**Plcy, Research, and External Affairs**

Policy and Review

# WPS 644

hI lis paper a joinl pr(xIl0cL ol thC Policy anld Rcview Department and the 1rra(le and( Finance D)i vision '1echnlinczl D)qpartinent, Europe. Middle East, and North Alrica Region - is part of a larger clf ort in PREl and the Region **L** investigate the chalileniges of econiomic ref-orm **i** i n Ccntral and Eastern Etrope. Copies are available fic Irom hlik Worl( Bank, 1818 1 StrLeet _NW,_ Washinigion, DC 2(433. Please contact Maureen C(olinct. iooni SI 2-(P45, extenioii 14698 (3 1 pages) 'I'hc web of trade an)d **paynienis** afrrangCmeIiits binding couinitries of Eastcm and Central Europe undcr thc Coouncil of Mutual Economic Assistance (CMEA) agrecemients is incompatible withl these countries' receint coiimmitmiients to move toward liberalized trade and currency convertibility, But the importance to these counitries' total tra(le of their trade withi other CMEA members - an( thc al)pareilt (lesirc ol thc USSR and othiers to dei-oiiiiate a1ll lutLre mutuail trade at international priccs - poses a numilber of problems of transitionl lor Itic couinitries of Easternl and Central Europe.

Michalopoulos andl Tarr identily thrce broad problems in this coiinnection:

* The brcakdown of thc CMEA arrangements has led to a serious breakdown of trade relations andl redluced tr-de volume amiong formler CMEA IleCIIlhers. What interim arraniigemicnitLs can be introdiuce(d to facilitalte trade?

* Denominating international trade at international prices implies chaniiiges in the terms ol tra(le for each country in the system. Terms of trade for the USSR should improve because iLs maini export to thc CMEA -energy proiuicts - has been undervalued. Bul if payments are settled in hard currency, olher countries ofE astern and Central Etirope aure going to rceluire more financing at a timiie whien they are already short on loreign exchange.

* All countries may not reacl lfull currency convertibility in thc neair terI, and ol(i CMEA arrangements cannot continue so what interim payment arrangemnenLs can be made among thcsc countrics an(d betwecn tlhcem and the USSR'?

Michalopoulos and Tarr focus on possible interim institutional arrangements for tra(le andi payiments among previous members of the CMEA

> anid hIow suchl a-rrangements can hlIel a Aress enicrging imbalanccs in payments. They recomimiicindI the following:

* Fundaimicntail trade reforms shoil(d allow Eastern aid Central European enterprises auitoilonimy to negotiate and( conclu(dc contracts directly vith foreign liriims or agents in itic lorimier CMEA couIntries, to be unider no statc obligaition, and(i to bear the risk ol thcir conttracts. Competition should be encouraged by minimllizinig or ciimninaitinig licenisinig and pricc equalization and the monopoly trading privileges ol foreign trad(ling organizations. Trade should be at world prices and - until convertibility is achieved - denominated and settled in dollairs (conivcrtible currency).

* These countries' conliuiiinents to introduc2ng competitivc exchange rates and a degree of convertibility should be encouraged. Countries might not achieve convertibility at the samne rate; the USSR in particular m ay lag bchind. If so, multilateral clcarilig arrangements with strictly limiied( tiime settclemnciits (no morc thaln three moniths) may be a uselul interim mieasure and( can be est.ablished witlhoit outsidc contributions. Shiort settlemcint periods are certLinl> prcfcrable to a system in which bilateral balancing of trade is lorced.

* More ambitious payments schemespaitcrned alter thc European Payments Union - are not desirable, as ithcy may retar(d integration into the international econiomy) ani( intr(xuce (listortions in the pattlern of trade an(l the allocation ol financing.

* Providing outsi(de cre(lit to support paymients arrangemiients amonig Eastcrni and Central European countries is not recomimiein(ld(e - whether stuch arrangements inciti(le or excilide the Soviet Ul;ioI. Such cre(lit hclps countries iinance intraregional balances. which have little econiomiiic justilication anld could result primarily fromii thc participants' iielleclive macroccononmic policies.

Thc PRE Working Paper Serics disseminaies the rindings of work under way in ihc Bank's Policy, Rcscarch, and E\tem.lI AffairsConiplex. An obicelive of the scrics is to get ihese findingpout quickly. **Cvefn** if prcsniaiioos ai **c** Ic'' h;an fulbl jxhfi.lic Flhc bndmng'.. inkirorclailoo.,, anl (coclo'ionI111' in tIhce paper. (lo notl uc( ssarli rcprc'.ciw ot ficial ltaiik polic.

IProdu,, **I** 1,\. I PRE Dis. winmanon Ce. nl