FSU will require major assistance to meet its gross financial needs during the next several years. As the table shows, WEFA forecast a negative current account balance—a nation’s trade in goods and services and net transfers—for each year during the 1993 through 1997 period. Net capital flows—direct and portfolio investments and changes in gold and foreign exchange reserves (not shown in table 5.3)—were estimated to be positive in each of the years but were not large enough to offset the current account deficit. Consequently, net debt, i.e., debt in excess of reserves (also not shown in table 5.3) is expected to grow throughout the forecast period. The net new credit (debt) required to finance the current account deficit and net capital flows is expected to decrease from a high of $11.3 billion in 1992 to $1.5 billion in 1996. However, when combined with the financing required to meet scheduled repayments on short-term and long-term debt, the financial requirements of the FSU and its successor states are considerable—ranging between $22 billion and $30 billion per year. Unless the successor states of the FSU receive substantial debt relief, they would require, on average, an estimated $24 billion annually of external financing between 1993 and 1997.

In contrast, according to the IMF, the annual average gross external financing for developing countries as a whole and for the former centrally planned economies as a separate grouping for 1990 to 1993 was estimated at $213 billion and $45.6 billion, respectively. Thus, the FSU annual gross financial requirement represents approximately 11 percent of the requirement for all developing countries and 53 percent of the gross financial requirement for all of the formerly centrally planned economies. It is doubtful that such a large financial inflow can be attained from financial markets if they are not confident that the successor states represent a growing economy and a stable investment climate.

We also provide in table 5.4 the distribution of the gross financial requirements among the successor states as well as the average ratio of the gross financial requirements to the gross domestic product for each republic from 1993 to 1997. The financial requirement of Russia and Ukraine combined accounts for about 85 percent of the total requirements for all successor states. However, when the gross financial requirements are viewed relative to the economic resources of the FSU and its successor states as measured by their GDP, the requirements of Russia and Ukraine represent only 27 percent of their respective gross domestic products. In contrast, the gross financial requirement for Estonia, Kyrgyzstan, Tajikistan, and Turkmenistan is less than $200 million each but represents several hundred percent of their respective gross domestic products.

Liquidity Ratios of the Successor States

We used four indicator ratios to measure liquidity: (1) foreign exchange reserves to imports, (2) current account balance to GNP, (3) government budget balance to GNP, and (4) short-term debt (credit) to imports. These variables were selected because they are used by the banking industry to determine a country’s general ability to service its debt in the shortterm.

Reserves-to-Imports Ratio. This ratio describes a country’s stock of foreign exchange relative to its annual import levels. As such, it measures the extent to which a country could pay for its imports out of reserves alone if that were necessary. Moreover, a country with large reserves relative to imports is likely to have increased flexibility for using reserves to help service its debt, at least over the short run.

Current Account Balance-to-GNP Ratio. The current account balance measures a country’s trade in goods and services and financial flows related to interest and dividends and transfer payments. If a country has a current account deficit, it is not taking in sufficient foreign exchange from its exports of goods and services and financial earnings inflows to offset the costs of its imports and financial payments outflows. A current account deficit is roughly equal to the amount of new financing required to meet international purchases and transfers. The lower a country’s current account deficit relative to its GNP, the greater its potential for servicing its debt and the lower the probability of default.

Government Budget Balance-to-GNP Ratio. Countries with a surplus of central government revenues relative to expenditures are less likely to face short-term liquidity problems. Countries in surplus may be able to dedicate some of the surplus to paying off foreign debt if it is in the form of hard currency. However, countries that have a budget deficit will need additional domestic or foreign financing if they want to use government monies to help pay off debt.

Short-Term Debt (Credit)-to-Imports Ratio. As short-term debt increases relative to medium- and long-term debt, a country will require more foreign exchange over the short term to meet its near-term payments. When not paid for in cash, imports represent the amount of revolving trade credits that have to be maintained in good order. The ratio of short-term debt to imports is a measure of the short-term cash flow or immediate demands on a country’s foreign exchange. We hypothesize that as short-term debt to imports increases, a country’s creditworthiness is more likely to decrease.

We constructed our own thresholds for these indicators by using IMF and World Bank data on net debtor developing countries for 1986-90. In October 1992, the IMF reported that 72 out of 122 net debtor countries had experienced recent debt service difficulties because they had incurred external payments arrears or entered into official or commercial bank debt-rescheduling agreements during 1986 through 1990. For each of our liquidity measures, we calculated the liquidity ratio for each of 114 countries for each year between 1986-90. We then calculated the average ratio for each country over the 5-year period. Since roughly 60 percent of the IMF’s list of net debtor countries (72 of 122) were designated as having a debt service problem, we used the observation that marks the 60th percentile on each liquidity measure as a threshold for characterizing a severe liquidity problem. We believe this is a reasonable characterization, since arrears and rescheduling are indicative of serious liquidity problems.

We followed the World Bank’s old method of designating “moderate” thresholds equal to 60 percent of the value of “severe” thresholds. Also similar to the bank’s approach, we designated a country as having an overall moderate or severe liquidity problem only if three or more of its liquidity ratios equaled or exceeded the moderate or severe threshold values, respectively. (See prior discussion on debt burden.) Table 5.5 presents our country liquidity thresholds for the ratios of reserves to imports, current account deficit to GNP, government deficit to GNP, and short-term debt to imports.

We used data from the WEFA Group to calculate the liquidity ratios for the successor states. However, data were not available for republic-level foreign currency reserves. To estimate the foreign currency reserves for each republic, we defined a relationship between the FSU’s foreign currency reserves and its imports and exports. We then estimated each republic’s reserve using its export and import data so that the level of reserves is proportional to its external trade balance. In addition, we used data on GDP in place of GNP for the two ratios previously discussed that include the GNP variable. As with the debt burden analysis, we used historical and forecast data provided by WEFA in January 1993. Table 5.6 summarizes the results of our analysis in terms of whether and when each country is considered to have low, moderate, or severe liquidity problems.

As table 5.6 shows, for 1988 through 1991, the liquidity problem of the FSU would have been classified in the severe category. However, if the outstanding debt at that time were distributed among the various republics, three—Kazakhstan, Tajikistan, and Uzbekistan—would have been classified as having moderate liquidity problems. The rest would have remained in the severe category.

For 1992, 11 of the 15 successor states were estimated to have severe liquidity problems. The other four states were estimated to have moderate problems. For the forecast period, 1993 through 1997, 8 of the 15 states are expected to experience severe liquidity problems. The other seven are estimated to have moderate problems. During both periods, Russia and the 15 successor states treated as a single entity are estimated to have severe liquidity problems.

Liquidity is a more appropriate measure of creditworthiness than debt burden, since liquidity more directly measures the ability to generate foreign currency for servicing short- and medium-term debt. The liquidity results indicate that most of the successor states, including Russia, are high-risk countries because of their severe liquidity problems.

Arrears, Debt Relief, and IMF Arrangements

The amount of arrears, the need for debt relief, and the specific types of IMF loan arrangements a country has accepted are major indicators of a lack of creditworthiness.

When countries with liquidity problems cannot meet all of their immediate debt obligations, they fall into arrears. In some cases, arrears reflect an unwillingness to service debt. In either case, if arrears continue and the situation is not remedied, the country is likely to be considered a poor credit risk. If arrears persist and/or become prolonged, a country may reach a point where it concludes it cannot meet its current and future debt payments unless it obtains debt relief.

Debt relief is obtained by rescheduling outstanding debt or by debt forgiveness. Debt rescheduling alters the terms and maturity of outstanding debt. Debt relief is typically undertaken only after payments have been missed or when default is imminent or has already occurred.

To initiate a debt renegotiation, official creditors must be convinced that (1) the debtor country will be unable to meet its external payments obligations unless it receives the relief and (2) the debtor will take necessary steps to eliminate the causes of its payment difficulties and to achieve a lasting improvement in its external payments position. For countries that are members of the IMF, creditors rely on the IMF to help the debtor country design appropriate adjustment measures. Creditors have also required that an “upper credit tranche” arrangement with the IMF be in place before the start of debt renegotiations. Many countries that have accepted IMF arrangements are also countries that have rescheduled their debts.

As previously discussed, the Soviet Union was in substantial arrears by the end of 1990 (see ch. 3). In the fall of 1991, international creditors agreed to defer a substantial amount of the country’s principal payments that were due in 1992. Since the dissolution of the Soviet Union in December 1991, only Russia has been making payments on Soviet debt. During 1992, Russia’s arrears worsened, and Russian officials requested debt relief. In April 1993, official creditors agreed to reschedule $15 billion in debt that was already in arrears or scheduled for payment in 1993. By the end of 1993 a number of the successor states had reached agreement with Russia to exchange their responsibility for repaying a portion of the FSU debt in return for dropping their claims on a share of the FSU’s assets held by Russia. In June 1994, Russia’s official creditors agreed to reschedule another $7 billion (approximately) of FSU debt already due and/or yet to come due during 1994—indicating that Russia was unable to fully service the debt in spite of the 1993 rescheduling.

Meanwhile, Russia had still not reached agreement with bank creditors on rescheduling remaining FSU commercial debt. This issue had been outstanding since the dissolution of the Soviet Union in December 1991. As discussed in chapter 3, the commercial debt at the end of July 1993 was estimated by one source at $28.5 billion.

According to an April 1994 IMF assessment, it is clear that Russia will require a further comprehensive debt-relief package to normalize relations with external creditors. And, the IMF said, Russia and the other FSU countries will require external financing to help them consolidate large budget deficits in a noninflationary manner and to finance social safety nets. But, the IMF warned, official and private external financing will be forthcoming and helpful to Russia and the other states only in the context of strong and sustained stabilization and reform programs. (See also ch. 4.) Otherwise, foreign lending will tend to increase capital flight and external debt and further delay the development of an environment in which a strong private sector can emerge.

As discussed in chapter 2, Ukraine began defaulting on its GSM-102 loan repayments to the United States in the spring of 1994. As of August 17, 1994, defaults totaled about $31.1 million, and CCC had paid $21.6 million on claims made by lenders.

The successor states’ prolonged arrears, the repeated need to reschedule debt, and the failure to reach agreement on re-scheduling FSU commercial debt all indicate a lack of creditworthiness. Successor states that have agreed with Russia to exchange their responsibility for the FSU debt for forgoing claims on FSU assets cannot be faulted for subsequent arrears that arise on FSU debt or a need to further reschedule FSU debt. However, as the recent IMF assessment indicates, other successor countries will still require external financing to help them consolidate large budget deficits in a noninflationary manner and to finance social safety nets.

USDA Criteria Focus on Debt Relief in Assessing Creditworthiness

As discussed in chapter 1, USDA’s Trade and Economic Information Division is responsible for analyzing the ability and willingness of countries that have requested GSM-102 export credit guarantees to meet their current and future external debts, including potential GSM debt. As reported in chapter 2, TEID judged FSU and Russian debt as high risk between December 1990 and September 1992 when USDA committed to making available more than $5 billion in export credit guarantees to these states.

Table 5.7 shows that TEID grades countries on a scale that ranges between A and F, and risk is evaluated primarily in terms of whether a country is currently involved in and likely to be involved in future debt rescheduling. For example, a country is classified as “high risk” or a “D” if there is a greater than 50-percent chance that it will reschedule its old debt during the next 3 years. (See table 5.7.)

TEID considers a country’s risk to be “unacceptable” or an “F” if the state is both currently involved in rescheduling old debt and likely to reschedule new debt within the next 3 years.

On the basis of the analyses presented in this report and the terms of the April 1993 and June 1994 debt-rescheduling agreements and related developments, we believe that additional debt rescheduling for Russia during the next 3 years is a real possibility. As discussed in chapter 4, Russia experienced a constitutional crisis during 1993 that was based importantly on disagreement between the parliament and the President over the pace and extent of economic reform. Although voters approved a new constitution and elected a new parliament in December 1993, it remains to be seen whether the executive and legislative branches will work well together. As presented in this chapter, Russia is shown to have both a severe debt burden and severe liquidity problems. Although the April 1993 debt rescheduling alleviated Russia’s liquidity problems in 1993, it has continued to have serious problems in 1994. In June, it entered into another substantial rescheduling agreement with its official creditors. As table 5.3 showed, the FSU gross financial requirements could exceed $20 billion per year between 1994 and 1997.

Given these considerations, we believe that Russia would continue to be classified as at least high risk under the TEID criteria displayed in table 5.7.

In fact, in May 1994, USDA officials advised us that TEID has assessed Russia as not creditworthy for more than a year. Other countries rated as not creditworthy by TEID included Armenia, Azerbaijan, Belarus, Georgia, Kyrgyzstan, Moldova, Tajikistan, and Ukraine. According to the officials, TEID has rated the Baltic states, Kazakhstan, Turkmenistan, and Uzbekistan as creditworthy.

The Secondary Market

The secondary market for trading developing countries’ loans and bonds is another measure that can be used to assess creditworthiness. Countries whose debt trades close to the face value of the loan or bond are considered quite creditworthy, whereas those whose debt is traded at a deep discount are not.

Some observers have criticized the use of secondary market prices as a measure of creditworthiness. They assert that the market exhibits abrupt price movements regardless of changes in the underlying economic conditions of the debtor countries. There have also been allegations that publicly reported secondary prices and actual transaction prices are different. Additionally, not all secondary market price movements can be linked to economic performance, as some price movements reflect only a country’s willingness to pay back its debt. Moreover, the ability to service debt is dependent, in part, on the economic conditions of developed countries. Therefore, one might expect that the secondary market would be correlated with global economic conditions. However, there is little correlation between secondary price movements and variations in measures of global economic aggregates, such as industrial countries’ growth.

On the other hand, we believe the secondary market is the most reliable source of risk-adjusted valuation of debt that can be used to convert judgmental perceptions of risk into a measurable amount in dollars and cents. Prices in the secondary market for countries with strong growth and lower levels of external debt have been found to be generally higher than prices in the secondary market for countries with severe economic and debt problems in part because investors associate strong growth and low debt with improved creditworthiness. (See ch. 6 for further discussion of why we believe the secondary market is a useful measure.)

Secondary Market’s Assessment of the FSU and Russia

A secondary market has developed for FSU loans and bonds. According to a March 1993 trade publication, the FSU/Russian debt market had been very illiquid. The study reported that transactions on FSU/Russian debt in the secondary market were very structured and often took a few months. Very often transactions were in the form of debt-for-debt swaps, and each transaction was dependent on its own specifications. As a result, the study said, FSU/Russian debt has been one of the most illiquid papers on the secondary market, and total market turnover for the sovereign debt amounted to at most $200 million in 1992. However, according to more recent information, trading of FSU/Russian debt was considerably higher in 1992 (i.e., $678 million) and increased dramatically in 1993, to $24.7 billion.

According to another trade publication, Soviet debt started trading in the secondary market in about 1990 and during 1991 traded at 55 to 60 cents on the dollar. By spring 1992, it said, prices had fallen to 30 to 35 cents on the dollar. According to Chemical Bank data, secondary market prices for FSU loans traded for about 17 to 21 cents on the dollar between July 1992 and February 1993 and then fell to a low of 10 to 11 cents on the dollar in March 1993. Loan prices gradually increased to reach a high of 55 cents on the dollar during part of December 1993. Between then and March 1994, prices again declined, reaching a low of 28 cents on the dollar on March 21, 1994.

Vnesheconombank began issuing Eurobonds in the late 1980s. By March 1993, there were seven issues, amounting to a total value of $1.7 billion. VEB made servicing of these bonds a priority, continuing to make payments despite defaults on its debt service payments for loans. Consequently, the bonds have carried a higher price than the loans since they started being quoted at a discount at the beginning of 1991. In mid-1991 the bonds approached 55 to 60 cents on the dollar. By spring 1992, they had fallen as low as 44 cents. In June 1993, they were trading at 60 to 65 cents on the dollar.

We believe the secondary market’s valuation of FSU debt can be considered to represent market participants’ judgment about Russian creditworthiness. (As previously discussed, Russia has assumed responsibility for making payments on FSU loans and bonds.) Figure 5.1 provides secondary market prices of FSU loans for July 1992 to March 1994. The low prices indicate that the market finds Russia quite uncreditworthy.

Country Risk Assessments

Following the rapid growth of developing countries’ debt in the early 1970s and an increasing number of debt reschedulings in the 1980s, an assessment of the risk posed by cross-border lending and investments grew in importance. Therefore, the international financial community developed country risk assessments to evaluate the risk of loss from the future actions of debtors.

Country risk analysis is based on a holistic approach. It encompasses social and economic risk, as well as “sovereign” (i.e., political) risk. The latter refers to exposure arising from events that are substantially under the control of a foreign government rather than a country’s private sector.

A number of private organizations rate countries on the degree of risk associated with cross-border financial transactions. Lenders and investors can use the ratings in deciding whether to lend to or invest in particular countries. We analyzed the ratings of three publication services: Euromoney, Institutional Investor, and International Country Risk Guide (ICRG). Each assigns a country risk rating ranging between 0 for least creditworthy to 100 for most creditworthy. Each rating service uses a unique methodology for assessing country risk. Not surprisingly, there is considerable overlap in terms of the factors each considers.

Euromoney

Euromoney, a leading international publication, assigns credit ratings as a weighted average of market indicators covering access to bond markets and trade finance, credit indicators covering payment records and rescheduling difficulties, and analytical indicators incorporating economic performance forecasts and political environments.

In April 1992, a Euromoney analysis concluded that the republics of the FSU were not in a position to repay the full amount of their debts at that time and that a debt restructuring package seemed inevitable. At the same time, the analysis said it was generally accepted that the former Soviet republics as a whole were potentially wealthy enough to meet their obligations over time and that debts should be fully serviced and paid.

As shown in table 5.8, in September 1992, Euromoney rated Russia and several other successor states in the range of 14.6 (Moldova) to 24.2 (Estonia) out of a possible 100. Relative to 169 countries rated, they fell into the bottom quartile. Euromoney concluded that access to bank lending by any of the successor states is “impossible” and that their access to international bond and syndicated loan markets is “nearly impossible.”

Institutional Investor

Institutional Investor surveys leading international banks to rate the creditworthiness of sovereign states. Each bank provides its own rating, and Institutional Investor weights the responses using a formula that gives more importance to responses from banks with greater worldwide exposure and more sophisticated country analysis systems.

In March 1992, following the demise of the Soviet Union, Institutional Investor made its last rating for that entity. The score, 29.7, represented a staggering decline of 34.6 points over the previous 2-1/2 year period. The Soviet Union’s score of 29.7 placed it 58 out of the 113 countries rated by Institutional Investor.

In September 1992, Institutional Investor rated Russia 23.6, Belarus 21.1, Ukraine 21.1, Kazakhstan 18.7, and Uzbekistan 16.6. These ratings placed them 73, 78, 79, 90, and 98, respectively, among 126 countries. With the exception of the Baltic states, individual scores for the other republics were not reported. The ratings for the Baltics were lower than their March 1992 ratings. Estonia was rated 22.1, Latvia 21.4, and Lithuania 20.7.

International Country Risk Guide

International Country Risk Guide (ICRG) provides a detailed country-by-country assessment of the risk of operating, investing in, or lending to particular countries using a three-part system that evaluates political, financial, and economic risk. It assigns an overall score to each country by using a weighting system that allocates 50 percent of the score to political risk, 25 percent to financial risk, and 25 percent to economic risk. According to ICRG, its country scores can be interpreted as in table 5.9.

In August 1992, ICRG rated Russia 52.5, putting it slightly above countries it considers as very high risk. ICRG did not provide ratings for any other former republic. (See table 5.8.)

Comparison of Country Risk Ratings and Our Composite Rating and Ranking

As table 5.8 shows, the scores of the three rating services appear to be generally consistent with one another in the way they rank the creditworthiness of countries. Not surprisingly, though, there are some differences. The scores of Euromoney and Institutional Investor most closely approximate one another. ICRG scores are generally considerably higher than those of the other two services except for countries that are rated as high in creditworthiness.

Using a statistical method for effectively summarizing data from several sources, known as “principal components analysis,” we analyzed whether the three rating services are measuring the same phenomenon. The analysis indicated that overall the ratings do measure a common factor. The principal components method was then used to generate a combined, overall rating for each of the countries. To the extent that the rating services are measuring different yet important aspects of creditworthiness and to the extent that bias or poor information may affect their ratings of some countries, we believe our combined ratings provide a better measure of the relative creditworthiness of countries.

As table 5.8 shows, the combined creditworthiness ratings for the successor states range from a low of 13.6 points for Moldova to a high of 31.8 points for Russia. In terms of rankings, Moldova ranked 158 and Russia 100 out of the 172 countries rated.

More Recent Country Risk Ratings

The previous analysis was prepared using country risk ratings from the August and September 1992 period. Table 5.10 provides more recent information on the FSU successor states for two of the rating services, Euromoney and Institutional Investor. The table shows that both services ranked nearly all of the countries as worse on creditworthiness in September 1993 as compared to September 1992.

In March 1994, all of the countries rated by Institutional Investor, including the Baltic states, were ranked lower than they had been in September 1993. In March 1994, 8 of the 15 countries rated by Euromoney, including the Baltic states, improved on their rankings relative to September 1992 and September 1993. Even so, four of those countries were still ranked among the bottom quartile of all countries rated (i.e., Kyrgyzstan, Moldova, Tajikistan, and Uzbekistan); the other four were ranked close to or among the bottom one-third of all countries rated (i.e., the Baltic states and Turkmenistan, respectively). For both services, the 1994 rankings of Russia and Ukraine declined further compared to September 1993.

The Cost of GSM-102 Exports to the FSU/Russia When the Risk of Default Is Taken Into Account

As of August 17, 1994, the extension of GSM-102 credit guarantees for exports to the FSU and to Russia had created a contingent liability to the U.S. government of about $2.9 billion for outstanding principal payments. That amount includes the large reschedulings that occurred in September 1993 and early June 1994. We used country risk ratings and secondary market prices to estimate the risk of default and, in turn, the expected cost of the GSM-102 loans to the FSU and Russia as of June 1994.

Risk of Default Estimated From Country Risk Ratings

Table 5.11 provides Euromoney country risk ratings for the FSU successor states for three time periods between September 1992 and March 1994 and the average of the three ratings. As previously discussed, countries were rated by Euromoney on a scale ranging between 0 and 100. The higher the score, the better the creditworthiness and the lower the score, the worse the creditworthiness.

We used the country risk ratings to estimate an implied risk of the country’s defaulting on its external debt. The results are presented in table 5.11. As with the country risk ratings, we also calculated the average risk of default for the three time periods. As table 5.11 shows, the average country risk ratings for the FSU successor states varied between a low of 17.2 for Armenia and Azerbaijan to a high of 28.9 for Estonia. The average implied risk of default for the countries ranged between a low of 71 percent for Estonia to a high of 83 percent for Armenia and Azerbaijan.

Russia’s country risk ratings ranged from 21.8 in September 1992, to 24.7 in September 1993, to 26.0 in March 1994. Its average rating was 24.2. The March 1994 implied risk of Russia’s defaulting was 74 percent, and its average risk of default for the September 1992 to March 1994 period was 76 percent. As previously stated, Russia’s contingent liability for GSM-102 debt in August 1994 was about $2.9 billion. Using the March 1994 implied risk of default score for Russia, we calculated that $2.1 billion in outstanding GSM-102 guaranteed principal repayments was at risk of default. If one uses the average risk of default score, nearly $2.2 billion was at risk of default.

Risk of Default Estimated From Secondary Market Prices

The average price of FSU loans in the secondary market in March 1994 was 32 cents on the dollar. This price implies a 68-percent risk of default at that time. According to data provided to us by Chemical Bank, between July 1992 and March 1994, the price of FSU loans in the secondary market averaged 26.8 cents on the dollar—implying that financial markets expected about a 73-percent discount on repayment of outstanding FSU loans over that time period. These default risk rates are quite similar to those indicated by the Euromoney country risk ratings previously discussed.

The March 1994 implied risk of default through the secondary market price suggests that $2 billion of the $2.9 billion GSM-102 principal is at risk of default. The average risk of default score for the secondary market price suggests that about $2.1 billion is at risk of default.

These estimates do not take account of possible savings in the cost of commodity support programs that may result when the GSM-102 program is used to promote increased exports of U.S. commodities. However, as discussed in chapter 2, whether and to what extent lower costs will result from the GSM-102 program depends importantly on the availability of alternative markets for the exports in question and how world market prices are affected by actions taken by other exporter nations in the absence of U.S. GSM program benefits for the FSU and its successor states.

According to an ERS official, while the potential CCC liability on GSM loans is great, one should consider Russia’s self-interest in meeting its GSM-102 repayments responsibilities. If Russia does not meet its obligations, the official said, its ability to obtain future credit from the United States and other potential creditors would be complicated. In addition, the official noted that if Russia repays the credit and at an appropriate higher interest rate for rescheduled debt, U.S. taxpayers would endure no long-term cost under the program. Hence, the official said, rather than suffering a loss, U.S. taxpayers may earn revenue from rescheduled loans. In commenting on a draft of this report, USDA said GAO should examine the terms of rescheduled debt with the FSU. USDA said that taxpayers do not lose money as long as the interest charge exceeds the opportunity cost of funds to U.S. taxpayers and as long as principal is repaid.

We agree that Russia will have greater difficulty in obtaining future credit if it does not meet its GSM-102 repayment obligations. However, whether and to what extent it will do so is the question. We have provided estimates of the likelihood of its repaying based on country risk ratings and the secondary market’s valuation of FSU loans. It is conceivable that at some point in the future Russia may seek and obtain forgiveness for a substantial part of its GSM loan obligations. In the meantime, as of mid-August 1994, the United States had already paid out $1.4 billion to cover claims on GSM-102 defaults for FSU loans and was expecting to pay out another $429 million in claims by the end of 1994 as part of the June 4, 1994, rescheduling agreement.

In its comments on our draft report, USDA disagreed with our use of the secondary market to estimate the risk of default on GSM-102 loans. (See ch. 6.) However, in its comments, USDA itself questioned whether Russia had sufficient self-interest to repay GSM-102 debt. USDA said that Russia’s self-interest had been overtaken by recent events, including lower import demand, large infusions of food aid, and the fact that the Russians had not requested new credit and did not seem very interested in staying current on GSM-102 debt payments.

Impact of Default Risk on the GSM-102 Portfolio

As discussed in chapter 1, the GSM statute prohibits USDA from extending credit guarantees to any country the Secretary determines cannot service the debt. However, the statute does not require that a country be considered generally creditworthy to receive GSM credit guarantees. In addition, the law does not provide any guidance as to what is an acceptable level of risk in evaluating whether countries can adequately service proposed GSM debt. Consequently, countries that USDA program officials assess as high risk in terms of creditworthiness can still be approved to receive GSM credit guarantees. Also, the statute does not place a limit on the amount of GSM guarantees that can be provided each year to high-risk countries in aggregate or to individual high-risk countries. As a result, USDA can allocate large amounts of guarantees to high-risk countries, making the GSM-102 portfolio subject to a potentially high rate of default.

In chapter 1 we showed that the FSU and two of its successor states (Russia and Ukraine) received the largest portion of GSM-102 credit guarantees provided during the fiscal years 1990-92. As a result of the large guarantees provided to the FSU and its successor states, the GSM-102 program became considerably exposed to default by these states. Table 5.12 shows that on January 29, 1993, the FSU and its successor states were responsible for $3.6 billion, or about 44 percent, of all outstanding principal on GSM-102 guaranteed loans. Except for Mexico and Algeria, which were responsible for 26 percent and 11.5 percent, respectively, of the outstanding principal, most of the other GSM-102 recipients each accounted for less than 1 percent of the outstanding principal.

We used the combined country risk ratings presented in table 5.8 to estimate the principal at risk for each country participant in the GSM-102 export credit guarantee program. The results are presented in table 5.12. As the table shows, the exposure of the GSM-102 program to default by the FSU and its successor states is considerably larger when the potential for default is considered. Whereas the FSU and its successor states together accounted for about 44 percent of the outstanding principal at the end of January 1993, they represented approximately 59 percent of the portfolio’s risk, because their country risk ratings were lower than most of the other GSM-102 credit guarantee recipients. In contrast, Mexico, which accounted for 26.1 percent of the principal exposure, represented only 12.5 percent of the risk because its country risk ratings were significantly higher than most of the GSM-102 recipients.

GSM-102 Program Does Not Use Risk-Based Fees

Although GSM-102 recipient countries vary significantly from one another in terms of their risk of defaulting on GSM-102 loans, CCC does not adjust the fee that it charges for credit guarantees to take account of country risk. CCC fees are based upon the length of the credit period and the number of principal payments to be made. For example, for a 3-year GSM-102 loan with semiannual principal payments, CCC charges a fee of 55.6 cents per $100, or 0.56 percent of the covered amount. For 3-year loans with annual principal payments, the fee is 66.3 cents per $100. CCC fees that included a risk-based component might not cover all of the country risk, but they could help to offset the cost of loan defaults.

USDA officials told us that including a fee for country risk could reduce the competitiveness of GSM-102 exports. However, they said they did not have recent or current data to support their claim.

The U.S. Export-Import Bank, which provides credit guarantees to promote a variety of U.S. exports, uses risk-based fees to defray the cost of defaults on its portfolio. Under its system, each borrower/guarantor is rated in one of eight country risk categories. Exposure fees vary based on both the level of assessed risk and the length of time provided for repayment. For example, in the case of repayment over 3 years, a country rated in the lowest risk category is charged a fee of 75 cents per $100, whereas a country in the highest risk category is charged a fee of $5.70 per $100 of coverage. Thus, the bank’s fee structure includes a substantial added charge for high country risk. According to the bank, its system is designed to remain as competitive as possible with fees charged by official export credit agencies of other countries.

Under section 211(b)(1)(b) of the 1990 Farm Bill, CCC is currently restricted from charging an origination fee for any GSM-102 credit guarantee in excess of an amount equal to 1 percent of the amount of credit extended under the transaction. This restriction was initially enacted in 1985 following proposed administration legislation to charge a 5-percent user fee for exports backed with credit guarantees. Some Members of Congress were concerned that such a fee would adversely affect the competitiveness of GSM-102 exports. Under the 1-percent restriction, CCC would be considerably limited in the size of the fee that it could charge to take account of country risk should it decide to do so. For example, as previously noted, CCC charges 0.56 percent for a loan payable in 3 years and with principal payments due annually. The most it could increase the fee would be 0.44 percent. In contrast, the Export-Import Bank currently charges fees as high as 5.7 percent for 3-year loans.

Implications of a Lack of Creditworthiness and the High Exposure to Default of the GSM Portfolio

The various analyses previously presented above indicate that Russia and the other successor states are high-risk countries in terms of creditworthiness. Russia is severely indebted, and its agreement to accept responsibility for the other states’ shares of the FSU debt increases its burden. Most of the successor states, including Russia, have severe liquidity problems, and these problems are likely to persist for the next several years. Russia’s arrearage problems and its need to reschedule its debts also demonstrate a lack of creditworthiness. In addition, secondary market valuations of FSU debt and country risk ratings point to poor creditworthiness.

The large amount of GSM-102 export credit guarantees already provided to the FSU and its successor states, along with their low creditworthiness, means that the GSM-102 portfolio is exposed to a high level of risk that could result in additional, substantial costs to U.S. taxpayers. As earlier discussed, in September 1993 and June 1994 the United States rescheduled large amounts of GSM-102 debt. Providing the successor states with more guarantees at this time would add to the already high exposure of the GSM-102 portfolio to further defaults. Since the GSM-102 program provides financing with terms up to only 3 years, additional guarantees for the successor states would add to the difficult liquidity problems that they are expected to experience over the next several years. Consequently, the GSM-102 program may not be an appropriate vehicle for continued financing of U.S. agricultural exports to the FSU successor states at this time.

Nonetheless, there may be important economic and national security reasons for the United States to further assist the financing of food exports to Russia and one or more successor states. For example, if circumstances arise where the Russian government cannot obtain the hard currency to pay for food imports needed to balance its food needs, political stability could be threatened. In a major policy statement on April 1, 1993, President Clinton said that nothing could contribute more to global freedom, security, and prosperity than the peaceful progression of Russia’s transformation from a totalitarian state into a democracy, a command economy into a market, and an empire into an a modern nation-state.However, he noted, the outcome is not assured. The President warned of the danger of Russia, with its vast arsenal of nuclear weapons, being torn apart by the ethnic strife that has engulfed former Yugoslavia. If Russia were to revert to imperialism or plunge into chaos, he said, the United States would need to reassess its plans for defense savings. This could mean billions of less dollars for other uses, including creating new businesses and new jobs in the United States. America’s interests, he said, lie with Russian reform and Russian reformers, and America’s position is to support democracy and free markets in Russia and the other new independent states.

In support of the policy statement, on April 4, 1993, President Clinton announced a $1.6 billion assistance package for Russia for 1993. As discussed in chapter 3, on April 15, the United States, in concert with the G-7 nations, announced a financial assistance program of $28.4 billion for Russia. Also on April 15, the Secretary of State announced that the administration would propose to Congress another U.S. aid package for Russia of $1.3 billion in direct aid and $500 million in assistance to be channeled through international assistance agencies. Subsequently on September 30, 1993, the President signed the fiscal year 1994 foreign aid bill that included $2.5 billion for the NIS.

Alternatives to GSM-102 Export Credit Guarantees

There are alternatives to the GSM-102 program for helping to finance continued U.S. agricultural exports to successor states to the FSU. Examples include the GSM-103 program and various food aid programs. Since the latter include substantial concessionality and at times total grant aid, they would entail higher budgetary outlays.

As discussed in chapter 1, the GSM-103 export credit guarantee program is similar to the GSM-102 program but provides terms of credit whereby the repayment period can range up to 10 years. An advantage of this program is that it would help recipient successor states to finance food imports without adding to their difficult liquidity problems during the next few years, since repayments can be stretched out over a decade. However, GSM-103 is not an appropriate program to use if the successor states are uncreditworthy and is questionable if they are high risk, since longer repayment terms may also increase risk. A limitation of the program is that far fewer dollars have been authorized for GSM-103 guarantees than for GSM-102 guarantees (see table 1.1). Under the 1990 Farm Bill, CCC is required to make available at least $5 billion for each of fiscal years 1991 through 1995, whereas the minimum level stipulated for GSM-103 assistance is only $500 million.

USDA has used several food aid programs to provide food assistance to the successor states during the past few years. These include Public Law 480, title I, the section 416(b) program of the Agricultural Act of 1949 (P.L. 81-439), and the Food for Progress program of the Food Security Act of 1985 (P.L. 99-198).

Title I of the Food for Peace program (P.L. 480) is a concessional sales program to promote exports of agricultural commodities from the United States and to foster economic development in recipient countries. The program requires annual appropriations and thus has a direct impact on federal spending. Food for Peace provides export financing over payment periods of 10 to 30 years, grace periods on payments of principal of up to 7 years, and low interest rates. Eligible countries are developing countries experiencing a shortage of foreign exchange earnings and having difficulty meeting all of their food needs through commercial channels. According to USDA, program allocations take into account changing economic and foreign policy situations, market development opportunities, existence of adequate storage facilities, and possible disincentives to local production.

Section 416(b) of the Agricultural Act of 1949 authorizes donations of uncommitted CCC stocks to assist needy people overseas. Food for Progress is a food aid program that is carried out using funds or commodities made available through Public Law 480, title I, or the section 416(b) program. Food for Progress is generally administered on grant terms. It provides commodities to developing countries and emerging democracies to encourage democracy and private enterprise, including agricultural reform.

Table 5.13 provides figures on the value of GSM-102 credit guarantee and food aid assistance to the FSU/successor states during fiscal year 1991 through April of fiscal year 1994. As the table shows, GSM-102 credit guarantees accounted for all of the assistance provided during fiscal year 1991 and most of the assistance made available during fiscal year 1992. As a result of the suspension of the GSM-102 program in the fourth quarter of 1992, food aid became the dominant form of agricultural assistance in fiscal year 1993. The combined total of GSM-102 and food aid assistance in fiscal year 1993 was slightly more than all GSM-102 assistance provided during fiscal year 1991 but represented only about two-thirds of the combined value of the GSM-102 and food aid assistance made available during fiscal year 1992. As the table shows, from fiscal year 1991 through April of fiscal year 1994, GSM-102 credit-guaranteed assistance was about $5.1 billion, while food aid assistance equaled about $2 billion. Total agricultural assistance made available in fiscal year 1994 (through April) was a small fraction of that provided during each of the 3 previous fiscal years.

Questions About the Need for More Credit Guarantees And/or Food Aid

Questions exist about the need for and value of additional credit guarantees and food aid for the FSU successor states. For example, FSU agricultural imports were down considerably in 1993 and, according to USDA, there generally is not a food shortage problem in the area.According to USDA, economic reforms have begun to have some positive effects, and as they take further hold, the successor states are not likely to continue importing at their former high levels. At the same time, credits and credit guarantees have unintentionally impeded the reform process by increasing the successor states’ external debt burden and perpetuating state control of agricultural distribution.

According to USDA, the successor states’ demand for agricultural imports diminished by 27 percent in 1993 compared to 1992 levels. In commenting on a draft of this report, USDA said that Russian agricultural imports are down sharply largely due to a reduction in demand, particularly of grain, which makes up the bulk of imports. The drop in FSU agricultural imports is expected to continue and, according to USDA, is a sign that economic reforms are working, at least to some degree. USDA noted that high levels of Soviet agricultural imports in the 1980s were used to prop up an overexpanded and inefficient livestock sector. Declines in that sector have freed up domestic grain supplies (production of which has remained steady with the exception of 1991’s drought-affected crop) and lowered the FSU demand for imports. In addition, USDA said, price liberalization in several republics has led to lower waste, increased incentives, and more rational use of inputs.

In commenting on a draft of our report, USDA indicated that food assistance has adversely affected reform in the FSU. USDA said that although widespread dislocation in the FSU food supply never occurred, the West continued to provide assistance (credits and food aid) to the FSU, which accepted it to the likely detriment of economic reforms (increased debt and continued state control of agricultural marketing).

According to a USDA analysis, the high level of FSU grain imports in recent years—sustained by credits, credit guarantees, and food donations—allowed FSU authorities to delay increases in farm prices and to maintain the centralized grain distribution and marketing system to a large degree. For example, the average price of wheat imported by the FSU in 1992-93 was $125 a ton (excluding freight), while Russian farmers received less than $40 a ton. The state provided massive subsidies that lowered the price of the imported grain relative to domestic farm prices. Thus, instead of paying Russian farmers higher prices, which would have improved farm incomes, increased farm sales, and reduced waste, the state chose instead to purchase large amounts of foreign grain. When commercial financing was no longer available, the state requested concessional loans and donations to help maintain these imports. Obtaining imports on concessional terms, which meant deferring immediate repayment, was easier for state planners than allowing market forces to set domestic grain prices. The commercial credits and credit guarantees also adversely affected the reform process, because scarce hard currency needed to support domestic reform was instead required to service the increased external debt.

According to the USDA analysis, fewer credits and credit guarantees are likely to be provided in the future because of increased western concerns about FSU creditworthiness, particularly Russia’s, and expectations of decreased FSU demand for imports. USDA also believes that concessional financing and humanitarian assistance may still be necessary for some of the successor states in the short- to medium-term future.

Conclusions

The GSM statute prohibits USDA from extending credit guarantees to any country the Secretary determines cannot service the debt. However, the statute does not provide any guidance as to what is an acceptable level of risk in evaluating whether countries can adequately service proposed GSM debt. In addition, the statute does not limit the amount of GSM guarantees that can be provided each year to very risky countries—either individually or in aggregate. Consequently, USDA can allocate large amounts of guarantees to high-risk countries and even to countries that are judged not creditworthy, making the GSM-102 portfolio subject to a potentially high rate of default. CCC fees that included a risk-based component could help to offset the cost of loan defaults. However, under the 1990 Farm Bill, CCC is currently restricted from charging an origination fee for any GSM-102 credit guarantee in excess of an amount equal to 1 percent of the amount of credit extended under the transaction. Given this restriction, CCC would be considerably limited in the size of the fee that it could charge to take account of country risk should it decide to do so.

Most, if not all, of the FSU successor states are not creditworthy and all should be considered at least high risk from a creditworthiness perspective. The GSM-102 portfolio is exposed to a high level of risk of default because a large portion of the portfolio includes FSU debt and because of Russia’s lack of creditworthiness. Since the GSM-102 program provides financing with terms to only 3 years, providing additional GSM-102 guarantees to the successor states could further add to their liquidity problems during the financing period. The GSM-103 program could help successor states to finance food imports without adding to their difficult liquidity problems during the next few years, since repayments can be stretched out over 10 years. However, GSM-103 is not a good program to use if the successor states are uncreditworthy and is questionable if they are high risk, since longer repayment terms may also increase risk. Consequently, both GSM programs may not be an appropriate vehicle at this time for financing additional U.S. agricultural exports to Russia or other successor states. Alternatives to the GSM programs include various food aid programs. Of course, the latter include substantial concessionality and at times total grant aid, and thus would result in higher budgetary outlays.

There may be important economic and national security reasons for the United States to further assist the financing of food exports to Russia and one or more successor states. For example, if circumstances develop where the Russian government cannot obtain the hard currency to pay for food imports needed to balance Russia’s food needs, the country’s political stability could be threatened. The latter could disrupt Russia’s progress toward establishing democratic institutions and a free market economy and, in turn, significantly affect U.S. defense expenditures.

Matters for Congressional Consideration

If Congress concludes that Russia or other successor states are too risky to receive additional GSM-102 credit guarantees, and if Congress concludes that continued agricultural exports to the states serve important U.S. economic and national security interests, Congress may wish to consider authorizing additional foreign aid to finance the sale of the food. Such additional authorization of foreign aid to finance food exports to the states could then be weighed against other priorities for U.S. foreign economic assistance.

To reduce future exposure of the GSM-102 portfolio to default, Congress may wish to consider limiting the total amount of credit guarantees that can be issued each year to high-risk countries and the amount that can be provided to any single high-risk country. In addition, Congress may wish to consider (1) amending the statutory provision that precludes the Commodity Credit Corporation from charging a fee in excess of 1 percent of the amount of the credit guarantee and (2) requiring CCC to include a risk-based charge as part of its overall fee for GSM credit guarantees.

Agency Comments and Our Evaluation

We requested comments on a draft of this report from USDA. It provided general comments that are reproduced in appendix III. Most of these comments are discussed in this chapter; some are addressed directly in other chapters of this report, as indicated in marginal references. USDA also provided a separate set of technical and editorial comments that were incorporated into the previous chapters where appropriate.

Overall Comments

Our draft report was reviewed by a number of offices in USDA that concluded the draft was well researched and presented. According to USDA, the report accurately presented USDA source materials, the GSM-102/103 decisionmaking process, and the interviews we conducted pursuant to the investigation.

USDA expressed principal disagreements with our methodology for assessing the costs and benefits of the GSM-102 credit guarantees provided to the FSU and its successor states, particularly our use of the secondary market as a means of estimating losses. USDA also disagreed with our draft conclusion that all of the 15 successor states were not creditworthy.

Use of the Secondary Market to Estimate Default Costs

As discussed in chapter 5, we considered secondary market valuations of FSU loans in evaluating the creditworthiness of the FSU and its successor states, and we used the secondary market’s valuation of FSU loans to estimate expected losses on the value of outstanding GSM-102 loans to the FSU. According to USDA, there are too few participants in the secondary market and they can easily manipulate the market. Thus, USDA said, none of its reviewing offices believe the secondary market is a reliable indicator of the value of FSU debt paper. In addition, USDA said that the attributes of debt traded in the secondary market might be materially different from the GSM debt. We disagree with USDA on these points.

As discussed in a previous GAO report, we concluded that the secondary market provides the best available risk-based valuations of sovereign debt of countries that do not have well developed financial systems. More specifically, we found that the secondary market provides the same characteristics of many functioning securities markets. Generally speaking, the market is (1) self-correcting; (2) appears to have minimal outside forces operating on it other than the risk-reward evaluation by a large number of participants—banks, insurance companies, pension funds, and private investors; (3) has substantial volume and appears to be efficient; (4) and has a wide variety of instruments with varying lengths of maturity and other characteristics.

USDA seems to ignore the emergence of the secondary market as a major financial market. According to a World Bank 1992 study, the total volume of secondary market trading rose from an estimated $4 billion in 1985 to $100 billion in 1990. The bank noted that as a result of improved market efficiencies, secondary market prices were increasingly used as indicators of a country’s creditworthiness and as benchmarks in debt reductions/restructuring packages. According to more recent studies, secondary market trading increased enormously in 1992 and 1993, reaching volumes of $773.7 billion and $1.9 trillion, respectively. As concerns FSU or Russian paper, it has become one of the more popularly traded assets in the secondary market. According to the Emerging Markets Traders Association, Russian debt ranked eighth on trading volume out of 42 countries for which the group reported data for 1993. Trading volume in Russian debt increased more than 35-fold—from $678 million in 1992 to $24.7 billion in 1993.

Although we feel confident about our use of secondary market data to estimate expected losses on the value of outstanding GSM-102 loans to the FSU, we developed a second method for estimating such losses after receiving USDA’s comments on our draft report. As discussed in chapter 5, we used Euromoney country risk ratings to estimate the risk of default and, in turn, the expected cost of GSM-102 loans to the FSU and Russia as of June 1994. The results were very similar to the results obtained from our use of the secondary market prices and, thus, increase our confidence in the secondary market method.

As noted previously, USDA also commented that the attributes of secondary market debt may be materially different from the GSM debt. USDA did not cite any examples of how the debt might be materially different or explain how such differences might affect the use of secondary market prices to reflect the risk of default on GSM-102 loans. GSM debt is different in the sense that the U.S. government guarantees most, if not all, of the principal in the event that the borrower defaults on its loans. Since lending banks are guaranteed that USDA will repay at least 98 percent of defaulted GSM-102 loans, lenders to Russia would presumably have little reason to trade the debt on the secondary market when Russia defaults on such debt. However, this characteristic of GSM-102 loans does not reflect on the likelihood of whether Russia will default on its payoff of GSM-102 debt.

Creditworthiness

In its comments on our draft report, USDA said that it disagreed with our conclusion that all of the FSU successor states are not creditworthy. USDA indicated that between August 1993 and February 1994 it had found Ukraine, Uzbekistan, and Turkmenistan to be creditworthy; it noted that each of these states had been found qualified to receive modest amounts of GSM-102 credits during that period. (USDA also said that each program was driven by market development objectives.) However, in May 1994 USDA officials advised us that the office responsible for preparing creditworthy assessments had rated Ukraine as not creditworthy during the previous year and still considered Ukraine as uncreditworthy. Thus, USDA had made credit guarantees available to Ukraine in fiscal year 1994 even though its own analysis indicated the country was uncreditworthy.

In addition to Ukraine, other successor states identified by USDA as still not creditworthy in May 1994 were Russia, Armenia, Azerbaijan, Belarus, Georgia, Kyrgyzstan, Moldova, and Tajikistan. Thus, USDA classified 9 of the 15 successor states as not creditworthy. Creditworthy successor states at that time, according to USDA, included the three Baltic states (Estonia, Latvia, and Lithuania) as well as Kazakhstan, Turkmenistan, and Uzbekistan.

Creditworthiness evaluations involve a multidimensional analysis of a variety of factors and some subjective judgment. As a result, evaluations by different parties may not always fully agree. This is best evidenced in chapter 5, where we compare the country risk evaluations of three different private rating services (see table 5.8). Consequently, it is not necessarily surprising that USDA did not agree with the conclusion in our draft report that all of the successor states were not creditworthy. After considering USDA’s comment, we decided to restate our conclusion as follows: Most, if not all, FSU successor states are not creditworthy and all should be considered at least high risk from a creditworthiness perspective.

We believe our restated conclusion is well supported by the information and analyses presented in the report, especially by the material presented in chapters 4 and 5. The most recent summary information in support of our restated conclusion is found in tables 5.10 and table 5.11. As table 5.10 shows, in March 1994 both Euromoney and Institutional Investor rated nearly all of the FSU successor states among the bottom one-third of all the countries they rated on creditworthiness, and most of the rated successor states were in the bottom quartile. As table 5.11 shows, Euromoney’s actual risk ratings for the 15 successor states for March 1994 imply risks of default ranging between about 66 percent (Latvia) to about 82 percent (Armenia). We believe it is reasonable to characterize countries that rank among the bottom one-third of all countries on country risk and that have an implied risk of default equal to or greater than 66 percent as being either uncreditworthy or at least highly risky from a creditworthiness perspective.

Additionality Issue

As discussed in chapter 2, whether and to what extent GSM-102 exports lower domestic commodity support program costs depends importantly on the availability of alternative markets for the exports. This is referred to as the “additionality” issue. For example, if one assumes that in the absence of the GSM-102 credit guaranteed exports to the FSU and its successor states alternative export markets would not exist, this is characterized as 100-percent program additionality. If one assumes that 75 percent of the commodities could be exported to other countries, the program additionality would be only 25 percent.

In chapter 2, we raised questions about USDA’s approach, which largely relied on an assumption of 100-percent additionality. We expressed the view that analyses should consider a range of additionality levels. In commenting on our draft report, USDA provided mixed views on this issue. On the one hand, USDA agreed that one should consider a range of additionalities. In fact, USDA cited a third estimate, provided to the Secretary of Agriculture in February 1993, in which two levels of additionality were assumed for $2 billion in credits to the FSU—50-percent additionality and 100-percent additionality. According to USDA, the estimate indicated deficiency payment savings of $0.7 billion to $1.4 billion. However, USDA further assumed a loan concessionality of 60 percent, or $1.2 billion, to cover loan defaults, freight costs, EEP bonus payments, and other unspecified factors. USDA estimated that the net budget costs of $2 billion in credits (after subtracting estimated deficiency payment savings from the loan concessionality cost) would vary between a cost of $500 million to a savings of $200 million. Although USDA’s comments cited a third estimate that included a 50-percent additionality case, USDA went on to say that an assumption of 100-percent additionality with regard to the FSU and its successor states seemed reasonable. In support of the latter view, USDA said it is likely that without the GSM-102 coverage the FSU would not have been able to purchase substantial quantities of U.S. commodities. This is illustrated, USDA said, by the sharp decline in U.S. exports to the FSU after it was suspended from the program. In addition, USDA said there were few alternative opportunities for the use of the credit guarantees in other countries.

In chapter 2, we questioned USDA’s assumption that alternative export markets would not be available on the grounds that special features of the GSM-102 program made available to the FSU and its successor states should be attractive if offered to other importing nations. One special feature we noted was USDA coverage of 100 percent of the value of the commodities. However, in commenting on our draft report, USDA indicated that it does not like and would be unlikely to provide 100-percent coverage. In addition, USDA said, our analysis presumes there are creditworthy countries in the world marketplace that are interested in participating in a large-scale GSM-102 program. According to USDA, during fiscal years 1991 and 1992 principal markets not targeted for the GSM-102 program included China, Cuba, Iran, Libya, and Japan. With the exception of China and Japan, USDA said, there were few alternative markets that could exert the same amount of influence on U.S. domestic prices as that exerted by the FSU market; and both China and Japan purchased heavily from the United States during the time period without credit guarantees.

We do not believe that 100-percent additionality is the most reasonable assumption. As discussed in chapter 2, we estimated that the combination of freight cost financing and EEP bonus payments, alone, made the additionality attributable to the GSM program for the FSU and its successor states in fiscal years 1991 and 1992 equal at most to about 77 percent. In addition, the issue of what assumed additionality level is most appropriate does not depend simply on whether the FSU could have purchased the U.S. commodities without the GSM-102 guarantees. If the United States had not provided the guarantees, other exporting countries might have provided credits or credit guarantees to assist the FSU. Doing so could have reduced those countries’ exports to third countries, enabling the United States to increase its exports to the latter. Even if the United States had not provided the guarantees and other countries had not provided additional guarantees, it is not obvious that the 100-percent additionality case should be applied. A decline in sales to the FSU would tend to lead to reduced prices on world markets, which, in turn, could result in increased demand.

We have not advocated providing 100-percent loan guarantee coverage. However, we believe that if one wants to consider to what extent credit guarantees to the FSU and its successor states increased U.S. exports, a fair comparison should consider what would have happened if comparable terms had been offered to other countries. We are not aware of any single country with a market comparable to that of the FSU that would have been interested in GSM-102 credit guarantees. However, it is possible that a number of countries with smaller markets might have been interested in credit guarantees or additional guarantees if the terms were comparable to those extended to the FSU. Any guarantees or increase in guarantees provided to other countries would, of course, further detract from the realism of a 100-percent additionality assumption.

Views on Matters for Congressional Consideration

USDA did not express any view regarding our suggestions in chapter 5 on how Congress could reduce future exposure of the GSM-102 portfolio to default. A USDA official told us that it had been examining the issue but had not yet reached any conclusions.

USDA approved of our suggestion that if Congress concludes the United States needs to ensure continued U.S. agricultural exports to Russia and/or other successor states but decides additional GSM-102 guarantees are not appropriate at this time, it may want to consider authorizing additional foreign aid money to finance export sales. USDA said that ongoing agricultural exports to the FSU are essential to the American farm community and to U.S. geopolitical interests and provide needed foodstuffs to a market of enormous potential.

We agree that the American farm community may benefit from ongoing exports to the FSU. We also agree that broader U.S. interests may be served by U.S. agricultural exports to the successor states but do not believe that such exports automatically advance such interests. For example, the United States has favored economic reforms in the FSU that promote development of a free market economy. Yet, as USDA itself noted in commenting on our draft report, western assistance (credits and food aid) to the FSU has probably had a detrimental impact on FSU economic reforms—including increased debt and continued state control of agricultural marketing.