orange in one hand and a bottle of vodka in the other, and he paid for the orange with food stamps and he took the change and paid for the vodka. That's what's wrong. And we just shake our heads."

Many Congressional leaders have remarked privately on Reagan's fondness for simplifying analogies. "You don't know whether to cry, laugh or sit with a straight face," says one top Democrat. But going public with such criticism, said a White House aide, was "very damaging" to a President already on the defense about his command of facts and issues. Criticized for a lack of loyalty by some Senate colleagues, and pressed by Baker to apologize, Packwood spoke directly to Air Force One. "I'm pretty upset about it, but I accept your apology," said Reagan. After learning that the offending remarks had not been retracted, however, White House aides expressed delight with the growing pressure for Packwood's replacement as head of the GOP Senate campaign committee. "We won't be out front on that," said one top staffer. "But we won't throw any bodies in front of the truck." "Several senators are extremely upset at Packwood," one top Senate aide confirmed. "But maybe they will calm down."

**Enough Nerve?** Criticism such as Packwood's was likely to make the President even less willing to compromise on key elements of his embattled budget. Some top White House aides think that eventually he must, but others recall his earlier defiance of their advice—and of pressure from the Hill. Some also doubt that Congress has the nerve to make major cuts in defense or entitlements, or raise taxes, in an election year. "We're probably talking about a maximum change in that deficit of $10 billion to $15 billion—with any alternative," says one top staffer. Then the question for Reagan will be whether it is worth compromising at all for a comparatively modest saving.

DAVID M. ALPERN with ELEANOR CLIFT, HOWARD FINEMAN and GLORIA BORGER in Washington and THOMAS M. DeFRANK with Reagan

# Clark Cracks NSC Whip

After a year in disarray under Richard V. Allen, the National Security Council is quietly being restored to the lofty status it enjoyed under Henry Kissinger and Zbigniew Brzezinski. Since his appointment as NSC chief, William P. Clark has virtually disappeared from public view, but the lanky, affable Californian is very visible where it counts—inside the White House, where his early efforts are getting the highest marks. "Wonderfull!" is the word I would use to characterize having him in the White House," says one senior Reagan aide. "He's doing what badly needs to be done: bringing foreign policy into the White House where you don't have Haig and Weinberger making it on the road and then telling us what the decisions are."

Word of the new order has been exported to State and Defense in no uncertain terms. Clark has reprimanded his old boss, Secretary of State Alexander Haig, and Secretary of Defense Caspar Weinberger for their public spats and informed them that policy decisions are the President's prerogative and that the path to the Oval Office is through him. He has also instructed all Cabinet officials to notify his office in advance of any foreign travel—a dictum that, an Administration source says, caused a "huge stink at State," but is, nevertheless, in effect. "Now we have a national-security adviser who can speak for the President, bang heads and pull chains," exulted a White House aide. Clark, a longtime Reagan friend and his top aide as governor, appears confident of the President's backing. Under him, strategic study and planning have been declared the NSC's special province. And NEWSWEEK has learned that he has even appointed a special consulting group on East-West credits chaired by

Kissinger and including David Rockefeller—two names certain to irritate Reagan's far-right constituency.

Clark, who found a two- to three-month backlog of paper and dozens of major matters dangling when he took over the West Wing basement office, is bringing order to the foreign-policy process. NSC meetings now are brisk, almost brusque, adhering to time limits set by Clark. Before a recent meeting, with a dozen participants hoping to talk in the half hour allotted to Soviet sanctions, Haig leaned over to the President and stage-whispered, "I sure would have hated to appear before Bill when he was a judge." The NSC chief has also reinstituted personal briefings of the President each morning (he helicoptered to Reagan's Santa Barbara ranch from his own nearby spread last week) and tries to keep Reagan up to date on key issues while exposing him to more views and options. He expects these sessions to spawn decisions and insists that Reagan himself make them public.

While Clark appears to prefer coordinat-

Larry Downing—Newsweek

In charge: The President's prerogatives

# The Three Halves of Ronald Reagan

A familiar voice explains his economic policy in terms of blueberry pie. "The top half is defense spending. The bottom half is for domestic programs. And the other half is for the national debt ..." More uncensored bloopers from a Presidential press conference? Not quite. It's impressionist Rich Little's rendition of Ronald Reagan on Little's new album, "The First Family Rides Again." The album has climbed to No. 33 on the national LP charts, and last week it turned "gold" as sales topped half a million records.

Most of Little's Reagan gags—which feature cameo “appearances” by Kermit the Frog, Mr. Bill and Fantasy Island's

Herve Villechaize—aren't exactly knee-slappers. Most turn on the President's Hollywood origins. (For example, the ghost of Abraham Lincoln advises an awe-struck Reagan to dance a jig with a banana in his ear, then chuckles, "I finally got even with an actor.") White House aides are relieved that the Reagan gibes to date have stayed generally "affectionate in nature," and the President himself seems determined to laugh along. After listening to the copy of the album that Little sent him, Reagan wrote a congratulatory note—and expressed bewilderment that Little seemed "to have so much trouble [understanding] the three halves of the pie."

NEWSWEEK/MARCH 15, 1982

I do not own any of the works cited in this article.

THE WHITE HOUSE
WASHINGTON

February 16, 1982

FEB 18 1982

Dear Henry:

I was interested in the suggestion you made recently concerning the formation of a small group to look expeditiously at the question of Western credit flow to the Soviet Bloc.

I have enclosed an unclassified analysis of the present Soviet Bloc economic and financial situation for the use of the group.

The group might consider the following matters:

(1) What advantages and costs do Western credits to the Soviet Bloc countries have for the Western countries, the Western banks and Western industry and trade?

(2) What advantages and costs do Western credits to the Soviet Bloc countries have for the Soviet Bloc?

(3) Should this credit flow be reduced, eliminated or increased?

(4) Should Western governments increase the cost of official and officially-guaranteed credits?

(5) What would be the effect on the Western banking, industrial and trade systems of a cutoff of credit to the Soviet Bloc?

Again, thank you for your continuing assistance.

Enclosure

The Honorable Henry A. Kissinger
1800 K Street, N.W.
Suite 400
Washington, D.C. 20006

UNCLASSIFIED

Press Perceptions of the Soviet Financial Position

A survey of the open literature since early 1980 to present
we believe presents a fairly accurate view of the unfolding
payments dilemma facing the USSR and the East European
countries. In only one in notable instance (a 6 February article
in the Economist) does the view vary widely from our bottom line
judgment.

Since the beginning of 1980, the general perception of the
Soviet financial position--and overall Bloc creditworthiness--has
changed significantly. Rising world oil prices during the late
1970s had boosted Moscow's hard currency earnings to record
levels by the end of the decade and 1980 began with expectations of
even greater earnings. As a result, the Soviet payments position
was viewed as robust. These perceptions were reflected in
Western attitudes toward general Bloc creditworthiness. The
general belief was that the Soviets could and would come to the
aid of any of its allies.

The beginnings of political unrest in Poland served as a
turning point in the general Western perceptions. Publications
more and more frequently printed articles on Soviet Bloc
creditworthiness. By early 1981 reporters were seriously
questioning the belief that the Soviet Union would automatically
act to bail out one of its satillites from financial problems.
By summer--when it was clear that Moscow was not attempting to

UNCLASSIFIED

prevent a Polish default--this belief was all but dead. Instead,
press reports began to appear about the cost to the Soviets of
supporting its empire. This issue was explored in detail in
feature articles in both *Fortune* magazine and the *Los Angeles*
*Times*.

Even so, the net assessment of Moscow's payments position
remained fairly bullish through the summer. In the fall of 1981,
with publication of Soviet mid-year trade statistics and the Bank
of International Settlements data on Soviet assets and
liabilities to Western lenders, this perception began to crumble
as far as the USSR's short run position goes. Since then the
press has reported on:

* Soviet attempts to delay imports and defer payments,

* increased Soviet gold sales,

* other indications that the Soviets are in a hard currency pinch.

Attitudes on Soviet long-term financial strength have however
remained unchanged. The belief in the abundance of Soviet
reserves of oil, gas, and other raw material resources has led
Western analysts to rate Soviet long-term prospects as good.

The attached articles (listed in the Appendix) are
representative of the trends in Western press reporting on the
USSR's balance of payments position and Soviet Bloc
creditworthiness in general. Of particular interest, and as a
fair accounting of reporting, are the *International Investor*
articles published in January 1982. In contrast to the better
articles is the 6 February piece in the *Economist*.

UNCLASSIFIED

-2-

UNCLASSIFIED

Appendix

Selected Press Items on Bloc Payments Position.

Press statements on Soviet Trade and Payments 1980-81.

"The New Skittishness of East Bloc Loans", Business Week, Sep. 15
1980.

"Lending to Communist Nations", Time, Dec. 1 1980.

"Polish Debt: A Game of Chicken", Business Week, Feb 16, 1981

"Once Burned. . .Western Banks Now Demur on Soviet-Bloc Loans",
Wall Street Journal, May 19, 1981.

Polish Debt Enmeshes the West", The New York Times, May 21,
1981.

"Soviet Imperialism is in the Red", Fortune, July 13, 1981.

"Soviets Pay High Price to Run an Empire", Los Angeles Times, Aug
30, 1981.

"Eyeing Warsaw, West Gets Cautious on East Bloc Loans", The New
York Times, Sep. 27 1981.

"Soviet Bloc Owes West $73 bn", Financial Times, Oct 12, 1981.

"Projected EE Debt to Double by 1985", Business Eastern Europe,
Oct. 23, 1981.

"Why Russia is Selling gold in a Soft Market", Business Week,
November 9, 1981.

"Banks and US Officials Hopeful on Polish Debt", The New York
Times, Dec 15, 1981.

"Who's Worried About Eastern European Debt?", International
Investor, Jan 1982.

"Why Poland Went Bankrupt" Wall Street Journal, date unknown.

"Soviet Said to Seek Payment Delay" The New York Times, February
1, 1982.

"Now Russian Asks for Time to Pay", The Economist, Feb 6 1982.

UNCLASSIFIED

-3-

UNIONS

Polish workers inch
toward free unionism

With an extraordinary display of unity and power, striking Polish workers forced their government to accept a basic paradox: the existence of free trade unions within a restrictive Communist nation. The Polish strike settlement represents—on paper, at least—enormous potential for change in Poland and the East bloc countries. But whether this settlement will be translated into real gains for workers is totally unpredictable.

The main series of strikes, starting in the Baltic port of Gdansk in early Au-

gust and involving 350,000 workers at the peak, ended on Aug. 31. For the first time in the history of Communist states, government officials formally negotiated with worker groups and signed written agreements. The government capitulated on 21 strike issues, including demands for free trade unions which will exist side by side with government-controlled unions. On Sept. 3 some 30,000 coal miners won a similar settlement. But Poland remains volatile. On one hand, the strike settlement could mark the beginning of a free labor movement, restricted at first, but with a rising potential for challenging the authority of the Communist Party.

**Sabotage to come?** At the other extreme, and just as unlikely to happen in the immediate future, Poland or the Soviet Union could crush the worker movement with force. More likely is a middle course, with many variations, in which the Polish government will

allow new trade unions to evolve slowly but in the end, under pressure from the Soviets, attempt to sabotage them. "A Communist regime can't tolerate free unions," says Tadeusz Szafar, a journalist who emigrated from Poland in 1975 and now works at Harvard University's Russian Research Center. "The government will allow a bit more freedom at first and then start dismantling it by promoting the union leaders, corrupting

them, or jailing them on trumped-up charges."

A significant difference between the 1980 Polish strikes and those of 1956, 1970, and 1976 is that in the past the government was able to use a combination of force and concessions on prices to halt the stoppages rather quickly. It never delivered on verbal promises to change the union structure. But it was clear this time that Polish workers—with more sophisticated organization—were determined to make the unions truly representative.

As in all Soviet bloc countries, unions are an appendage of the government. Lenin conceived of unions in a Communist system as the "transmission belts" from the party vanguard to the masses of workers. Practically all of Poland's 12.5 million workers belong to 23 national unions, each of which elects two delegates to sit on a top policymaking body,

may be formed without prior authorization of the council, and all unions must recognize the "guiding role" of the party in union affairs. The International Labor Organization has been pressing Poland for years to remove these provisions and bring Polish law into compliance with an ILO convention on freedom of association. In the strike settlement, the workers agreed to recognize the "guiding role" of the party, but if that link is removed from the law, the formation of independent unions may be somewhat more feasible.

**Right to strike.** Lech Walesa, the 36-year-old electrician at the Gdansk shipyard who headed the Interfactory Strike Committee, has already started to form a new union, but it is unclear what the government will allow it to do. As for collective bargaining, the strike settlement says only that "the new trade unions should have the real possibility to make public their views on key discussions" involving living conditions, wages, and long-range economic plans, among other things. The document grants the right to strike, but observers note that Polish workers—fearful of Soviet intervention—are unlikely to exercise this "right" as an American union does.

But if the promise of free trade unions turns out to be a paper victory, Polish officials will have to cope with the fact that ordinary Poles are not likely to forget the awesome power that workers can muster. "There is a feeling on the part of the population that something has been achieved, that somebody has been successful in forcing the power structure to go along," says J. B. de Weydenthal, an analyst of Polish events in Munich. ■

Strike leader Walesa: He is already forming a new union, but it is unclear what Warsaw will allow it to do.

the Central Council of Trade Unions. The chairman of the council normally has been a member of the ruling Politburo, and the council members—all party members—are chosen by the party. The council suggests officers for county-level union organizations, who in turn nominate candidates for plant-level union offices. In this way, the party keeps a grip on the union structure.

Moreover, under Polish law no union

With the ink barely dry on their government's historic pact with Poland's striking workers, a team of Polish officials led by Marion Minkiewicz, head of the Handlowy State Commercial Bank, is preparing for a visit to Washington. Their goal: securing $675 million in credits from the U. S. government-backed Commodity Credit Corp. to buy American farm goods.

The Minkiewicz mission starkly underscores Poland's now-chronic need for infusions of hard-currency credit to keep its economy moving. Likely to be warmly received in Washington, the mission also marks Poland's hope that the West will help it bridge its now-worsened financial crisis. President Carter has urged U. S.

38 BUSINESS WEEK: September 15, 1980

[L]

t prior authorize-
d all unions must
“role” of the party
International La-
been pressing Po-
ve these provisions
to into compliance
on on freedom of
like settlement, the
recognize the “guiding
out if that link is
y, the formation of
may be somewhat

alesa, the 36-year-
Gdansk shipyard
interfactory Strike
dy started to form
is unclear what the
it to do. As for
the strike settle-
“the new trade
the real possibility to
ews on key discus-
ing conditions, wages,
economic plans, among
ument grants the
observers note that
ful of Soviet inter-
ary to exercise this
an union does.
of free trade unions
per victory, Polish
cope with the fact
are not likely to for-
ther that workers can
geeling on the part of
something has been
body has been suc-
power structure to
de Weydenthal, an
ants in Munich. ■

Bitterness
loans

ry on their govern-
with Poland's strik-
n of Polish officials
tiewicz, head of the
commercial Bank, is
sit to Washington.
$675 million in cred-
government-backed
Corp. to buy Ameri-

mission starkly un-
ow-chronic need for
currency credit to keep
Likely to be warmly
ton, the mission also
the that the West will
v-worsened financial
rter has urged U. S.

allies to look favorably on Polish credit
requests as a means of supporting the
country's liberalization.

But there is scant hope that the coun-
try will be able to reduce its $20 billion
debt any time soon. Although two major
loans, a $675 million public package
from West German banks partly guar-
anteed by the Bonn government and a
$325 million syndication led by Bank of
America International (BW—Sept. 1),
appear to have averted an imminent
financial crisis, one Europe-based U.S.
banker predicts that Warsaw will face

The Polish crisis makes
Western bankers worry
about their loan exposure

"the same mess" next year and will need
$4 billion to $6 billion a year from 1981
to 1983 to finance its debt and cover
trade deficits.

Far more important than any threat
of Polish default—a possibility that
Western bankers and government offi-
cials scoff at—are the ramifications of
the Polish upheaval for the East bloc as
a whole.

PRIVATE LENDING. Western commercial
banks will be increasingly unwilling to
deepen their loan exposures in East bloc
nations. "Nobody's keen to go in there
with new money," says a well-informed
U. S. banker. As for Poland, he adds:
"None of the major banks will be ex-
tending new credits. We're essentially
passing on the risk to the public sector.
Any expansion of credit in Poland will
come from governments—the U. S.,
France, West Germany, the Austrians,
etc." Confirming that view, a West Ger-
man banker says: "We see no circum-
stances where we could increase the
credit [to Poland] on our own risk. When
it becomes a political question, it should
be between governments, not banks."

COMMUNIST BORROWING. Observing the
debt-induced economic crisis in Poland,
other East bloc governments will become
far more cautious about borrowing. Po-
land's strategy of borrowing to buy in-
dustrial plant and paying for it with
exports has been an exemplary failure.
Although Poland did succeed from 1971
to 1976 in boosting its growth by buying
Western equipment on credit, a recent
Central Intelligence Agency report con-
cludes: "Warsaw's ability to effect a pos-
itive resource transfer deteriorated in
1976-79. In effect, 85% of every dollar
borrowed went into servicing debt in
1979 compared with 35% in 1973-1976."

ECONOMIC REFORM. Because inflexible
and inefficient planning helped derail
Poland's export prospects, pressures for
major economic reforms—such as prof-
it-oriented enterprise management,
worker and management incentives, and
market-influenced planning—are likely

to mount. One model is Hungary, where
price reforms last year aimed at making
national industry compete with global-
scale efficiency.

INVESTMENT. Eastern Europe is in the
midst of a harsh transition period
toward slow growth and higher oil and
raw materials costs as the Soviet Union
raises its charges to satellites as its own
production of such materials declines.
But with worker unrest latent in several
nations, East bloc experts believe that
the Polish example will now influence
Communist governments to squeeze
hardest on projected investment budg-
ets, rather than lowering workers' in-
comes and risking revolt. "Ironically,"
says Bankers Trust Co. Vice-President
Lawrence J. Brainard, "the immediate
result could be that the whole bloc could
appear more creditworthy, because they
will be more cautious and run lower defi-
cits." But by the mid-1980s, Brainard
warned in a June speech in Stockholm,
the East bloc will have aging industrial

plant while still burdened by "the stock
of foreign debt . . . which must be ser-
viced."

TRADE. The hesitation of both Western
bankers and Communist bureaucrats to
invest heavily or to run deficits to spur
East bloc growth is likely to dampen
trade with the West. Hardest-hit will be
Western companies that make the capi-
tal goods that bureaucrats once viewed
as the engines of East bloc growth. But
deepening austerity may leave the bloc
by 1984 or so even less well-equipped to
compete on world markets than it is
today. Banks that will have meanwhile
financed the region may find themselves
still mired in continuing demands for
extensions and rollovers. ■

Jiri Tomášek - BneP

Why Britain's pound
is acting so strong

The British pound, buoyed by high
est rates, has risen to a five-year
against the U. S. dollar on the
exchange markets. With seven-d
ling deposits fetching an alluring
interest rate in London, inter-
investors ranging from U. S. co-
treasurers to Arab sheiks bid t
of sterling up to $2.42.

The apparent paradox in st
strength is that the British cur-
risen despite bearish economi
from Britain. On Aug. 29, w
pound broke through the $2.40
London was absorbing the new
million British are unemploy
highest number since the De-
With British papers reporting
tions in textiles, chemicals, st
automobiles daily, the high e
rate seems perverse.

But it is not in the opinion o
exchange dealers, who attri
strength of sterling to the diff
erent interest rates that can be
ered with sterling deposits compared with
any other significant current
pared to a seven-day sterling
rate of 16½%, Eurodollars ir
command an interest rate of
German marks 8¼%, and Swi
to like that," says one dealer, "st
drop by quite a bit, and the in
still get out ahead."

An unstable dollar. Interest r
also creating some havoc for
dollar. In the space of just tw
late August, short-term dolla
both New York and London sh
then plummeted by nearly
points. This sent the dollar
before it dropped.

The instability of the dollar'
overseas reflects uncertainty
Federal Reserve's monetary p
lar interest rates have fluctua
tions for months now since the Fed
concentrate its efforts on t
supply and to neglect rates p
that has led to growing inst
the dollar.

There is more to the streng
ling than interest rate differ
course. The impact of British
oil production has pushed t
account into surplus, in con-
deficits of the French (page
Germans, and Japanese. At 1
the pound, sterling is at a five
against the French franc, wh

BUSINESS WEEK: September 1

Economy & Business

Lending to Communist Nations

The $70 billion dilemma spotlighted by Poland's crisis

The paradox could hardly be more striking. Poland, a Soviet bloc country whose economy is based on Marxist-Leninist dogma, is appealing to the capitalist West for financial aid. Warsaw has asked Washington, to which it is already in hock for $1.2 billion in assorted credits, for another $3 billion in assistance. The Polish government clearly needs the cash: it must pay off foreign lenders and continue to finance the food imports required to keep the Poles from becoming more resitive than they are.

The State Department announced last week that the Carter Administration put off a decision on the aid indefinitely, leaving the matter for its successor. But Washington officials were already raising ques-

off by hikes in meat prices, added to the economic breakdown.

Western banks have been happy to lend to Eastern European countries, which they believe are good risks. Communist governments are presumed to be stable. Moreover, the debtors in socialist nations are not firms but governments, and their repayment record over the past 35 years is unblemished. That helps explain why Yugoslavia has been able to borrow more than $7.5 billion from Western banks and why Rumania owes $4.2 billion to private foreign lenders.

In Western eyes, the Soviet Union has contributed to the creditworthiness of the East bloc economies because no one believes that Moscow would allow one of its

of all borrowing countries to foreign banks, now totaling $600 billion, the Polish economy has raised new fears about the ability of many hat-in-hand nations to repay loans. Turkey, for example, would be totally insolvent without West German support. Among the developing countries Brazil has run up the largest foreign debt of about $57 billion, mostly to pay for oil. The crushing debt has hindered zil's attempts to expand its industrial base and has helped push its annual inflation rate above 100%. For political reasons, government has refused to borrow from the International Monetary Fund, to dismay of many bankers.

All major banks now routinely lend the credit risks of countries. The International Investor, a U.S. monthly for men, regularly publishes a summary of ratings cited by world bankers. As most creditworthy nation, the U.S. ranked first among the 98 countries in the latest survey, while Poland in-

Amid food shortages and meat rationing, Poles queue up in front of a Warsaw butcher shop waiting for the store to open

"It is not just a question of loans and credits and money, but a supreme matter of state in East-West relations."

Itions about the security of Western loans to East bloc nations, which now total about $70 billion. The matter is also increasingly being seen as a test of Moscow's willingness to bail out its overextended satellites. "It is not just a question of loans and credits and money," says a senior member of the Belgium banking community, "but a supreme matter of state in East-West relations."

Poland's problems go well beyond its immediate need, which is to make good on a balance of $7.5 billion in interest and capital due next year on $21 billion in foreign debts. Already Warsaw must spend 82% of its foreign sales revenue to service such debt. Most of it stems from bobbed efforts to build an industrial base after World War II. Two primary exports, steel and textiles, have been hurt by slack demand abroad. Polish agriculture contributes little either to foreign earnings or do-

allies to go bankrupt. True, North Korea defaulted on a Western loan in 1975, but bankers attributed Moscow's failure to bail out Pyongyang to Sino-Soviet rivalry. The Kremlin has helped Poland in the past and could do so again, for example, and today it is flush with funds. Thanks to foreign sales of gold and oil, the Soviets have paid off $2.5 billion in private bank loans: Thus far, however, they have shown no inclination to bail out the Poles. A Polish default on foreign loans might give Moscow an excuse to tighten its hold on the economy or, at worst, grab direct power in Warsaw.

"Countries don't go bankrupt," as Citicorp Chairman Walter Wriston once said. But they can delay or, as in the case of Iran, freeze payment on foreign debts, even though such moves endanger the profitability and, eventually, the sta-

71st and Zaîre is at the bottom. The Union ranked 27th and Brazil 500th.

If Washington or private banks to bail out Poland again, it could be as a vote of confidence in the Union: lenders would be saying that expect the Polish economy to be back to health by Moscow so that eventually be able to repay its loans. International financial community prevailing sentiment is that the West not afford to turn down Poland's request for fear of a more pronouncement of Soviet intervention in the country's affairs. Says Lawrence Brainard, a Trust vice president: "The real question is the price of political stability in Eastern Europe." More broadly, the Eastern problem seems certain to alert the world to the dangers of much offshore lending, which in turn will make borrowing difficult for impoverished nations. With debts to the world-

["INTERNATIONAL MONEY MANAGEMENT", "Polish debt: A game of chicken", "As Poland sinks deeper into economic and political decay, Western commercial bankers and official creditors are playing a financial game of chicken with Moscow to determine who will supply Warsaw's financing requirements—expected to reach $8.5 billion in 1981. At stake are Poland's $24 billion debt, and an estimated $77 billion in total Eastern bloc debts to the West.", "For the past month, Poland's official creditors in the West have fought a holding action, trying to force Moscow to show its hand. At a meeting held at the Palais du Louvre, in Paris, on last Dec. 22 and 23, and at another meeting, on Jan. 16, these lenders agreed to conduct a bridging operation until March. The Poles will be granted new credits only in amounts equal to those that are paid off, and new cash will be provided for short-term trade transactions only in small amounts. Says a Frankfurt banker: \"It's a kind of revolving-door arrangement—a sort of internal recycling.\"", "A vicious circle. These nations, led by Poland's four largest creditors—France, West Germany, Austria, and Britain—believe it is primarily the Soviet Union's responsibility to bail out the Poles. Wary of committing sizable sums of new cash to let the Soviets off the hook, Poland's Western creditors are pushing Moscow by delaying contributions to the proposed $14 billion Yamal pipeline. The Soviets, for their part, do not want to waste hard currency on Poland's sick economy, nor are they anxious to see their loans used to repay Western banks.", "Poland, says an international banker based in Paris, is caught in a \"vicious circle.\" It needs more help to stay afloat but appears increasingly unable to manage more debt. \"It is difficult to see how it can be solved in the next five, six, or", "even seven years,\" he says, speaking of the Polish debt situation. Western bankers are especially uncomfortable about Poland, because—in contrast to their influence in Zaire and Turkey, which are caught in similar financial crises—they have no political or economic leverage there. \"The main concern of bankers is that they are involved in something in which they have no hope of applying pressure,\" adds the Paris banker.", "For the moment, at least, most commercial bankers are clinging to the so-", "<table><caption>The Soviet bloc's debt to the West and Japan</caption><thead><tr><th></th><th>Dec. 31, 1979</th><th>Dec. 31, 1980</th></tr><tr><th></th><th colspan=\"2\">Millions of dollars</th></tr></thead><tbody><tr><td>Bulgaria</td><td>$3,900</td><td>$4,300</td></tr><tr><td>Czechoslovakia</td><td>4,200</td><td>5,000</td></tr><tr><td>East Germany</td><td>10,500</td><td>12,000</td></tr><tr><td>Hungary</td><td>8,100</td><td>7,600</td></tr><tr><td>Poland</td><td>21,000</td><td>24,000</td></tr><tr><td>Romania</td><td>6,750</td><td>9,000</td></tr><tr><td>Soviet Union</td><td>16,500</td><td>15,200</td></tr></tbody><tfoot><tr><td>Total</td><td>$70,950</td><td>$77,100</td></tr></tfoot></table><p>Data: BW estimates</p>", "called \"umbrella theory.\" The long-held assumption that Moscow is the ultimate guarantor of its satellites' debts. The logic behind such thinking is that the Soviet Union cannot renounce its obligations and risk shutting itself off from access to hard-currency loans needed to purchase wheat and Western technology. Says one Bonn source: \"Moscow knows that a failure by Poland to meet its Western debts would likely lead Western lenders to shut their money windows to the East bloc as a whole, and that's", "something they neither want nor really can afford.\"", "But the Soviets talk differently. Says Georg Skorov, deputy director of the Institute of U.S. & Canadian Studies in Moscow: \"There is no reason for the Soviet Union to pay Poland's debts, because they were incurred by a sovereign state on its own, without Russian consent.\" Skorov argues that if Poland defaulted, Moscow's credit standing would not be affected.", "Accommodation. Many experts admit that it is in everyone's interest to prevent Poland from defaulting—those of Moscow, official Western creditors, the banks, and especially, Poland. Therefore, they say, some accommodation is necessary. Bankers fear that once Western governments roll over the official portion of the debt, they will pressure the commercial banks to reschedule their own $15 billion share. For the Poles, it will mean higher interest rates and extended payment periods. Several bankers also claim the commercial banks will try to extract more concessions from Warsaw, such as membership in the International Monetary Fund and strict monitoring mechanisms—conditions not likely to be acceptable to Moscow.", "U.S. banks believed to be deeply exposed in Poland are Manufacturers Hanover Trust Co., Bank of America, Continental Illinois National Bank & Trust Co. of Chicago, and Morgan Guaranty Trust Co. of New York. \"The whole burden is being carried by the big international banks,\" says a U. S. banker. \"The small ones are out of the picture.\"", "Any rescheduling will bring the commercial banks a heavy cost in flexibility because their funds will be stuck in the Polish financial quagmire for years. Already many banks in Germany and the U.S. have reached their self-imposed lending limits for Poland, and one U. S. banker asserts that \"some banks are out on a limb and want others to join them on it. Many banks naively put a lot of money into Poland without knowing what could happen.\"", "Foreign exchange trader", "<table><thead><tr><th rowspan=\"2\"></th><th rowspan=\"2\">SPOT</th><th rowspan=\"2\">U.S. TREASURY BILLS</th><th colspan=\"3\">PERCENT</th><th colspan=\"8\">IN U.S. DOLLARS</th></tr><tr><th>U.S. EUROMARKET</th><th>SINGAPORE</th><th>EUROMARKET TIME DEPOSITS*</th><th>GERMAN MARK</th><th>SWISS FRANC</th><th>JAPANESE YEN</th><th>CANADIAN DOLLAR</th><th>FRENCH FRANC</th><th>BRITISH POUND</th><th>ITALIAN LIRA</th></tr></thead><tbody><tr><td></td><td></td><td></td><td></td><td></td><td></td><td></td><td></td><td></td><td></td><td></td><td></td><td></td><td></td></tr><tr><td></td><td></td><td></td><

[c]

COMMUNISTS

Soviet
Imperialism
Is in
the Red

As European colonial powers learned long ago, an empire can be expensive. The present-day Soviet version certainly is. And the costs have been climbing steeply, to the point where the Russians have started to complain aloud. In a recent blistering letter to the Polish Central Committee, the Soviet Central Committee growled about "slanderers and liars" who say the Soviet Union is "plundering" the Poles, when in fact it "is provisioning the main branches of Polish industry" with subsidized fuel and materials.

The chart on this page traces the leaping rise in the principal component of the Soviet empire's cost: the trade subsidy extended to the East European satellites—Poland, East Germany, Czechoslovakia, Hungary, Rumania, Bulgaria. In the early years after World War II, the flow ran the other way. Research done by Paul Marer, a top Soviet-bloc specialist who teaches at Indiana University, indicates that in the later 1940s the Russians removed—that is, looted—about $14 billion worth of machinery and other goods from Eastern Europe, an amount roughly equal to what the U.S. poured into Western Europe during those same years through the Marshall Plan.

After a while, the Soviet Union imposed a trading pattern designed to link the economies of the satellites to that of the imperium. The Russians send their

satellites oil, natural gas, minerals, and cotton in exchange for manufactured goods such as East German computers and Hungarian buses. As measured in ruble value, nearly 64% of the Soviet exports to Eastern Europe in 1978 consisted of raw materials; and of Soviet imports from Eastern Europe that year, 78% consisted of machinery and equipment, along with manufactured consumer goods.

The hook that helps ensure the satellites' fidelity is that the Russians sell their fuel and raw materials at less than world-market prices. For the Soviet Union, these trade subsidies constitute what economists call an opportunity cost. That is, the Russians are forgoing an opportunity to earn more money by, say, selling their oil in Rotterdam rather than in Prague. It's quite a cost, amounting on some estimates to more than $20 billion last year. The Russians also prop up the economies of their satellites through other means, including direct grants-in-aid, low-interest loans, and commercial credits.

A sweet deal for Castro

It might seem that the Russians incur a continuing military cost to keep their satellites from breaking away—as most of them, no doubt, would do if they could. But Western experts point out that a Soviet Union without its East European buffer would probably spend even more than

The Empire
Strikes Back

The Soviet Union props up the economies of its satellites by selling oil and minerals at less than world-market prices. Oil accounts for a large part of the total subsidy. The cost to the Soviet Union took off in two great surges in the Seventies, as the prices Moscow was charging the satellites lagged behind the OPEC run-ups of 1973-74 and 1979. The chart figures come from a study by economists Jan Vanous and Michael Marrese, respected authorities on Soviet-bloc trade. Under an arrangement adopted in 1975, East-bloc prices are adjusted annually on the basis of a five-year moving average of world prices. Thus if the world price of oil declines in years ahead, or increases less rapidly than other prices, the Soviet subsidy will shrink.

Illustration by Michael Kagan

FORTUNE July 13, 1981 107

[c]

The Russians have begun to demand
hard currency for weapons
sent to oil-rich countries like Libya.

the current awesome amount for defense,
since in the Russian view more hardware
would be needed to secure the country's
borders. A military invasion of Poland,
however, would be an expensive under-
taking. Aside from the costs of the in-
vasion itself, the Russians would have to
try to get a collapsed economy functioning
with a surly if not rebellious labor force,
and they might well find themselves held
accountable for Poland's $23-billion debt
to Western banks and governments.

The rise in Moscow's financial burden
has been the result of three factors. First,
the world prices of raw materials—espe-
cially oil—have gone up faster than the
discount prices Moscow has charged its
satellites. Second, some of the satellites
are in dire economic trouble—Poland and,
to a lesser extent, Czechoslovakia—and
the Russians have had to help bail out
these faltering dependents.

And finally, the empire itself has been
expanding—Cuba, Vietnam, some would
now include Afghanistan. Cuba has been
an especially costly satellite. According
to Fidel Castro, in a December 1979
speech, the Russians were going to sell
Havana 11.1 million metric tons of pe-
troleum and refined products in 1980 at
an estimated crude-oil-equivalent price of
$12.80 per barrel, vs. the world-market
price of about $35. The implied oppor-
tunity cost to Moscow for the year works
out to $1.8 billion.

Even Vietnamese vodka

Unlike the Eastern Europeans, who pay
for Soviet oil with manufactured goods
and some hard currency, the Cubans pay
with sugar and nickel. Moreover, the
prices of this sugar and nickel are linked
to the prices Moscow charges Havana for
oil. Thus the Cubans are assured that oil-
price hikes won't make any difference to
them whatsoever. Since the Soviet Union
is itself the world's largest producer of
both sugar and nickel, there is really no
doubt that this trade pattern is designed
to prop up the Cuban economy.

Vietnam's new trade relationship with
the Soviet Union is much like Cuba's. In

return for raw materials, the Vietnamese
send the Soviet Union consumer goods,
including clothing, carpets, handicrafts,
and some food, as well as rubber and rub-
ber products. The Soviet Union even im-
ports Vietnamese vodka; it's believed the
stuff is used for domestic Soviet consump-
tion, thus freeing Russian vodka for ex-
port to hard-currency markets. The U.S.
State Department estimates that the cur-
rent annual cost to the Soviet Union of
its new Indochina satellite comes to about
$1.1 billion.

Happily for the Russians, the rising
costs of empire in the last few years have
been extensively offset by three financial
windfalls. As the world price of oil went
up, the Russians made a hard-currency
killing even though they have frozen oil
exports to the West at about 1.3 million
barrels a day. In 1975 oil exports earned
the Russians $4 billion; in 1979 the same
volume of exports brought in $9.5 billion.
And as the world's second-largest produc-
er of gold, the Soviet Union has scored big
by making occasional sales to Western
buyers. Finally, the Russians have begun
to demand hard currency for weapons
sent to oil-rich countries like Libya; Mos-
cow used to give weapons away.

What's more, the Soviet Union does
enjoy some financial pluses from its em-
pire. Czechoslovakia is now pouring an
astounding 30% of its new investment
into a nuclear-power program designed
to serve the entire region; what the Czechs
spend on research and development, the
Russians save. And in return for their oil
the Russians do receive large volumes of
manufactured goods that are superior to
anything they themselves produce.

This hasn't stopped Russians from com-
plaining that the goods they get from the
satellites are of lower quality than West-
ern goods—which the Russians could af-
ford, they point out, if they sold their oil
for hard currency. But some Western ex-
perts have concluded that the Russians
are getting goods at prices lower than
they would have to pay in the West. If
this is true—and not all experts believe it
is—then in a sense the Russians are re-

ceiving a subsidy from their satellites.

Still, there's no doubt the empire is cost-
ing the Russians a pretty kopek. And this
comes in addition to the many billions of
rubles Moscow spends to project its pow-
er into countries like South Yemen, Ethi-
opia, and Angola. Since these countries
aren't part of the empire proper—at least
not yet—the money Moscow spends can
be regarded as economic and military aid
in the traditional big-power sense.

Economically, then, the empire is a
losing proposition, but its value to the
Soviet Union transcends balance-sheet
terms. The geographic and ideological
buffer between the Soviet Union's west-
ern border and the Free World is im-
mensely valuable in the eyes of Kremlin
leaders. Cuba provides an unsinkable air-
craft carrier just 90 miles off the Florida
coast, and presumably the services of
those 35,000 Cuban troops in Africa are
worth a lot to Moscow. Vietnam humil-
iated the U.S.—no way to put a dollar, or
ruble, value on that—and today Vietnam-
ese soldiers, like their Cuban and East
German comrades, are serving as effective
surrogates for the Russians.

The fatal error of avarice

Imperial powers have always incurred
financial costs in return for the non-finan-
cial benefits of empire. In the heydays of
the British and French empires, debates
went on incessantly over whether the em-
pires were worth the financial cost. All
the debates came down to the same point.
Empires are not meant to be economic
structures, hence their value can't be mea-
sured in economic terms. In 1933 the
French historian and champion of col-
onization Gabriel Hanotaux summed the
matter up like this: "Let us get away from
the fatal error of base and immoderate av-
arice that demands, 'How much does
colonization pay?' From it comes an em-
bellishment of living, an enlargement of
inspirational force: the Empire."

This isn't exactly the way Kremlin lead-
ers phrase it. But there's no evidence what-
soever that they have any doubt the
empire is worth its rising cost.

108 FORTUNE 11.13.1987

LOS ANGELES TIMES

30 August 1981

# $25 Billion for Foreign Aid Despite Shortages at Home

# Soviets Pay High Price to Run an Empire

By ROBERT GILLETTE, *Times Staff Writer*

MOSCOW—Meat and milk are in chronic short supply. Urban housing conditions are the poorest in the industrialized world. Shortages of consumer goods as diverse as vacuum cleaners, buttons and eyeglasses are a constant source of public grumbling.

For all this, the Soviet government nevertheless diverts the equivalent of more than $25 billion a year to foreign aid, a sum more than three times what the United States spends on foreign aid, siphoned from an economy only three-fifths the size of the U.S. economy.

The Kremlin is generally believed to commit no more than about $2 billion of this huge sum, and probably less, to economic aid for non-communist developing countries. According to a 1980 CIA publication, Moscow provides only about 1% of official development assistance to the Third World, and nearly all of that is said to consist of loans, not outright grants.

So virtually all of the Soviet Union's immense foreign aid investment goes to prop up the economies of its closest allies and satellites, from Vietnam, Mongolia and Afghanistan to distant Cuba. But most of all it supports the six Warsaw Pact nations of Eastern Europe.

It is the price the Soviet Union pays to maintain a modern-day empire, and as Eastern Europe's economies—Poland's chief among them—continue to stagnate, the price of the empire rises.

Although the Kremlin treats overall figures on foreign aid as a state secret, ordinary Russians seem acutely aware that their government's generosity imposes on them, and they often blame it for shortages of food and consumer goods. Few seem to realize, however, that the cost of keeping up the mammoth Soviet military establishment drains far more from the economy—11% to 13% of the gross national product annually, compared with about 2% of the GNP for foreign aid.

"In America, you have everything on the shelves of your supermarkets, but you can't afford to buy it," a Moscow pensioner said in a tone of absolute certainty. "Our

problem is just the opposite. We have all the money we need, but nothing in our stores to spend it on."

## Vital Help to Allies

Asked why he thought this was so, he paused thoughtfully and replied, "Foreign aid. We give so much to places like Cambodia, Afghanistan and Poland."

The pensioner quickly added that the Soviet Union is giving vital help to its allies. He evinced no suspicion that the biggest slice of the Soviet aid commitment benefits Eastern Europe, where standards of living as measured by such factors as meat consumption, the availability of modern housing and the variety and quality of consumer goods all are generally higher than in the Soviet Union.

The ruling Soviet Politburo is clearly concerned about its growing burden of economic aid to Eastern Europe, especially but not exclusively to Poland, which received $4.2 billion in Soviet credits between August, 1980, and mid-June of this year, $965 million of it in hard Western currencies, according to official Polish statements.

When the Kremlin sent a blistering letter to the Polish Communist Party's Central Committee last June, warning it to start living up to promises of economic reform and political control of the "enemies of socialism," the Soviet leadership took special umbrage at "slanderers and liars" who charge that the Soviet Union "plunders" Poland by means of unfair trade arrangements.

On the contrary, the Soviet letter insisted, the Soviet Union "actually nourishes the main branches of Polish industry" by selling oil, natural gas, ores and cotton to Poland "at prices from 30% to 50% lower than world prices."

In a recent statement the Soviet Politburo summed up the results of annual meetings in July and August between Communist leaders and President Leonid I. Brezhnev at his Crimean retreat by noting that the chief domestic policy concern in Eastern Europe and the Soviet Union—"the main emphasis"—is the task of invigorating their economies.

The Politburo also warned its allies "to pursue a realistic economic policy without running into excessive debt to the capitalist states." The main object of the warning was undoubtedly Poland, whose $23-billion debt to the West (and $5 billion hard-currency debt to the Soviet Union) has compounded the economic problems brought about by its inept management.

## Poland's Huge Debt

But the warning had general application. Overall, according to Wharton Econometric Forecasting Associates, a private U.S. research institute, Eastern Europe's medium- and long-term debt to Western banks and governments is likely to reach $60 billion this year, three times the $19 billion that other sources estimate Eastern Europe had accumulated as of 1975.

Wharton projects that East Germany's debt by the end of this year will be $12.8 billion and Romania's $11.9 billion. Payments on this huge and mounting debt drain resources from Eastern Europe's economies and raise the pressure on Moscow to compensate with still greater subsidies.

Eastern European nations that were drawn into the Soviet sphere by force of arms are now its economic dependents, along with the Soviet Union's closest Third World allies, Cuba, Mongolia and Vietnam.

The Russians have worked diligently since the 1950s to build economic dependency in Afghanistan, through about $2.5 billion in economic and military aid over a period of 25 years, and the process is accelerating now under the Soviet-installed regime of Babrak Karmal

## $1.1 Billion for Vietnam Yearly

Aid to Vietnam is thought to run the Soviets $1.1 billion a year while economic support for Mongolia has averaged about $380 million annually during the past 10 years.

The Soviet Union subsidizes its allies by selling them oil and other raw materials at prices well below world market levels. In payment, Moscow buys mostly agricultural products and manufactured goods—such as buses and computers from Hungary, bottled fruits and vegetables from Bulgaria, sugar from Cuba

24

THE CHRISTIAN SCIENCE MONITOR

Tuesday, September 1, 1981

# A year of Solidarity

and an equally pressing need for industrial modernization, is in a poor position to help. Along with Eastern Europe, the Soviet Union is undergoing a historic shift in the nature of its economy—one clearly recognized and widely discussed in the official press—as the country approaches the limits of its labor supply and as its ability to produce oil and other raw materials reaches a plateau.

Soviet leaders acknowledge that future economic growth must come increasingly from more efficient, modern industry and from material incentives—food and consumer goods—to inspire a hard-pressed work force to greater heights of productivity.

For the Soviet Union, the most difficult challenge of the 1980s may be that of satisfying the rising expectations of its own population while keeping Eastern Europe's economies afloat and dependent.

For Eastern Europe, caught between economic giants of the East and West, the challenge will be to draw sustenance from both and quietly to prosper.

Poles seem subdued as they mark the first anniversary of Poland's profound worker revolution. Economic chaos is taking its toll on the national spirit. There is no wild celebration in the streets. But today's sober mood need not rule out a pause to reflect on the depth and breadth of the changes that have taken place this past year. Who would have thought in those dangerous days of August 1980 that the worker strikes at the Gdansk shipyards would lead to such a far-reaching transformation of Polish society? And that the Soviet Union, for all its fears, would permit the revolution to go forward? Surely this is evidence of mankind's slow but inexorable progress toward freedom — and cause for quiet rejoicing.

The Polish reform movement seems to go from one unthinkable achievement to another. The gains in a once dogmatically communist country are impressive: establishment of a free industrial trade union, democratic election of the party leadership, formation of a private farmers' union, a more open and lively press, greater authority for parliament, radio broadcasts of Roman Catholic services, a five-day work week, more academic freedom for students and universities. And, all taken together, a rekindling of Polish self-respect.

How much farther can the reformers take Poland? Every revolution has its radical elements and the Polish movement is no different. The strikes, threats of strikes, and constant confrontations between Solidarity and the government indicate that the struggle for power goes on — within the union as well as between the union and the authorities. The party, for all the democratic changes, remains weak and vulnerable. The government,

too, is still mistrusted. In this climate the extremists in Solidarity are pressing for virtual undoing of the communist system — an objective many Poles regard as foolhardy given the nervousness in Moscow.

After all that has taken place, Westerners have learned to temper their judgments about the threshold of Soviet tolerance. Yet there cannot but be a feeling of concern and a sense of relief whenever it appears that Solidarity' moderate leadership has taken the upper hand. Indeed many reformers in the political center believe the time has come to consolidate the gains won, to cooperate with the government on the disputed economic reform and to get on with the urgent business of reiving the prostrate economy. For the moment there are in fact encouraging signs that radicalism is losing out to moderation. The powerful Roman Catholic Church, carefully acting as a balance between state and Solidarity in order to preserve national stability, now appears to be weighing in on the side of union cooperation with the government.

The first national congress of Solidarity takes place this month and will be watched for a sign of Poland's future direction. All those in Poland and abroad who see dangers in continuing economic anarchy and potential social unrest will hope that the moderates, including the leadership of Lech Walesa, succeed in their effort to engage the government in "dialogue and negotiation" rather than confrontation. There are legitimate differences of opinion over proposed economic reforms, including decentralization of industry. These can be honestly debated. But unless Poles of all ideological views begin to work together, the victories won may have little chance to bear concrete fruit.

26

OER/U/EE
3730.HQS BLDG

PEEL HERE

eastern Europe®

1

A WEEKLY REPORT TO MANAGERS OF EAST EUROPEAN OPERATIONS

OCTOBER 23, 1981

## Projected EE Debt To Double by 1985

Eastern Europe's debt to the West, now pegged at approximately $70 billion, could nearly double by 1985 and reach $185 billion by 1990. These startling figures are given in a report published by the respected Vienna Institute for Comparative Economic Studies.* The report seeks to anticipate possible EE financing problems in terms of hard-currency debt over the coming decade. Now with Romania joining Poland in admitting to payment problems, some sales executives responsible for EE are being asked by wary managements to concentrate their efforts in countries with minimal payment complications.

Dr. Gerhard Fink, author of the institute study, has taken EE debt projection formulas used in the '70s and tested them against actual current EE hard-currency borrowings. A new set of guidelines has been developed to reach conclusions covering the next few years. The study attempts not so much to predict future events, but to analyze various financial options that might be taken by the individual European Comecon countries. These options have a direct bearing on sales potential for Western goods and services in each EE country.

### Caution recommended

In a comment that is significant to Western firms selling to EE, the study cautions that Western lenders have shown too much optimism in assessing Comecon abilities to cope with debt burdens and borrowings. The author remarks that in some of the EE countries, a more favorable economic rating has been based on a single income-earning asset. "The example of coal mining in Poland should

make us more cautious," the report warns. "The coal is still there, and possibly it will remain there, because the mines are not worked."

"Our projections and conclusions basically agree with those of the institute," one banking official with considerable EE involvement confirms to BEE. While some of the added debt represents growing financing costs, it also anticipates the need for investment as well as balanced trade with the West, and where necessary, the refinancing of present debts.

"In looking to EE indebtedness, both a best-case and worst-case framework is necessary," adds the banking official, pointing out that "the institute study tries to take this into consideration." A spokesman for a Western central bank agrees. Indeed, the report suggests that at least in the case of Poland, the bankers ought to have known what to expect, as this should have been clear to them from existing projections.

### Country evaluations

The study anticipates no problems for the USSR in handling its Western indebtedness. In fact, balanced trade between the USSR and the West is foreseen during the 1980s, with no need for the Soviets to support their purchases through sales of gold. Indeed, trade could reach levels sufficient to underwrite Soviet grain purchases and permit further assistance to Poland, according to the report. Western bankers agree, acknowledging that from their standpoint as lenders and guarantors, neither over the short nor long term do they expect the Soviets to encounter problems with hard-currency indebtedness.

### INSIDE THIS WEEK

<table><tr><td>SPOTLIGHT ON EE DEVELOPMENTS</td><td>338</td></tr><tr><td>MAKING GKNT AGREEMENTS WORK</td><td>339</td></tr><tr><td>AID FOR YUGOSLAV IMPORTS</td><td>339</td></tr><tr><td>ROMANIA TAKES DRASTIC STEPS</td><td>340</td></tr><tr><td>POLAND'S 1982 PLAN: PART II.</td><td>340</td></tr><tr><td>WHAT'S NEW IN YOUR INDUSTRY</td><td>342</td></tr></table>

* Wiener Institut Fuer Internationale Wirtschaftsvergleiche, postfach 87, 1103 Vienna, Austria; research report 72, "An Assessment of European CMEA Countries' Hard Currency Debt."

337

For subscribers only - REPRODUCTION AND TRANSMISSION IN ANY FORM WITHOUT PRIOR PERMISSION PROHIBITED.
COPYRIGHT © 1981 by Business International S.A. All rights reserved under the International and Pan-American Copyrights Conventions.

VOL. X No. 43 JA-81

The report foresees no major problems for Czechoslovakia in dealing with its Western debt burden. However, one banker points out that a delicate balance must be maintained: the fact that the country is virtually self-supporting in agricultural terms contributes to economic stability, but sooner or later the tremendous pent-up investment demand must be met. Western financing will be needed, otherwise the country will find itself with industry hopelessly outdated.

With balanced trade anticipated for Hungary and Bulgaria with the West, the institute study projects no complications for either country in coping with its hard-currency borrowings. Banking sources agree that Bulgaria remains a favored borrower, capable of controlling its debt although possibly at the expense of accelerated growth.

## Reduced investment

Fears are expressed in the report that the GDR will have to cut back some of its ambitious growth and investment plans. The country cannot achieve the level of exports needed to keep Western borrowing in check, the study maintains. The projections indicate that supporting the planned growth rate over the current five-year period would mean Western imports leading to a $4.5 billion trade deficit with the West in 1985, and Western debts would top $31 billion by that year, obviously a practical impossibility.

Bankers also caution that the current GDR practice of accepting credits with massive repayments in later years can mean postponed trouble. Recalling that today's Polish financial problems began with the same financing methods, one banker declares that the GDR would have to sharply curtail investment to avoid future problems.

## PROJECTED HARD-CURRENCY DEBT ($billion)

<table><thead><tr><th rowspan="2"></th><th rowspan="2">1980*</th><th colspan="2">1985</th><th colspan="2">1990</th></tr><tr><th>Best case</th><th>Worst case</th><th>Best case</th><th>Worst case</th></tr></thead><tbody><tr><td>Bulgaria</td><td>4.0</td><td>5.9</td><td>7.5</td><td>3.8</td><td>9.0</td></tr><tr><td>Czechoslovakia</td><td>3.8</td><td>8.7</td><td>10.7</td><td>12.5</td><td>19.7</td></tr><tr><td>GDR</td><td>10.3</td><td>18.4</td><td>22.9</td><td>10.8</td><td>26.0</td></tr><tr><td>Hungary</td><td>8.4</td><td>17.1</td><td>21.2</td><td>23.0</td><td>37.5</td></tr><tr><td>Poland</td><td>23.0</td><td>33.1</td><td>42.2</td><td>31.6</td><td>61.3</td></tr><tr><td>Romania</td><td>7.9</td><td>13.9</td><td>17.3</td><td>19.1</td><td>31.2</td></tr><tr><td>USSR</td><td>7.5</td><td>4.6</td><td>6.5</td><td>-</td><td>-</td></tr></tbody><tfoot><tr><td>Total</td><td></td><td>101.7</td><td>128.3</td><td>100.8</td><td>184.7</td></tr></tfoot></table>

* Base year of study.

Source: Vienna Institute for Comparative Economic Studies.

In dealing with Romania, the institute report is pessimistic about the country's ability to cope with a growing oil and energy import bill. It suggests that if Western lenders overreact to the present liquidity crisis, a debt of $20-24 billion could result by 1985, an amount hardly manageable. Says one banker: "The reasoning is correct, but as bankers, we have not yet had time to swallow the bitter Polish pill, let alone take on another crisis."

The study leaves the problem of Poland to the bankers, who "will have to support Poland in closing the liquidity gap and provide additional means for financing interest payments. If not, the Polish problem certainly will not be solved before the end of this decade."

Yugoslavia, not a full Comecon member, is not included in the institute study.

## SPOTLIGHT...on East European Developments

* **Yugoslavia**—Foreign tourism earnings should reach about $1.3 billion this year, according to calculations of the Yugoslav tourism association. This accomplishment serves as a bright spot on the current cloudy economic horizon, particularly when compared with last year's earnings of $1.1 billion. Estimated additional private income from tourism could amount to $700 million. Commenting on current economic conditions, many foreign banks had predicted that Yugoslav tourist income would decline from 1980.

* **Poland**—Economical coal gasification will rely heavily on new technology to be developed within Poland with Western assistance. Of a 10-year Dm15 million grant from the West German Krupp Foundation, Dm1 million (notional, in erroneously reported earlier) will be spent this

year and next on cooperative research primarily with the Silesian Technical University, Gliwice.

* **GDR**—A nationwide census, the first in 10 years, will be taken over yearend. Particular attention is being given to details that will aid housing planning and investment.

* **Yugoslavia**—A yearend drive is planned to expand exports to the hard-currency area. Through administrative intervention of the Federal Executive Council (cabinet in Belgrade, each republic will be given an expanded monthly export target. Import rights will be strictly linked to successful achievement of export objectives. Hard currency priority for imports of raw materials and same finished goods will go to enterprises able to reexport finished goods to the West during the rest of 1981.

EUROPEAN EASTERN EUROPE

338

OCTOBER 23, 1985

LC

Why Russia is selling
gold in a soft market

International gold markets are buzzing over Soviet bullion sales. London metal traders estimate that Moscow has quietly unloaded 150 to 180 tons of gold so far in 1981, and can be expected to sell an additional 20 tons by yearend—compared with the Russians' 1980 total of 90 tons—in a market that is very soft.

What is pushing Moscow into a bullion market depressed by the effects of high U.S. interest rates and a strong dollar is the Kremlin's need for hard currency to pay for its growing $3.3 billion trade deficit with the West. The Soviet Union is expected to import 43 million tons of grain in the next year, 4 million tons of refined sugar, and a record 1 million tons of meat. The bill for those goods

could reach $10.2 billion. The continued fighting in Afghanistan and support for Poland also are costing the Soviets, and declines in world oil prices and the diversion of supplies to the East European satellites have lowered expected revenue from oil exports, which netted Moscow $16 billion last year.

**Delaying payments.** The foreign exchange pinch is felt most acutely in Moscow. Western business people complain that Soviet customers are delaying delivery dates of goods; they cannot finance. "They are looking with a microscope for any excuse not to pay a bill," says one Western banker. The "Soviet Foreign Trade Ministry's decision to limit cash outlays to transactions of $2 million and less—down from $5 million—and not to sign any deals that call for payment after Jan. 1, have sent its subsidiary agencies scrambling for loans and sup-

plier credits. Westerners in Moscow say the only exemptions to the hard-currency squeeze are imports for construction of the Yamburg natural gas pipeline from Siberia to West Germany and for Moscow's elite hospitals that care for aging Politburo members.

Joining Moscow in a search for hard currency is South Africa, the world's other major gold producer. Heading for a record $4.2 billion current account deficit, Pretoria has seen its foreign currency reserves dwindle to a seven-year low. Local bankers believe the country has concluded a number of hush-hush gold swaps with Swiss and West German banks. That way, Pretoria can get cash without having to sell its gold reserves in a depressed market. In effect, it is a gold-backed loan," says Nico Czypionka, an economist at Standard Bank of South Africa in Johannesburg.

recently as six months ago, it had no paper outstanding, and now it has $500 million. "Our margins have been somewhat flat," says Fodo, "and commercial paper has represented to us the cheapest source of funds."

The ease with which Gulf, SoCal, and other major issuers have been able to place their paper can be attributed at least in part to the massive appetite of the money market mutual funds, which now hold more than a third of their total assets of $166.9 billion in commercial paper. The fund managers, generally conservative investors looking for both high yield and good credit risks, are eager to see more top-rated names enter the paper market. "They've got an awful lot of borrowing power that's been untapped," notes John Hewitt, portfolio manager for the $21 billion Merrill Lynch Ready Assets Trust.

**The cushioning.** The funds' participation in the paper market has given it greater depth and liquidity, opening the way for "more marginal paper issuers," as one corporate treasurer puts it. Most of these lesser-rated credits have obtained a back-up line of credit from commercial banks, without which their paper could not be rated or sold. The prevalence of those back-up lines of credit is reassuring to paper issuers and buyers alike, and accounts for the widespread belief that even a major bankruptcy by a paper issuer would fail to rock the market.

Says Gary Wehrle, executive vice-president of Foothill Group Inc., the Los Angeles-based equipment lessor and commercial lender: "Even if the market gets a bit soft, companies still have their bank lines to borrow under." Adds Robert T. Parry, executive vice-president and chief economist at Security Pacific Bank: "The banks don't expect wide-

spread problems. If they did, they wouldn't be backing the paper."

Nonetheless, there are indications that paper buyers are becoming more watchful. "Investors are looking at the second-rated names with a careful eye," says James M. Walsh, vice-president at First Boston Corp. Walsh notes that many more buyers of paper, not just the money funds, are now doing their own financial reviews of the issuers, not merely relying on the rating agencies. Those agencies, meanwhile, have been busy changing their own appraisal of corporate America's financial health. In the first nine months of the year, Moody's Investor Service downgraded 20 commercial paper issuers, including J. P. Stevens, Ford Motor Credit, Norton Simon, Philadelphia Electric, and RCA, while only five enjoyed an upgrading. They were American Standard, Cooper Industries, Kansas Gas & Electric, PHH

Group, and Provident National Financial Corp.

Just to be on the safe side, some money fund managers have tilted away from commercial paper. *Money Fund Safety Ratings*, the Fort Lauderdale-based investment letter, reports that from Aug. 1 to Oct. 15 the percentage of money fund assets invested in commercial paper was shaved from 41% to 38.5%, while investments in less risky U. S. Treasury obligations rose from 4.5% to 7.5% during the same period. Other money funds are protecting themselves by shortening up maturities and increasing liquidity. Dreyfus Liquid Assets, for example, is holding 13% of its assets in overnight deposits of large commercial banks. Says Joseph DiMartino, president of Dreyfus Liquid Assets: "With the economy slowing, there is some vulnerability in the commercial paper market. A lot of guys are worried." ■

The S&Ls jump into brokerage

Savings and loan associations across the country are joining forces in a new, nationwide brokerage firm that will provide a wide range of investment services, including selling stocks, bonds, and mutual fund shares. Approval appears likely from the Securities & Exchange Commission and from the Federal Home Loan Bank Board, which is anxious to give the s&l industry a boost.

More than 200 s&l s have already indicated they will sign up, and the new venture is expected to begin operating in April. Thomas J. Owen, president of Perpetual American Savings & Loan Assn. of Washington, says he is encour-

aged by the response "from a group that hasn't adopted new ideas readily." Perpetual American is one of five s&l s that are providing the seed money for the program.

The brokerage plan is the brainchild of Coast Federal Savings & Loan in Sarasota, Fla., another founding partner. It calls for participating s&l s to join an umbrella service company, Savings Association Financial Corp., that will provide marketing, training, research, and technical assistance. The actual brokerage business will be handled by a wholly owned subsidiary, Savings Association Investment Securities, all of

BUSINESS WEEK: November 9, 1981 37

COVER STORY I

[c]

# The lessons of Poland

Poland was viewed as an accident just waiting to happen. So why didn't anyone get out of the way?

by Jane Baird and Darrell Delamaide

Poland has blown to pieces an orderly array of conventional beliefs about Eastern Europe. Take, for example, the presumed rock-like stability of Communist regimes. With a kind of I-told-you-so amusement, one economist recalls a conversation on Eastern Europe he had with a businessman several years ago. "One reason we like to deal with these countries," the man told him confidently, "is that they don't have a problem with strikes."

Among the other now-obsolete assumptions:

* Moscow will not allow any member of the Warsaw Pact to default or reschedule — the so-called "umbrella theory."

* Communist countries have reputations for fiscal conservatism, have perfect debt-servicing track records and are impecable about repayment.

* Comecon central planners have more unencumbered power to shift resources when a country must achieve a balance in its external accounts than do the authorities in market economies.

Such beliefs gave bankers a sense of security, even as Polish debt mounted to astronomical proportions. When Poland came crashing down, lenders not only found themselves caught in a prolonged, vicious struggle over rescheduling but were also faced with the real threat of default. Added to that was a flurry of re-criminations and accusations. Typical was a scathing *Wall Street Journal* analysis that appeared last August: "The banks asked Poland precious little about its economic health or how it expected to pay all the money back. Frugal middle-class Americans would have had to give more information to their friendly neighborhood banker to get a car loan than Poland gave to develop a country."

But the unhappy history of bank lending to Poland isn't quite

*The rise and impact of Solidarity in Poland was something even the most savvy country risk experts could not have anticipated*

photo by J. Czarnacki-Gamma Larson

INVESTOR

48 JANUARY 1982

that simple. True, the risks of lending to Poland were there for all prospective creditors to see. Knowledgeable economists were sounding danger warnings that the Polish economy was sliding into some kind of crisis at least as early as 1977. Indeed, violent political tremors had shaken the country before — in 1956, 1968, 1970 and 1976.

In July 1977, Richard Portes, a professor at the University of London, criticized Poland's "dash for growth" policy in an article published in *Foreign Affairs*: "Only a very large increase in the price of copper would offer any real hope that Poland might be able to meet its hard-currency debt repayment schedule at the end of the decade." Portes recalls that he conducted a seminar at the U.S. Department of Commerce in the fall of that year and explained his views to bankers there. "No one listened to me," he recounts. "I was just a pessimistic academic."

Paul Marer, professor of international business at Indiana University, remembers presenting "an absolutely devastating analysis" of Poland's prospects at another Commerce Department conference on Eastern Europe in March 1979. Several bank representatives were present. In Marer's opinion, "The bankers who heard that would not be in their right minds to go into a loan in Poland." Yet only a few months later, in May, a $500 million, seven-year syndicated deal for Bank Handlowy was oversubscribed to the tune of $50 million.

Why were lenders apparently so uninterested in listening? "Just to blame bankers is very easy," Marer acknowledges, "but the situation is more complicated. You worry if you do not refinance and provide extra credits, you will trigger a default. The lenders are locked in, at least as long as they are not convinced that they are throwing good money after bad." A banker who participated in the $550 million syndication candidly defends his action: "By the spring of 1979, most banks expected there would be some kind of restructuring in Poland. We provided the loan as a means to help the Poles get organized and on their feet."

This attitude persisted well into 1980, even though it was becoming increasingly clear that the proceeds of an internationally syndicated loan for $325 million in August of that year, along with Dm1.2 billion provided by a West German consortium at the same time, were going the way of so many other loans to Poland — right back to the West to pay interest on $24 billion in hard-currency credits and amortize that debt.

### Incipient accident

Poland, in short, was an accident waiting to happen, a crisis that most bankers interviewed for this article claim to have foreseen — but which they insist they were powerless to do anything about. "We saw this coming," asserts a U.S. bank economist. "It was virtually inevitable." But

## Will the fund help?

With Hungary's surprise application for membership in the International Monetary Fund, followed by Poland's turnaround in seeking to rejoin, a new factor was added to the evaluation of East European country risk.

In many Western banks, East European line officers heaved a sigh of relief: Warsaw's membership in the IMF would relieve them of the onerous and unwelcome task of trying to track implementation of a Polish economic program. "It will take away this mantle of monitoring," says an executive at a London clearing bank, "one we'd never be comfortable with." And in Paris, a French banker is already looking beyond Poland to the hope that the IMF's authority could now be brought to bear on other Comecon countries: "The IMF is the only official entity able to discuss with governments things like pricing, budgeting and investments."

But other centrally planned economies are already members of the IMF, and the results are not exactly encouraging. One central bank official, noting that IMF members Romania and Yugoslavia are among the most worrisome credits in Eastern Europe, points out that "some banks are skeptical." And they are not alone. "There's no evidence of any comprehension of centrally planned economies at the IMF," asserts an economist specializing in Eastern

Poland's condition was worsening so transparently. why couldn't it have been treated before the country wound up in the emergency ward? How did lenders — to say nothing of Polish authorities — allow the situation to get so out of hand? And most importantly, what have bankers learned from the experience that will help them forestall another Polish-type trauma in the future?

For bankers looking back on the Polish debt crisis, one very sobering fact remains: Even if Poland had been able to keep its exports to the West at the $8 billion level reached in 1980, and even if it had no imports to pay for, it could scarcely have serviced its debt in 1981.

Yet, despite the irrefutable logic of the figures, "in November 1980, Poland still believed it could avoid rescheduling," recalls one U.S. analyst in London. The Poles believed this because up to that point they had been keeping their Western creditors at bay by turning over to them the proceeds of an estimated $1.5 billion in hard-currency loans provided by the Soviet Union. When the Soviets tired of subsidizing Western bankers, however, they turned

off the dollar spigot and the game was up. By the end of last March there was no cash and no more credit, and the Poles asked 460 banks to reschedule their loans. The ensuing negotiations established that Poland would need to reschedule about $2.5 billion due in the last three quarters of the year. And it also became clear that further rescheduling accords would be needed for 1982 and 1983, and perhaps even for 1984.

As for the Poles, one reason the government put off the issue of rescheduling, says an economist, was that it was too busy with other concerns — keeping the Russian tanks away from the door and reaching a modus vivendi with Solidarity. The sudden political upheaval, furthermore, alarmed bankers. "Poland did not expect a cash crisis until late 1981 and early 1982, but the banks started to significantly curtail credit and brought it on much quicker," says a U.S. banker. Even the banks' sharpest critics acknowledge that no one foresaw the intensity of the Polish political earthquake. Jane Curry, political science professor at Columbia University, says, "There was a sense of the need for a rescheduling — but not that the economy

Poland's surprise request to join the IMF could produce $5 billion in standby credits

Europe. "They don't have that expertise." One U.S. banker is more sympathetic: "For the IMF, it's hard to go into a centrally planned economy."

But overall, most bankers seem

Illustration by Peter Porges

heartened, especially by the prospect of Polish membership. "It doesn't solve the problem, of course," admits a French line officer. "But it's better than if they aren't [a member], although I can't say exactly why." Clearly, one way IMF membership could help Poland is through standby credits. Poland's quota, reckon some experts, could be the equivalent of anywhere from $500 to $800 million, making it eligible for standby credits of as much as $5 billion.

But that's still a way down the road. IMF membership for Poland is unlikely to come before the September annual meetings, according to a fund source, which means that the Poles will not be eligible for IMF credits until 1983. And a participant in the rescheduling negotiations doubted whether the banks would be willing to provide bridging finance for back interest payments until then.

One cautious U.S. banker is not even taking it for granted that Polish membership is assured. The Reagan administration's stand is not yet clear, and the United States, of course, carries considerable weight in the lending agency. Moreover, membership could be something of a mixed blessing for Poland's creditors. "We don't want the Soviet Union to be able to wash its hands of Poland if it joins," says another U.S. lender. "We want to keep the Soviet Union involved."

would grind to a halt. There was no way to have known this would happen."

Bankers can scarcely be faulted for not having a political crystal ball. More to the point, they had commercial reasons for continued lending in the face of obviously high risks. Among others, they feared losing a client. "We wanted to maintain relations with Bank Handlowy," says one U.S. banker. "The business was not just balance-of-payments credits but also documentary business, account balances and other things. When you are not sure the economy is going bad, it is difficult to cut balance-of-payments loans and lose the other business."

Lenders feared even more the loss of a corporate client that would take its account elsewhere if a bank did not provide an East European country with the financing to carry out a particular deal. Comecon had been a good source of business since 1973, particularly for European suppliers. The jump in oil prices had made certain energy-intensive heavy industries suddenly unprofitable, and world demand for new plant capacity in these industries had dropped. By offering attractive deals and

financing, the suppliers were able to dump these plants on buyers in the Eastern bloc that were still thriving on cheap Soviet oil.

In the decade of Ostpolitik, Eastern Europe came to account for more than 5 per cent of West Germany's exports and 12 per cent of Austria's. Governments in Bonn and Vienna, as well as London and Paris, were generous with their guarantees for trade finance to the East. Lending by U.S. banks, for whom Eastern Europe was a marginal marketplace, had by contrast leveled off between 1976 and 1980 and especially after the Soviet invasion of Afghanistan. The U.S. Export-Import Bank, moreover, does not participate in the market to the extent of the European credit agencies; only the four countries with most-favored-nation status — Yugoslavia, Rumania, Poland and Hungary — have received credits.

By the time Poland acknowledged its inability to pay, West German banks had claims of $4.5 billion on Warsaw ($1.8 billion covered by Hermes) and Austrian banks $2 billion (but nearly 90 per cent was covered by Austrian government guarantees). The unguaranteed exposure of British and French banks was about $1.2 billion for each country. The Japanese, Canadians, Dutch, Swiss and eventually the Arabs all got into the act as well, and the banks kept pouring in money until the Gdansk strikes pulled the rug out from under Poland.

Throughout the late 1960s and early 1970s, Western businessmen and bankers were awed by this potential new market opening up. As the iron curtain drew back, nobody wanted to be left behind. "Who would have asked [former First Secretary of the Polish communist party Wladslaw] Gomulka critical questions about a steel plant?" ponders a West German line officer. "We're accused of putting too much money in Poland," argues a British lending official, "but the basic principle is to support your own customers. We went in there with eyes fairly wide open."

As projects in Poland and other Com- econ countries got more ambitious, imports and credits from the West expanded apace. Companies eager for sales and govern- ments eager for influence created a wave of enthusiasm a bank could scarcely have re- sisted had it thought to do so. The problem was that the projects were either ill- conceived or did not pay off fast enough. So the banks soon had to raise funds to cover burgeoning hard-currency trade def- icits run up by the East, and then in turn to finance the debt service. The "export" na- ture of certain loans began to be pure cosmetics; some prefinancings in export deals, in fact, were used to plug payments gaps and some bogus projects drew huge amounts of extra financing (like the dubi- ous Dm850 million raised by West German banks in the fall of 1979 to finance va- nadium exploration in Poland).

Each bank focused on its customers and its own portfolio. "There are so many

factors in lending," confesses a British banking executive. "It's not just the eco- nomics of the debtor country, but the need to finance exports." Poland's mounting debt certainly led to discussion and some worry. "But a good export business over- rides everything else," explains another British banker frankly.

"We developed the loans mainly for trade reasons," explains a French line of- ficer. "We were supported by the govern- ment. Banking criteria aren't so strict in those cases."

But here was the rub. Bankers will generally concede that the original loans to Poland and other East European countries often were made without the docu- mentation or information routinely de- manded from other countries, especially developing countries. Yet it is extremely difficult to do effective credit analysis in Eastern Europe. Several countries refuse to provide even the most basic statistics, while other data are not comparable with market economics. More important than number crunching, however, are subjective evaluations. The banker must get a feel for the efficiency of management, the opinions of decision-makers and planners, the po- tential political instability and so forth. Ac- cording to Edward Hewett, senior fellow at the Brookings Institution, "If you are at- tempting to get a macro view of what is happening in a West European country, you go to the fiscal and monetary au- thorities and ask about interest rates and exchange rates. In Eastern Europe, it is not the interest rate that determines investment, it is the planners."

## Different rules

Eastern Europe is riddled with obsta- cles and pitfalls for the unwary banker at- tempting to make these kinds of judgments. There are few branches or representative offices with resident bankers who can ob- tain a daily, on-the-scene feel for events. Besides, communist societies do not look kindly on any of their citizens who casually pass on the newest gossip to foreigners. Only someone who spends years of time and trouble can forge trusted private con- tacts. A bank analyst who is generally re- garded as one of the few experts in the re- gion says, for example, that he talks with economists and academics outside of gov- ernment power circles, who tend to have a less biased view. "Bankers tend to talk more to the bankers of the country," he admits.

"The IMF, Western government of- ficials and bankers have the same prob- lem," says Marer. "They talk just to other bankers. They think they are talking to government decision-makers, but bankers in these countries are messenger boys, buff- ers with the foreign banking community and they have no effect on policy." And, Hewett warns, "When a banker in the West talks to a banker of a centrally planned economy, he may talk the same language. These East European bankers

INSTITUTIONAL INVESTOR 49

50 JANUARY 1982

"The banks asked Poland precious little about its economic health or how it expected to pay the money back."

know the money markets, and they will say things that the Western bankers would want to hear. But it will sound like you are on more familiar terrain than you really are."

And so Poland's debt mushroomed until it was unmanageable. Who was responsible? "Nobody," a European banker bravely declares, "has overall responsibility. No one did and no one could." In any event, say bankers, it was the Poles who refused to countenance a rescheduling at any earlier stage. One West German banker closely involved in the Polish negotiations also maintains that restructuring per se could have been avoided if the economic crisis had not been so dramatic. The whole point of the 1980 loans, he recalls, was "to help them over their problems." Even without the shipyard strikes and the subsequent rise of Solidarity, argue many bankers and economists, Poland and the rest of Eastern Europe would have suffered from the "unforeseeable" catastrophes that overtook the entire world economy. A West German specialist in Eastern Europe lists these as the explosion in energy prices, the high price of credit and the recession in the West, which deprived the East of the export markets.

## Sauve qui peut

But the University of London's Portes refuses to let the banks off the hook. The very delay in getting on with the rescheduling contributed to Poland's economic collapse, he maintains. "They started by pulling out the short-term facilities," Portes said in a November interview. "It was sauve qui peut, keeping Poland in an impossible situation." And in a charge representative of the criticism from nonbanking experts, Portes accuses Western companies and their banks of aggressive sales techniques and excessive lending. "The financing urged upon Poland did not facilitate adjustment to foreign-sector problems but rather generated them," he asserted in a Chatham House paper last January. Moreover, he said, one of the factors that could have been changed to avert eventual economic collapse was "the mismatch between the maturity structure of Poland's debt and the likely evolution over time of its capacity to repay."

It's a chicken-or-the-egg argument that not many bankers are willing to pursue. When a similar situation developed last June after rumors of Rumanian payments difficulties surfaced, the immediate reaction was again to cut off short-term lines. "The banks were perfectly right in doing this," argues one banker, stoutly defending the action. "What else is a prudent banker to do?"

In any case, the Polish rescheduling is an expedition into uncharted territory.

Banks are exploring a dark hinterland of international lending and encountering new pitfalls.

"Bankers have had a hundred years to develop procedures for making a loan to the butcher on the corner," observes a central banking official, "but the majority of them started just a decade ago in international markets. It's a learning experience. The only way it happens is through the banks' own experience." This official intimates that the Polish experience, if only it could have been on a smaller scale, would have been a welcome one for the lessons it holds.

## New scrutiny

For the medium and long term these lessons are clear. Credits to Eastern Europe will receive much closer scrutiny. Bankers will demand more detailed information from the Comecon countries on their external position and economic development. The projects themselves will have to have concrete, realistic figures to justify their financing. "We have learned that funds directed to investment are not enough by themselves to secure debt," suggests a senior banking executive in France. "We can't fund white elephants."

"We'll want much more hard information," predicts a senior manager at one British clearing bank. "We'll be more keen to see projects that will generate hard currency." If a loan is sought for a non-productive investment, he adds, then it will be granted only if the country is deemed to have a manageable debt. "We'll be looking at the quality of each investment, going a step beyond the debt-service ratio," he adds. Bankers will expect more openness from the Eastern bloc borrowers as well. They will look for a freer give and take, a greater willingness to accept criticism. "We'll also be having franker, more critical discussions in the West German consortium itself," notes a Frankfurt banker.

It appears unlikely, however, that Western banks will beef up their credit analysis capability for East bloc borrowers. In the United States, most of the large money-center banks assign one analyst part-time to Eastern Europe. Jan Vaňous, senior economist with Wharton Economics Forecasting Associates, estimates that there are seven to, at most, ten individuals in the U.S. banking community, either lending officers or analysts, who have an in-depth knowledge of Eastern Europe. "A lot of people know the business side of things, but the difficulty is getting a good macroeconomic feel." The rest of the banking community depends on the good will of these few experts to help with hard credit information. "There is a completely different attitude for Eastern Europe," says

a New York lending officer. "Here, we exchange information. If we go to the Soviet Union, we all see the same man; he is a monopoly there, so there is no point in being secretive. The view on Eastern Europe is pretty much shunned out." (It should be noted that this same banker had criticized the "herd instinct of the market" in Eastern Europe.)

In Europe, there is no evidence that the commitment of manpower is much higher. American and European banks frequently trade information, bankers say, but European banks are often less cooperative with each other. Dutch banks were reportedly complaining that German banks would invite them into a syndicate but would refuse to provide credit information until the Dutch banks committed themselves to go in.

Moreover, the supply of bankers knowledgeable on Eastern Europe appears to be shrinking rather than expanding. Bankers realize that expertise in the region will not help their careers, says a U.S. government source. "A lot of the old guard on Eastern Europe have bailed out, gone to other jobs, other banks," says an economist. Taking their place are a "lot of junior staff, trainees out of business school. People are confused."

And even if a bank decides to go outside for a special consultant, the number of economists who have an up-to-date acquaintance with Eastern Europe are pitifully scanty. When a major bank told one economist, for example, that it was assembling a team of "Rumanian experts," he was skeptical. "You could count the Rumanian experts in the world on two hands and still hold a cup of coffee."

## New loans?

Nevertheless, "it's not reasonable to stop lending to these countries," was the simple formulation of one European. "Right now, though, we are traumatized by the Polish affair." And one observer points out that part of the trauma is simply not having time in the midst of the complex Polish negotiations to consider new loans for other countries. "You have to keep in mind," adds a central banker, "that the East European people [at banks] are not the most popular guys in the shop." A line of ficer quickly agrees: "If we even mention project to the board, they say, 'Does it have to be?'"

Still, under the frosty surface, some loans were going through (Hungary, for instance, is said to be getting small amounts for two to three years) and that is foreseen in the spring. "The better risk will get credits," proffers one analyst. "The others will have to accept short maturities and higher margins." Indeed the same pressures that pushed Western industry and banks into the East to begin working are still there, as the Siberian pipeline did made clear. Even while Western banks were in Warsaw wrangling over the text the debt accord, Soviet and West German officials signed a pricing agreement

"The lenders are locked in, as long as they are convinced they are not throwing good money after bad."

Siberian gas that will mean billions of dollars of orders for pipeline equipment to West European industry — and billions of dollars in trade credits from West European banks. "It's not the gas the West Europeans need," observes a U.K. economist, "it's the trade." (The gas is available from other sources, as Europe's contingency plans to tap Dutch and North Sea fields demonstrate.)

Ironically, once the banks' taps are opened again, Poland itself will be one of the countries first in line for fresh credits — assuming, of course, the rescheduling accord is signed and effective. "One of the critical things is to reinstate at least some short-term lending," explains a U.S. banker.

The debt accord is the first step to restoring the badly shaken confidence of the banks. It is the visible sign of what most banks implicitly count on — that Poland will not repudiate its debt. Difficult as the rescheduling is, it is simply a question of making the debt manageable — the main point being that the debt is good and the borrower creditworthy. "Somebody in the bank asked me today whether Poland will ever be able to repay its debt," mused one

of the participants in the rescheduling negotiations. "That depends on what you mean. 'Repayment' is not an issue. I hope they can manage their debt."

And that, for the banks, is perhaps one of the biggest lessons of Poland. The key is not to get back that $26 billion ("What would the banks do with all that money if Poland paid it back?" asks one cynic), but to strike the proper balance so that Poland can grow and produce (and service its debt) without falling over the financial cliff.

## Other lessons

There were lessons, too, for other East European countries, which shared many of Poland's economic deficiencies. Professor Marer explains how: Following World War II, the Soviet Union told its allies to follow its model of economic development, "to become little Soviet Unions," with the same emphasis on building a domestic industrial economy by shutting out import competition. This strategy made more sense for the resource-rich Soviet Union than for its more vulnerable satellites, which invested indiscriminately, typically in heavy industry. In the 1950s and 1960s the Soviet Union nursed this economic

strategy by providing oil and raw materials in exchange for substandard manufactures. In the 1970s, however, when the Soviet Union was not willing to increase the supplies as fast as the countries wanted to grow, Eastern Europe turned to the West for its raw materials, for better technology and for finance — what Marer calls "the baby bottle."

In 1981, East European leadership suddenly found that all the props had been pulled out from under it. The Soviet Union served notice of effective cuts in oil supplies, while Western banks curtailed credit. Eastern Europe's central planners now have to grapple with the same problems — expensive energy and tight credit — that have brought recession in the market economies.

By the final days of 1981, of course, lenders were scarcely in a reflective mood. Lessons from the past were like so much blood under the bridge as the imposition of martial law in Poland cast grave doubts over payment of interest arrears and the whole rescheduling process. Yet even as Warsaw's plea for a $350 million bridge financing was falling largely on deaf ears in the West, bankers were agonizing over contingency plans should the Poles fail to meet the year-end interest-payment deadline. Looming over their desperate search for a united strategy was the specter of default and the very real threat that the whole jury-built edifice would come crashing down.

10c

December 1981

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52 JANUARY 1982

COVER STORY II

# Sizing up Eastern Europe's borrowers

Here is a country-by-country rundown of the financial and economic prospects for the region's eight sovereign credits.

by Darrell Delamaide

The Polish rescheduling has taught bankers to assess East European countries more closely as individual credits. Paradoxically, it is the Polish crisis, and particularly the uncertainty regarding the Soviet Union's intentions, that has put East European credit in general in the deep freeze, at least for the moment.

In theory, bankers continue to rank the Soviet Union as the best risk in the bloc. The worst, obviously, is Poland. Czechoslovakia ranks high for most bankers — generally second — because of its small existing debt. Rumania, again for obvious reasons, is seen as the second-worst risk. The remaining Comecon countries — East Germany, Hungary and Bulgaria — occupy the middle range, with the actual rank depending on individual bankers' experience, priorities or prejudices. While most bankers insist on viewing Yugoslavia separately from Comecon, they concede that Belgrade's credit standing is affected by general East European conditions and they tend to rank it at the lower end of the middle range. Following is a country-by-country report on the problems and prospects.

## Bulgaria: The advantages of industrial specialization

Even with the best intentions in the world, it's not always easy for a centrally planned economy to boost its exports when deemed necessary. Bulgaria, for instance, thought it was onto a good thing when Cadbury-Schweppes decided to locate a plant there to export its soft drinks. But the planners overlooked one important factor — Bulgarian thirst. Even when the plant reached full capacity, scarcely a bottle made it across the border because domestic demand was so high.

But not too many Western bankers are worrying about Bulgarian exports. The relatively high debt level of $4 billion caused some anxiety a few years ago, but Bulgaria began to sell oil (evidently re-exporting Soviet imports) and actually produced a tidy hard-currency trade surplus and reduced its debt. Most consider Bulgaria's transformation from a tiny agricultural state into a tiny industrial state as reasonably successful.

“It's practically part of the Soviet

### Bulgarians have made a successful transition from farming to industry

Union," is the most frequently heard comment regarding Bulgaria. A U.S. banker calls it the "sixteenth republic of the U.S.S.R.," while a West European even compares it to the Baltic republics. And from a French lender comes a variation on the umbrella analogy: Regardless of how small the umbrella is, he says, the Bulgarians are standing right next to the pole. More than half of Bulgaria's trade is with the Soviet Union and more than 80 per cent with Comecon.

In fact, if Bulgaria continues to exploit the advantages it gets from industrial specialization within Comecon, it could become a competitive exporter and improve its credit standing. Already, one major bank is ready to rank it with Czechoslovakia — right behind the Soviet Union — because of the successful reduction of debt.

## Czechoslovakia: The merits of conservatism

In November, a New York Times report announced gravely that Czechoslovakia

"has joined Poland and Rumania among Eastern Europe's basket cases." Yet, despite the nervousness surrounding East European country risk in the wake of the Polish rescheduling, economists and bankers reacted with a marked indifference. "It was a big surprise that somebody said they have problems," comments an unmoved U.S. banker, "although it is true that modernizing their industry is going to be expensive."

The Times report referred to a grim speech by Czechoslovakian Premier Lubomír Strougal describing the difficult economic challenges facing the country. Besides the agricultural problem endemic to the East bloc, Strougal revealed new challenges in energy. The Soviet Union apparently plans to cut oil deliveries by 10 per cent next year (a measure that may be affecting all Comecon countries), while Rumania has suspended delivery of 3.5 billion kilowatt hours of electricity, equivalent to 10 per cent of Czechoslovakia's

### Czechs have traditionally spurned bank debt

energy consumption, in the wake of its own difficulties.

Wharton Econometric Forecasting Associates objected strongly to the article's slant, saying: "that neither the contents of the speech nor the present Czechoslovak economic reality justify labeling Czechoslovakia 'the East's new economic disaster.'" The Washington-based ana-

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lysts even see a silver lining in Strougal's cloudy speech: The frank discussion of economic problems could be an attempt by the premier to force the hand of hard-line opponents and allow some liberalization of the economy.

Even before Strougal's speech, bankers were aware that resource-poor Czechoslovakia faced problems. The biggest is antiquated industrial machinery. "Why, their plant is as old as ours," chuckles a British banker. This inefficient and energy-wasteful industrial plant makes Czechoslovak products increasingly less competitive. But the decisive consideration for Western lenders is the country's low debt. "They haven't done much," remarks one European banker. "But then, they haven't borrowed much, either," adds a French observer. "Czechoslovakia is a poor country, but a good risk."

With a population half again as big as Hungary's, Czechoslovakia has a hard-currency debt put at about $4.5 billion, or about half the size of Hungary's. Nor is Prague likely to go on a borrowing spree, even if the atmosphere were more conducive. One of the party's chief ideologues, Vasil Bilak, has become famous for his comparison of borrowing in the West to a pact with the devil. Beyond that, Czechoslovakia is seen as a historically conservative land. "Nothing ever changes there," says a frequent American visitor. This can be a virtue in bankers' eyes. "They are conservative, prudent," nods one banker approvingly, "extremely responsible and reliable."

Happy as they are about Czechoslovakia's low indebtedness, most bankers don't seem to give much thought to how the country will correct its obvious deficiencies. Prague has been in the market, they report, for small operations of two to three years' maturity. Its public stand on Western credit makes it unlikely to tap the syndicated loan market in a big way even when that source of funds is open again to East European borrowers. Wharton economists see the possibility of some expansion of borrowing to gradually modernize Czechoslovak industry, but "we expect the country's external economic difficulties to be reflected primarily in much slower economic growth rather than increased indebtedness."

## East Germany: Relying on links with Bonn

The Hotel Metropole in East Berlin has the best breakfast in the Eastern bloc. "You can't even get a breakfast that good in London," explains the British banker who made this claim. East Germany, agree bankers who travel in the Comecon countries, has far and away the highest living standard in Eastern Europe, even before you count the shampoo, bananas and Deutsche marks they get from the cousins, parents, children, friends and ex-spouses

East Germans are paying dearly for over-ambitious industrialization

on the other side of the "zonal border."

East Germany is an anomaly — one of Moscow's most loyal allies but the one East bloc country with an unbreakable link to the West. "The West Germans will never leave the East Germans in the lurch," says one central European banker simply, echoing similar remarks in all financial capitals. Indeed, one observer even speaks of a "West German umbrella."

West German bankers almost invariably list East Germany as the best credit risk in the bloc (although ironically they cannot make loans directly to the East German government). Because trade between the two Germanies is not considered "foreign trade," East Germany is a sort of unofficial member of the European Economic Community by virtue of its trade with Bonn. And there are the famous swing credits — interest-free financings for intra-German trade provided by the respective state banks. (The West German Bundesbank, perhaps in retaliation for Bonn's plundering of the central bank's 1981 profit to plug the federal budget deficit, was reportedly arguing recently that it should not have to carry the loss for the Dm850 million in such credits, or at least for the Dm650 million overdraft facility running out at the end of 1981.)

The importance of cooperation to both countries was evidenced by the recent meeting between Chancellor Helmut Schmidt and East German leader Erich Honecker. Previously scheduled "summits" have been canceled, first because of Soviet intervention in Afghanistan and then because of the unrest in Poland. Relations between East Berlin and Bonn remain extremely sensitive to the nuances of East-West relations in general, but the ties are special and won't go away. "German banks will always lend to the East," asserts a British economist.

But for banks in the rest of Europe, it's not so clear. "East Germany is a real

problem for us," confesses one continental banker. "Our industries get very good orders, but we have reached our limits in East Germany. It's almost with sadness that we see we cannot do any more business with them."

East German debt is around the $12 billion level, according to most estimates, and this is seen as very high for a country of 17 million people. Most worrisome for some bankers is that much of this debt was taken on to finance a heavy program of industrialization. "You have to ask about the profitability of some of these projects," concludes one lender. "They've pushed too hard."

A banker in another European country concurs. "Their investment program has been too ambitious," he says. "I'm not sure of the efficiency." He went so far as to say that East Germany would rank "at the end" of East European borrowers, excepting the problem cases of Poland and Rumania.

Even those who give the East Germans high marks for management are looking for them to slow down the expansion of the last few years. "The East Germans have handled industrialization very well, but they might get into trouble if they keep pushing it," comments one sympathetic economist. For many, though, the traditional German virtues of discipline, hard work and quality are still guarantee enough. "The Prussian rule operates under any system," is a typical remark. "East Germany will overcome lots of its problems."

East Germany has certainly been one of the big contributors to the estimated $500 to $700 million in Polish aid from the non-Soviet Comecon members. It is suspected that at least part of the $250 million raised by Deutsche Aussenhandelsbank in March was passed on to Poland. East Germany also tapped the market in May for a $100 million club deal and later for a piddling $20 million from an Arab consortium (which some European bankers saw as ill-advised). Nor will East Germany be able to stay away from the market too long. Honacker indicated in November, comparing grain shortages to the oil crunch, that East Germany would have to import large amounts of grain in 1982.

## Hungary: Sailing close to the wind

Hungary is one of the undisputed darlings of the Euromarket. Janos Fekete is everybody's favorite East European central banker, Hungarian officials are considered the most competent and sophisticated and, last but not least, Budapest is generally seen as the most congenial East European capital to visit. "There is the comfort feature," affirms a British banker.

Western bankers applaud Hungary's transition to a partial market economy. (A New Yorker magazine correspondent recently related a new political joke in Hun

gary: "What's the difference between the French government and the Hungarian government? There are Communists in the French government.") Even more impressive was the implementation two years ago of a belt-tightening policy to keep a manageable trade balance, as well as an openness with statistics, the sophistication of planning and the move to make the Hungarian forint at least partially convertible.

Beneath all the bubbly praise, though, is the realization that Hungary, a country with fewer than 11 million people and few natural resources, has proportionately as high a debt as Poland and has the most to lose if a Soviet invasion of Poland throws a Stalinist blanket over Eastern Europe. "Hungary has a very heavy debt burden," notes one economist. "It's a question of how much longer they can enforce austerity after two years of it already. They realize they have a serious problem, and they're trying to do everything to reassure the banking community." Despite the high regard for Hungary's managers, he continues, "Fekete is only human."

"Hungary is not all that sound," reflects a London lender. "They're sailing close to the wind." This banker relates how a Rumanian official, perhaps chewing sour grapes, once said, "I'd hate to be in Hungary's shoes when the honeymoon is over." Hungary's debt, estimated at about $8.5 billion, is near Rumania's, although Hungary, with half the population, has nearly the same gross national product, according to one estimate.

Nonetheless, many Western bankers reported that they were still willing to lend to Hungary even while the general Com-excon credit frost prevented any syndicated loans. And some still see it as the best East European risk after the Soviet Union.

The object of the liveliest conversation, however, was Budapest's surprise move at the beginning of November to seek membership in the International Monetary Fund and the World Bank. Bankers immediately saw this as setting a precedent for Poland to rejoin the Bretton Woods institutions, which Poland petitioned to do a week later. While some press commentators viewed Hungary's move cynically — the Soviet Union was pushing off unwanted risk on the West, they snickered — most bankers lean toward the interpretation that Hungary is seeking to "differentiate" itself from its East European neighbors. Budapest is looking much more to becoming a member of the club than to draw on the IMF's credit facilities, they reason. Indeed, the uncertainties in Poland and the lurking danger of Soviet intervention do lend a certain urgency to Hungary's action. In the same vein, these bankers suggest, the steps to make the forint convertible may also be accelerated (some even looked for an announcement at the turn of the year).

Initially, everyone believed that the Hungarian application, sudden as it was, nonetheless came only with the explicit approval of the Kremlin. But reports began to surface that perhaps Moscow itself was given only cursory notice of the Hungar-

Hungarians continue to win praise for sophisticated economic planning

ians' intentions.

"It reminds me of the old joke," reflects an Austrian banker with close contacts to Hungary, "about the Jesuit and the Franciscan who discussed the propriety of smoking while reading the Holy Office." The Franciscan finally decided to ask Rome. Sometime later, he reported to the Jesuit that Rome's reply was negative — how dare he consider smoking during prayer. The Jesuit said he would ask Rome himself, and came back later to the Franciscan explaining that he got a positive response. "But how?" the Franciscan wanted to know. "It's all how you ask the question," answered the Jesuit. "I asked whether I would be allowed to pray while smoking." In other words, Moscow may have indicated likely approval in earlier theoretical discussions of the subject — and Hungary didn't ask a second time.

At any rate, bankers expect quick action from the IMF in accepting Hungary's application. Some even venture that Hungary's official entry into the IMF in the spring might be an auspicious occasion for Budapest to reopen the syndicated market for Eastern Europe. (IMF insiders are predicting a May date for membership.)

Hungary's banking friends note that Budapest has already moderated its borrowing, has kept a hard-currency trade surplus (mostly by virtue of hard-currency trade with Comecon neighbors) and has never been late with a payment. "The Hungarians borrowed a lot, but planned wisely and did not neglect agriculture," is how one neutral economist sums up the conventional wisdom.

In fact, the Hungarians have been so concerned with stabilizing their foreign debt that they have completely reversed the usual strategy for coming up with an economic plan, other economists say. Most

planners start off by deciding how much they want the economy to grow. By contrast, the Hungarian leaders first determine what the country's hard-currency export possibilities are and how much they are willing to let the debt increase. Then they calculate how much Hungary can afford to import and, consequently, how much they can allow the economy to grow.

It's a strategy that seems to have paid off handsomely. "Hungary's natural resources are small," acknowledges a British specialist, "but they have a remarkable ability to manage affairs. They manage the economy rather than manipulate it." This banker also notes Hungary's clear understanding of currency markets. "They actually made money on Swiss franc trading," he confides, with just a trace of envy. "Hungarians are so sophisticated," adds one academic specialist, "that they have done enormous studies on how much change in the standard of living is necessary to prevent rioting."

Hungary also has an important link to the Western community through its close relationship to Austria. To listen to the Austrians talk, the ties are almost as important as West Germany's to its Eastern counterpart. The Austro-Hungarian empire doesn't really lie that much further back in history and nostalgia sometimes runs high. Open borders have reinforced the links, leading to expanded tourism on both sides. "When the Hungarians come here," says one banker in Vienna, "they feel at home." Another relates how a Hungarian official quipped that "Austria and Hungary are like many marriage partners — they become better friends after the divorce." Meanwhile, the rest of the Western financial community continues to enjoy its honormoon with Budapest.

## Poland: Questions for Solidarity

The biggest problem as the December 29 deadline approached for signing the Polish debt accord was where Warsaw would find the $500 million to bring its interest payments up to date as stipulated by the Western banks as a precondition for the rescheduling. "I don't know where they're going to get it — and neither do the Poles," commented a poker-faced participant in the negotiations. He and other members of the banks' multinational task force spent the third week of November in Warsaw going over the draft text of the debt accord with Polish authorities.

"As you can imagine, they have grave doubts about some passages," commented another of the bank delegates, who, at this writing, was arguing that from a purely technical point of view the agreement could be ready for a mid-December signing nevertheless. But he ruled out any chance that Poland would be able to fulfill the "precedents" of the accord, namely, having interest payments and the unrescheduled part of its official debt paid in

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full. (Although the banks themselves are rescheduling 95 per cent of the approximately $2.5 billion owed to them in the last three quarters of 1981, they have also deferred payment on the remaining 5 per cent until 1982.)

Still, even before the November meeting in Warsaw, many major bankers involved in the rescheduling were growing skeptical that the document could be signed by the end of the year. And there was a divergence of opinion about the effect that would have on banks that close their books on December 31.

But there was hardly any skepticism that the rescheduling would go through one way or the other and no divergence of opinion about what needs to happen in Poland. "The Poles could have a good economy," commented a West German banker, "but they don't want to work anymore. They seem to think that a Western living standard comes with democracy. We worked damned hard for that." "It's nice to take a year off," carped another European banker, "but now they have to go back to work." Indeed, bankers suggest, the rescheduling agreement itself will be worthless unless labor unrest in Poland subsides. "All our 'accomplishments' are just so much paper," said one of the participants in the negotiations. "It doesn't give the Poles the $500 million they need right now, doesn't get the people back to work and it doesn't change Solidarity."

Nor, ostensibly, were developments in Poland encouraging by the last week in December. The imposition of martial law and the bloody showdown between troops and Polish workers seemed to dash any hopes that the country's main political forces — the Party, the Church and Solidarity — would reach a peaceful social consensus. Privately, however, bankers were expressing relief at the "silver lining" in the implied restoration of order. Summed up one British lender: former party chief Stanislaw "Kania was the wrong man in the wrong job at the wrong time. But I have a lot of time for General [Wojciech] Jaruzelski."

Most bankers remain deliberately vague about Polish politics because they don't want to talk about, or perhaps face, the possibility of a Soviet invasion, with its incalculable consequences for East-West commerce. "If the Russians are in Poland tomorrow, then everything is changed," said a French banker with Gallic clarity. It is, of course, this fundamental imponderable that has thrown such a long shadow over the East European market as a whole. "The situation of Poland is of such magnitude and the future so difficult to assess," worried another French banker aloud, "that it is better to stand aside for the time being. It's too open-ended." Meanwhile, hapless lenders slogging through the rescheduling process are proceeding step by step, a thankless, time-consuming task.

Most bankers are satisfied that the banking task force has functioned smoothly, considering the circumstances. The

Polish workers simply must get back to work

much-publicized hard-line approach of the Americans was appreciated in retrospect as a useful "hard guy, soft guy" tactic to extract concessions from Warsaw. However, the tough line initially followed by Frederick Schwartz of Bankers Trust was a little too much for the Europeans (and even some of the Americans), and by the time the memorandum of intent was signed in late September, leadership of the U.S. delegation had passed to Bank of America.

## Excessively hard line?

If the Americans finally settled on a "combination" approach — "push for as much information as possible, but don't lose sight of the problems at hand," is how one U.S. representative phrases it — their ambivalence over the summer months certainly prolonged the rescheduling process and drew some outside criticism. Professor Richard Portes, an Eastern Europe specialist at the University of London who had been warning about the dangers of Polish debt since 1977, wrote in *The New York Times* last June: "It is foolish to overcompensate for past indulgent lending policies with an excessively hard line now."

A further criticism is that the time span for repaying the rescheduled debt — three years after a four-year grace period — is not sufficient, considering that 1982, 1983 and probably 1984 debt also will have to be rescheduled and that Poland will need new credits in the meantime. Moreover, notes one banker whose exposure allows him to be more objective, "1½ over LIBOR is too high for rescheduled debt, it only exacerbates the problems." Of course, he concedes, "it is the price for the anxiety" Poland has caused and will continue to cause.

The poker game of the Polish rescheduling seems likely to continue to the

bitter end. The question of whether the rescheduling agreement could be signed even if the Poles failed to pay the interest due will probably be decided "at the last minute," predicts one participant. In other words, the agreement could probably be signed without the payments, but would not become effective until they were made.

In the meantime, the dilemma for many banks is how to treat the rescheduled loans. If the agreement is signed and the interest payments are up to date, there is no problem. If the agreement is not signed — or not effective because interest is overdue — then accountants may insist on reserve provisions or even charges on all or part of the loans, which could make a noticeable dent in some income statements. On the other hand, reason some bankers, the memorandum of intent by itself (or a retroactive debt accord) could allow some flexibility in bookkeeping.

Any one bank's approach, of course, depends on other contingencies. Deutsche Bank, for instance, is reliably understood to have set aside reserves for all of its Dm500 million exposure to Poland. Other West German banks, less happy in their earnings, would be hard put to follow suit, although "most prudent banks" have reserved at least part of their exposure, figures one European.

Although the psychological impact of Poland's application to rejoin the International Monetary Fund has been salutary and the hoped-for standby credit (if Poland is accepted) would certainly ease pressure on the banks down the road, the key factor for creditors today is the successful implementation of an economic recovery program. Whether monitored by the IMF or the banks' "economic committee," future reschedulings, let alone new credits, will depend on the Poles' determination to turn the economy around.

Yet, despite recent unhappy experience, most bankers still give credence to the underlying potential, which originally lured them to Poland like a siren's song — coal and copper resources, a large population and agricultural potential ("Don't forget that until 1971, Poland was an agricultural exporter," notes one veteran of East European lending). Even in the catastrophic circumstances of 1981 — with national income plunging an estimated 15 per cent and coal production down 20 per cent from 1980's level — there are comforting anomalies. France reports fulfillment of coal contracts with Poland, and a West German contract for copper deliveries has proceeded apace.

Then there is the sympathy quotient. For one thing, the Poles, prior to this crisis, had always been meticulous in their financial dealings. And even if they were unrealistic going into 1981 in gauging their ability to keep up debt service, they paid as long as they could. Moreover, even in the midst of their own exasperation, bankers realize that some concession has to be made to the causes of the crisis and its social implications. "It's hard not to like the Poles," sighs one British banker. "Don't

forget, we went to war for them."

Indeed, emotions, especially in Central Europe, run deep. Two Frankfurt businessmen sitting at lunch recently came to discuss a grass-roots food-aid program being mounted in the local schools. "My little girl came home the other day and said we have to pack food for Poland," relates the one. "I said, 'First, let them give back Silesia.'" The other businessman, shocked at his colleague's tale, says, "I sat down and wrote a four-digit check for the same program."

Such ambivalence evidently prevails even in the West German government. Despite all the routine protestations to the contrary, Bonn brought considerable pressure to bear on West German banks in the summer of 1980 to mount a Dm1.2 billion balance-of-payments loan to Poland. Reluctantly, in the words of the highly regarded financial commentator Rudolf Herlt of Die Zeit, the banks "bowed to the political wishes of the federal government." Bonn's largesse, however, was limited to what the banks were expected to do: The government was willing to take only Dm400 million under the aegis of Hermes export credit guarantees.

Yet, slightly more than a year later, it was that same Bonn government that was reportedly balking at authorization for the West German share of a $500 million loan from Western central banks to be channeled to Poland through the Bank for International Settlements. The loan, originally proposed by France, has been consigned to limbo pending West German approval, which appeared highly unlikely in view of Bonn's budget problems.

The BIS loan would have been one possible solution for Poland's interest arises. But Western governments seemed willing to stand pat and let the banks and the Soviet Union fight it out over who will bail out the Poles.

## Rumania: Heads in the sand

Bankers tend to reserve their harshest and frankest language for the Rumanians, who have never been liked, but who reportedly became downright obnoxious when they ran into payments difficulties in the latter half of 1981. "They may yet sidestep a rescheduling," sighed one travel-worn banker wistfully, "but I don't really think they will."

Rumors surfaced in June that Rumania, which had more than 40 per cent of its roughly $10 billion debt in short-term facilities, might be facing liquidity problems. In a kind of self-fulfilling prophecy, first smaller West European banks, then the Swiss and finally the others rushed to the credit spigots, choking off the short-term funds, reportedly costing Rumania $600 million between June and November of last year. Predictably enough, Rumania began missing payments. Worse, they pretended nothing was wrong. "They wouldn't answer telexes, they'd cut off phone conver-

## Rumanians must learn to face reality

sations in midsentence," relates a central bank official. When an excuse was forthcoming it was the tired one that "technical" problems were forcing a "delay" of payments. "They're sticking their heads in the sand," says one exasperated banker. "The Rumanians," intones one European ominously, "are doing long-term damage to their reputation."

Not that their reputation was such an enviable one to begin with. Betraying certain prejudices of their own, bankers have long labeled the Rumanians "carpet salesmen" and "arrogant horse traders" for their wheedling way in loan negotiations. "It's not that they were such tough bar gainers — but they were terribly fatiguing, unpleasant and boring," recalls one senior banking executive. One of the more delicate characterizations of the Rumanian attitude is offered by a well-informed economist: "The Rumanians have behaved in a remarkably inept way." He goes on to compare Rumania to Poland, saying that both have suffered from "gross mismanagement, a fantastic blundering in planning not made by the other [Comecon] countries." The two, he suggests, are plagued by "industrial megalomania, while ignoring agriculture." Investment programs, he adds, have proceeded without any coordination. But the full weight of bankers' criticism falls on Rumanian leader Nicolae Ceauşescu, whose regime they see as autocratic and corrupt. "This man Ceauşescu," declaims one Western banker, "has built up a system directed to himself and a whole bunch of obsequious servants."

Less unanimous are the opinions about Rumania's alternatives in overcoming its liquidity crisis and its medium-term economic prospects. The optimists say a marked improvement in Rumania's trade balance — some foresee exports up 25 per cent and imports down 5 per cent in 1981 — could restore bankers' confidence and allow at least partial restoration of the credit lines. Others note Ceauşescu's recent emphasis on agriculture, which many see

as a key to economic recovery in both Poland and Rumania.

One of the perennial problems with Rumania is the lack of reliable statistics. Nor has Bucharest's IMF membership enhanced its transparency much. While the IMF credits of nearly $1.5 billion authorized for Rumania for the period 1981-1983 should ease the liquidity crunch somewhat, banks have not been overly impressed with the efficacy of the IMF's conditions, restricted mainly to certain price adjustments and a reduction of government investment.

No less an authority than Wharton Econometrics Forecasting Associates took the IMF to task for its soft attitude toward Rumania. "Rather than warning of the already serious and worsening economic problems in Rumania, the IMF action is likely to be interpreted as an endorsement of present Rumanian economic policies," the consultants wrote last June. One French observer agrees: "I don't think Mr. Ceauşescu is ready to follow the IMF. The regime is too autocratic to be able to criticize the situation."

Not everyone is so pessimistic, however. One British banker, in fact, is quite upbeat about the country's prospects. "We're confident that by next June the Rumanians will have restored their credibility and learned from their mistakes," comments a senior executive at one of the big clearers. The East European line officer, just back from Rumania, adds, "They are rationing food. But you know, that bread ration is pretty generous. If you could eat that much bread, you'd be doing all right."

In somewhat the same spirit, the respected Vienna Institute for Comparative Economic Studies, in a September report, ranked Rumania ahead of East Germany as well as Poland in terms of country risk. Institute economist Gerhard Fink noted that Rumania has "liquidity problems" but a moderate level of debt and sees the main potential threat to be oil imports. (Not surprisingly, Wharton economists, reviewing several country risk rankings in October, found Vienna's attitude "puzzling" and noted that the ranking of Rumania before East Germany "cannot be justified.")

But even given the most optimistic prognosis, a key question becomes, in the words of the U.S. banker, "Can the bloc afford to have a second Poland on its hands?" A Rumanian rescheduling, many observers point out, would keep East European credits on ice for another year. In this context, Rumanian-Soviet relations are critical. Even though Bucharest has ostentatiously displayed its independence from Moscow, Rumania's latest economic difficulties, especially the need for imported oil, have led that country to tone down its go-it-alone line recently, and press commentators in Bucharest have spoken of a rapprochement with the Soviets. Yet just how willing the Russians or other Comecon members would be to go out on a limb for this renegade remains to be seen.

The other political factor causing

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some pause is Ceauescu's rule itself. "Who would want to take bets on the stability of that regime over a six-month period?" asks an academic expert on the region. And a British banker, ticking off factors of political risk in Eastern Europe, cites Rumania's "oppressive dictatorship." Most bankers, however, consider Ceauescu's iron grip an element of at least some stability, and precisely for that reason abjure any comparison to Poland. The other reason that this analogy limps, they claim, is that Rumania's debt, estimated at around $10 billion, is smaller in both absolute and relative terms.

Rather, some bankers say, Rumania is a victim of Poland rather than an imitator. The reaction to rumors of payment difficulties would not have been nearly so quick, they assert, had there been no Poland. Some criticize the hasty action of the banks. "Everybody's trying to get out of the woods by their own means," notes a French executive. A West German who claims his bank had kept a line open to Rumania says they did not want to cause the problem they were trying to avoid. "Short-term lines should be cut back — but not cut off," concurs a U.S. bank executive. "In Rumania, it is better that the crunch has come now rather than later," agrees an economist. "Rumania is not in the disastrous shape that Poland was — but it could have gone that way in a few years."

While most bankers reject the notion that Rumania might become a second Poland in the sense of economic collapse, they are also conservatively calculating that some form of restructuring or rescheduling of debt will be necessary once the Romanians decide to come clean about their problems. Whether the Soviet Union would bail out Bucharest with oil or whether Ceauescu would suddenly tap a cache of gold are among the alternatives put forth.

## Soviet Union: A hard-currency crunch

When the Bank for International Settlements published its second-quarter figures last year on the Western banking system, BIS economists noted that the Soviet Union had drawn down its deposits in the West by $5 billion in the first half of 1981, leaving only $3.6 billion in the kitty. The sharp drop was "unusual," comments one analyst. "It shows that even Russia has limits."

The U.S.S.R. ran smack up against those limits in 1981, when its hard-currency deficit was projected to be about $8.3 billion. Part of the solution, at least temporarily, was to turn to the Western banks for short-term financing. "The Russians are now in the market right, left and center," reported one European banker in late November. "picking up money wherever they can." They were, he added

The Soviets are being squeezed by grain imports and aid to satellites

with some understatement, "publicity shy" about this activity. Adds another banker: "It's very clear what the Russians are doing — taking up credits, delaying payments — it's a typical commercial maneuver. They are stretching out their money."

Furthermore, the squeeze on Russia's hard-currency balance, bankers and economists say, is not a temporary phenomenon. It will persist at least until 1985 and, according to some analysts, could extend throughout the 1980s.

Just a year earlier, the U.S.S.R. was coming off a "super decade," in the words of one analyst. The hikes in prices of gold and oil, plus increasing arms sales to newly rich OPEC client states, had contributed additional revenues of some $50 billion to Soviet coffers (about half of its total import bill) between 1973 and 1980. In 1981, these three sources of export revenue were sharply reduced.

On the import side, Soviet agriculture was burdened with its third year of bad weather in 1981, and Soviet grain imports in the first half were near the 20-million-ton mark. These imports will continue to be at least 30 million tons through 1985, even if the weather is perfect, just to replenish the country's exhausted stocks. According to Jan Vahous of Wharton Econometric Forecasting Associates. "The only thing that really matters is agriculture," comments another analyst. "They are quite successful at having bad harvests. Otherwise, foreign trade is small."

But in 1981, there was an additional drain on Soviet funds — the expense of keeping the Polish economy afloat. By conservative estimates, Poland cost the Soviets between $1.5 and $2 billion in 1981 and the Polish crisis may continue to demand Soviet contributions for several years to come.

Meanwhile, the heavy capital imports for the much-publicized Siberian gas pipeline are requiring extensive Western

financing. Although the initial contracts signed last fall are worth about $2 billion, Soviet imports for the project are expected to reach $15 billion over the next several years. Financing is no problem, but the Soviets evidently feel that the huge trade credits and their attendant publicity use up much of their credit standing in the West. There is also a nagging suspicion among some bankers that all the shuffling and revising of the plans for the pipeline have successfully disguised the fact that some credits ostensibly going for prefinancing of Western purchases are being put to more urgent uses.

The Polish affair is also affecting Soviet credit standing. Bankers, as a result, clearly see a chance to add an eighth or two to Soviet margins. "If they're willing to accept bad market conditions," says a West German banker, "then the credits are there." Of course, he continues, it's not easy for the Soviet Union to accept that it has to pay a higher margin than Malaysia or Ireland.

Several bankers who said they would have nothing to do with East European credits for the time being, however, carefully excepted the Soviet Union. "It is now, like before, absolutely first class," enthuses one. The U.S.S.R.'s huge oil and gas reserves, gold production and industrial sophistication, not to mention its political weight, assure that it is far and away the top-rated risk in the bloc. "If you go look at it," muses a British banker, "you really do wonder why we put it at the top. Sheer size comes to bear, but the debt record is the main reason."

The chief economist at a British bank has another point of view. The Polish experience, he says, "shows the basic incompetence of the system. You have this totally incompetent civilian economy next to this magnificent military machine. It's so mad as to be incredible." Another economist says bluntly, "The Soviet internal economic performance has been deteriorating for about ten years."

Over the long run, there are also some differences of opinion as to whether the Siberian gas pipeline will take the pressure off the external balance by 1985. Edward Hewett, senior fellow of the Brookings Institution, says the Soviets will have the capacity to export between 90 and 100 billion cubic meters of gas by 1985, "but they will soon have contracts for only about 60 bcm." Furthermore, some analysts believe that gas prices may continue far below oil prices on world markets. Hewett estimates that Soviet gas exports in 1985 will amount to only $10 to $11 billion (1980 prices) compared to $15 to $17 billion in oil and gas revenues in 1980. Oil exports will decrease and may vanish completely by 1985 he says. "By my scenario, it makes all of the 1980s a stressful period, although I am trying to steer away from those people who predict Armageddon by 1985."

There is also a political risk, however. The perennial question of who comes after Brezhnev has ebbed for the time being, but it is still there. In the meantime, observes

68 JANUARY 1982

British expert, demographic changes within the Soviet Union indicate increasing ethnic strains by the end of this decade.

There is one overhanging uncertainty right now. The invasion of Afghanistan marked the end of large syndicated credits for the Soviet Union. No one is talking much about what the invasion of Poland would mean.

## Yugoslavia: Decentralization backfires

In case anyone was wondering whether the Polish rescheduling would have any effect on Yugoslavia's standing in the market, Belgrade's difficulty in mounting a $400 million syndicated credit in the last quarter of 1981 gave an answer of sorts. While Yugoslavia balked at paying any more than an already high 1¼ margin, banks were not willing to talk about much less than 1½.

"The Yugoslavs were affected. They're not in the same pot, but they were affected," confirms one East European specialist. Most East European line officers protest that they do not want to discuss Yugoslavia together with the Comecon countries. On the other hand, they are generally responsible for Yugoslavia as well and concede that it shares many of the same problems. "The two countries that worry us the most are Rumania and Yugo-

slavia," confides a U.S. bank economist (he was excluding Poland, which is beyond the worrying stage).

There seems to be plenty to worry about. One estimate puts Yugoslavia's debt at $20 billion, while the key figure to ar- resting the growth of that debt, the

current-account deficit, is not encouraging. Wharton Econometrics Forecasting As- sociates projected in late October that Bel- grade would overshoot its target of a $1.8 billion deficit by at least $400 and perhaps by $800 million. (In fact, since October the Yugoslavs imposed draconian measures that virtually shut off imports altogether, enabling them to meet this target.) On the other hand, remarks a U.S. banking execu- tive in Europe, meeting the targets might mean hurting the economy in the long run. "But it's hard to see them overcoming their short-term difficulties," he admits.

"There have been a couple of technical defaults," acknowledges a Euro- pean banker. He notes that one problem in Yugoslavia is that there are fifteen banks involved in foreign trade, unlike the Com- econ countries, where one or two banks handle foreign transactions. The foreign currency may be available in one bank but won't be channeled to paying off the debt falling due.

Yugoslavia's decentralized adminis- tration in general is blamed for a large part of its current economic disarray. The sepa- rate republics and provinces have pursued their investment schemes independently, leading to waste and duplication and, in the end — as in its Comecon neighbors — to overinvestment in industry. "There's com- petition between the republics," a West German line officer notes. "And at least beforehand, they were always fighting Belgrade."

On the other hand, a more sanguine British banker sees this lack of central con- trol working in Yugoslavia's favor when adjustments are necessary. "They're very versatile. Plans can be altered and the people accept it. Things can be adjusted to current needs and problems," he explains. "We don't like the workers' councils, but they work."

Another British banker sees hope in the high quality of Yugoslavia's manufac- tured exports. "Their consumer goods are infinitely better than Comecon's," this banker says. "They will come through." Acknowledging that the unprecedented energy price explosion of 1979 had pushed Yugoslavia into a payments bind, this op- timist continues: "An Adriatic find could change their fortunes overnight — like the U.K."

Although some may like the fluidity of the Yugoslav situation, others are wor- ried about the slack political control of Tito's successors. Among other things, the persistent unrest amid the Albanian ethnic majority in the Kosovo region gives them pause.

The Yugoslavs have earned a lot of points over the years, however, and there's a great deal of sympathy for them in the market. Bankers see a good deal of politi- cal backing because of Yugoslavia' strategic importance. And then there is the potential IMF safety net. But most would prefer to see Yugoslavia succeed in it tightrope act and not plunge now into re- scheduling.

Yugoslav leaders are straining to hold things together

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> "The Soviets are worried, and they are looking to shift some of the burden on to the Eastern bloc."

was a sudden trade surplus and economic recovery," notes Paul Marer, professor of international business at Indiana University. How can the turnaround be explained? "The Soviet Union clearly helped Bulgaria by shipping extra oil that Bulgaria then re-exports at a profit." But within the Eastern bloc, Bulgaria is the most dependent on the U.S.S.R. By contrast, Rumania, the maverick of the Warsaw Pact, is "now desperately screaming for oil, but the Soviet Union is not going to help in the same way," notes Marer. These two countries represent the extremes of Soviet umbrella policy (nonaligned Yugoslavia was never considered to be under an umbrella). The remaining four Comecon countries have some sort of intermediate position, but it is difficult to determine exactly what kind of umbrella the Soviets would extend for each and for how long.

## New climate

Poland has proved that this modest umbrella does exist — "up to now," cautions Marer. "It may be the opposite tomorrow." Just how much aid is involved is not clear. Sources as diverse as Wharton Econometrics Forecasting Associates and Radio Free Europe put Soviet hard-currency loans to Poland over the past year at $1.5 billion. One U.S. government source says "more than a billion," while a banker knowledgeable about the Polish re-scheduling said the figure was "much less than a billion." Soviet aid is also coming in two other forms that are difficult to measure, particularly in dollars. The U.S.S.R. has allowed Poland to run up a substantial trade deficit this year, not retaliating when Poland was forced to cut back its exports. The Soviets may also be supplying some extra hard goods, above the trade quotas, on credit.

The upshot of this is that while an umbrella may be in the background ready to shelter a country's balance-of-payments difficulties, as in Bulgaria's case, it is not something that can be relied on. "Bankers must have been out of their minds to lend on such a basis," notes one economist. Yet, to talk to bankers now, one has the impression that it was only "other banks" that ever really subscribed to the umbrella theory. "We didn't believe it," contends one European banking executive. "But all banks who make that claim acted inconsistently because they went on to make the loans without adequate information." A West German banker is particularly bitter: "There is an umbrella — but only in the West."

Among East European experts, however, discussion of the pros and cons of the umbrella theory, at least as it was originally viewed, is now passé. The more crucial concern nowadays, from bankers to economists to the U.S. Central Intelligence

Agency, involves Soviet policy about another kind of shelter over the Warsaw Pact.

For three decades, the Soviets have been using intrabloc trade to shield East European economies from the cold, cruel competition of world markets. The Soviets supply oil and raw materials in exchange for machinery and manufactured goods that Eastern Europe cannot market in the West. East European hard-currency balances are, therefore, extremely vulnerable to any Soviet decision to reduce the trade subsidies. And some such decision, Western experts say, is in the offing.

The reasons for a Soviet change of heart are plain to see. In the 1970s, the Soviet economy profited from three windfalls. Prices soared for two of the U.S.S.R.'s major exports, gold and oil, while it also sold military hardware to its now-wealthy clients in the OPEC states.

But in 1981, things changed dramatically. All three sources of revenue were abruptly reduced at the same time that the Soviets were forced to spend unforeseen billions on massive grain imports and aid to Poland. Jan Vañous, senior economist of Wharton Econometric Forecasting Associates, estimates that the USSR's balance-of-payments deficit in 1981 would amount to $7.6 billion.

Moreover, these difficulties are not temporary. The Soviet Union will continue to run immense deficits at least until 1985 — when the Siberian pipeline will bring in substantial new income, economists predict — and perhaps beyond. In the meantime, Vañous says, "the Soviets are worried, and they are looking to shift some of the burden on to Eastern Europe."

From the East Europeans' standpoint, such a shift would hardly be auspicious. In the 1970s, the intra-bloc trade arrangement had already begun to shift more to the Soviets' advantage. The prices of oil and other commodities, measured in transferable rubles, have been steadily adjusted upward according to a formula based on the average dollar price in the West for the past five years. The prices of manufactured goods tend to remain unchanged for a long time until new prices are established in bilateral bargaining. Eastern Europe's terms of trade with the U.S.S.R., therefore, have deteriorated markedly since 1973, although Russia is still charging only about 40 per cent of the OPEC price for its oil exports. At the same time, the rate of growth of the physical volume of Russian exports has also slowed.

While it is apparent that the U.S.S.R.'s own problems are making the burden of subsidies to Eastern Europe more untenable, it is not clear exactly what mechanisms the Soviets will use to put pressure on their Comecon partners. Vañous believes that the Russians will demand higher relative prices for Soviet exports.

The Soviets are already taking one step to improve prices, he says, by devaluation of the ruble/dollar exchange rate, which automatically increases the relative value of commodity exports in the bloc because of the formula tying prices to the dollar. After nine years of appreciating against the dollar, the ruble weakened in 1981, from about R65:$1 to R77:$1 by mid-July.

According to Indiana University's Marer, Soviet strategy will be to decrease the physical volume of subsidized oil exports. The Russians have already announced that the oil quotas to Eastern Europe for 1981-1985 will not increase above 1980 levels. Some reports have surfaced that the Russians will demand payment in hard currency for 10 per cent of each country's oil bill, probably at world prices, starting in 1982. The Soviets are also expected to adopt a more strict policy calling for its allies to be more prompt in clearing ruble deficits. Hungary, for example, has been running a dollar surplus with the U.S.S.R. for trade over and above the bloc quotas at the same time that its ruble trade has been in deficit. The Soviets could tell Hungary to divert hard-currency exports to the U.S.S.R. to clear the ruble deficit.

Whatever strategy the Soviets use, the key question is, How far will they push? "It is not going to be a heavy-handed action," Vañous predicts. "They do not want to plunge these countries into economic disasters." A New York banker roundly dismisses the idea that the Russians would slash subsidies: "It would only happen if the Soviet Union said, 'What the heck, we don't need Eastern Europe.' If they were going to cut the subsidies, they would start with Cuba." Moreover, when the Soviets push for change in the bloc, Vañous explains, "it is a fairly gradual, negotiated process. There is a great deal of haggling involved, although the Soviets obviously are at an advantage because of their size and power."

"The Soviets have to find out how far they can go," says Edward Hewett, senior fellow at the Brookings Institution. "They are not giving ultimatums. They are proving. They are playing poker, and when you make a move you have to be serious." If some countries can absorb greater pressures on their trade balances, then the U.S.S.R. may push them harder. "Sure, they could lose the whole game." he says. "There is probably a lot of leeway, but nobody knows just how much. The Soviets are in bad enough shape that they have to try."

Hewett also points out that the new Soviet attitude is consistent with a prevailing mood in the larger world context. "You will see that what is happening in the Eastern bloc is not all that different. The World Bank and the IMF are now talking about being tougher on LDCs, telling them to stop running deficits." Thus it is not a question of how many holes are in the Soviet umbrella, but rather, to what extent and how soon will it be furled altogether?

COVER IV

Where bankers went wrong in
Eastern Europe

In the following exclusive interview, former U.S.
policymaker Zbigniew Brzezinski talks about the
indecent haste with which banks lent to the
Eastern bloc and assesses the region's future.

Former U.S. President Jimmy Carter once described Zbigniew Brzezinski as "almost literally the eyes through which I view the world." Indeed, during the Carter administration Brzezinski, as presidential assistant for national security affairs, emerged as the central figure in shaping U.S. foreign policy. His views on issues ranging from SALT to international ocean boundaries to the presence of Soviet combat troops in Cuba probably carried more weight than those of anyone else in Washington, except the President himself.

Since leaving public office, Brzezinski has resumed his academic career, chiefly as Herbert Lehman professor of government and director of the Research Institute on International Change at Columbia University in New York. He is also a tenured professor and senior adviser at the Georgetown University Center for Strategic and International Studies in Washington, D.C. But his ties to Eastern Europe (Brzezinski was born in Warsaw) remain strong, as indicated by his suggestion that "the Polish experiment be helped in the short term to consolidate itself and, in the long term, encouraged to undertake some major structural reforms."

After a number of dealings with Brzezinski, one Chinese official described him as a *hao han* — "a hero who speaks his mind at whatever costs." The question of heroism aside, the following exclusive interview, conducted in his sparsely furnished Columbia University office by Associate Editor Jane Baird, demonstrates clearly that Brzezinski is not one to mince words.

**INSTITUTIONAL INVESTOR:** When did East European experts begin to realize that Poland's troubles were not just short-term but resulted from errors in basic strategy and mismanagement?

**BRZEZINSKI:** Experts probably knew that some years ago. The problem is that

the banking community didn't, and that is regrettable. I think it reflects a certain indecent haste in the granting of credits to the Soviet Union and the Eastern European countries. That haste created a stampede

mentality that resulted in a lot of poor research and poor judgments.

Could anyone have foreseen the straits Poland is in now?

Brzezinski: "One has to ask whether it is wise for Western financial institutions to overly expose themselves to countries with which we still have major political and strategic disagreements"

produced by Ralph Teodor

70 JANUARY 1982

Probably not, given the extent of the crisis.

What would be the consequences of a
Polish default?

I think they would be very damaging, not
only for East-West economic relations but
for the financial health of some of the in-
stitutions involved. This is why there is, in
my judgment, an overriding interest both in
the East and in the West in avoiding such a
default. That in turn means that the Polish
experiment should be helped in the short
term to consolidate itself and, in the long
term, encouraged to undertake some major
structural reforms, preferably within some
kind of association with the IMF.

Have the banks been caught in Rumania
in the same way? Have there been warn-
ing signs?

There have been some warning signs, but it
would be a mistake to exaggerate the diffi-
culties and create a panic mentality. At the
same time, it is important for the banking
community to be a little more fastidious in
its operations and particularly to get rid of
the idea that doing business with Com-
munist countries is necessarily profitable.

What about the countries that aren't in
crisis — East Germany, Hungary, Bul-
garia, Czechoslovakia?

I think careful scrutiny is very much in
order, and in general one also has to ask
oneself whether it is wise for the Western
financial institutions to overly expose
themselves in relation to countries with

which we still have major political and
strategic disagreements.

Besides Poland, are the banks getting to
the point of overexposure?

We are talking about commitments on the
scale of more than $80 billion.

Is there some validity to the Soviet umbrella theory?

I wouldn't count on it too much.

Some people are saying that the Soviet
Union is actually holding an umbrella of
sorts over Poland right now.

The Soviet Union wishes to avoid a mas-
sive calamity in Central Europe and that is
only sensible. But I think that people who
think that there is necessarily going to be a
Soviet umbrella for Poland are probably the
same people who previously weren't too
careful in their judgment regarding loans,
not just to Poland but also to the Soviet
Union and other countries.

There is a prediction that the Soviet
economy will speed up and we will see
greater Soviet deficits and borrowing
from the West in the 1980s. How will this
affect Eastern Europe?

The Soviet economy. I think, is going to be
faced with increasingly difficult choices.
and that is going to minimize Soviet capac-
ity to bail the East Europeans out if they get
into trouble.

How do you see future commercial rela-

tions with Eastern Europe, after the
Polish rescheduling is completed and the
Soviet gas pipeline deal is signed?

I think, by and large, the normal tendency
is for the Eastern European countries to try
to stimulate closer contacts with the West.
This has not only economic, but very much
cultural and social impulses. The trend,
therefore, is going to be in that direction.
However, a calamity in Poland could abort
that for quite a long time.

Because Western banks are withdrawing
credit?

And because it would be such a generation
of tension and anxiety that it would be
bound to spill over into the economic
reality.

How do you think the gas pipeline would
affect that?

I am very skeptical about this deal. I think
that it involves an excessive degree of
Western dependence on the Soviets and it
is going to create conditions in which
Western statesmen, particularly the Ger-
mans, will have to take possible Soviet
reactions into account in making political
and strategic decisions. I do not find the ar-
gument that this is a limited exposure very
convincing at all.

Can a centrally planned economy in
trouble adjust by shifting its planning
priorities or does it require structural
changes toward a market economy?

The notion that you can shift planning
priorities easily seems to run, in my judg-
ment, into conflict with the realities of a
complex, modern society. It is not very
easy to shift priorities by essentially bu-
reaucratic decisions. This is one of the dif-
ficulties of state-run economies. They are
cumbersome and difficult to direct. And
when you try to shift priorities, you cause
massive dislocations because the shift
originates largely in bureaucratic decisions.
As a consequence, the interplay of eco-
nomic factors isn't duly considered and
isn't sufficiently organic and spontaneous.
You therefore have a situation of these
periodic lurches and dislocations in state-
run economies that are so devastating. Po-
land is the best example of that.

What was the Carter administration's
feeling about U.S. bank lending to Eastern Europe?

We did not object to it, because it seemed
to us that creating close East-West links,
particularly with Eastern Europe, was de-
sirable. The scale of these loans to indi-
vidual countries and the criteria used and
the degree of care involved was up to the
banks.

Has this changed with the Reagan ad-
ministration?

I don't think it has changed much, except
for the pipeline deal, where the Reagan
administration is more openly critical of it.
While I was still in office, I was publicly
critical of it for national security rea-
sions.

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COVER VI

# Can the numbers be believed?

Not if they come from official East bloc sources, admit Western lenders. The only problem is that there are few other sources of information.

The World Bank Atlas contains a strange anomaly. It seems that the bank treats Rumanian income statistics differently from those of the rest of the Eastern bloc. For other Comecon countries, the bank uses tourist exchange rates to make GNP conversions. For Rumania, a member country, the bank accepts the commercial exchange rate provided by official sources, which, by comparison, understates the GNP estimate considerably. Therefore, while Rumanian and Bulgarian standards of living are in fact roughly equal, the Atlas shows Rumania's per capita income to be about 50 per cent lower.

Why would Rumania choose to appear poorer than its neighbors? The best explanation, observers say, is that a per capita income figure of less than $3,000 classifies Rumania as less developed and makes it eligible for fifteen-year World Bank loans at 8.25 per cent.

## Right vs. wrong

Despite appearances, the World Bank is not simply playing along with a crass deception. There is no clear-cut right or wrong in selecting the appropriate exchange rates for Eastern bloc countries, except Yugoslavia. Each country has at least four exchange rates — the official, the tourist, the commercial and the black-market rate. The World Bank generally uses the tourist rate because it is often adjusted to reflect changes in purchasing power and it is the closest to the implicit exchange rates that have been derived after years of work by the most knowledgeable of Western economists. But the tourist exchange rate is also riddled with problems and cannot be taken for granted as an accurate measurement. Indeed, bankers have pitifully little statistical data about these countries that they can take for granted. "With Eastern Europe, everything is guesswork," admits one U.S. banker. "It is put together catch-as-catch-can."

The worse problem is that Eastern bloc countries flatly refuse to provide even some of the most basic data. Hard-currency trade statistics are usually the easiest to come by. Even so, East Germany in recent years has been lumping its exports and imports into one figure, and economists must go to other sources in the bloc for reliable information. "East Germany is the only developed economy in the world that publishes its statistics in this form," says an indignant economist.

Trade within the Eastern bloc is a puzzle in itself. "The Soviets cease publication of figures when there is something embarrassing." such as, for example, subsidies to Eastern Europe and physical volumes of Soviet oil exports, notes another banking source. One of the most virulent debates among the experts concerns the

amount of Soviet subsidies to its European satellites. The 1980 estimates vary from $4 to $22 billion. Intrabloc trade is particularly difficult because many of the goods are not sold in the West and are not easily valued in dollars.

Hard-currency balance-of-payments data can be accepted as reliable for Hungary and Poland and used with some caution for Yugoslavia. The other countries require Western economists to go through the painstaking labor of making estimates of remittances, tourism earnings, transportation flows and interest payments. Even Hungary, normally so scrupulous in its economic management, presents a problem because it lumps together its hard-currency receipts from the West and from the Eastern bloc. A heated debate is now raging among the experts over exactly how much of Hungary's receipts from the East represents genuine, fully convertible currency and how much are only accounting transactions.

As for foreign debt, statisticians rely largely on figures compiled by the Bank for International Settlements from Western sources. BIS figures, however, fall far short of the kind of information that bankers would like to see. Only a rough debt profile is available. Debt held by Arab and LDC countries is not included. More important, none of the countries has revealed the amount of its hard-currency debt to the Soviet Union and the rest of the bloc. When authorities in Warsaw finally came forth with more complete debt figures for the Polish debt, for example, not only were estimates increased by $1 to $2 billion but bankers were also surprised to learn that Brazil was a large creditor.

No one really knows what's included in some of the production figures

## Good vs. bad

Economists agree that Hungary, Poland and Yugoslavia provide the best information, followed by Czechoslovakia. Between Czechoslovakia and the rest of the

ASIA-AMERICA INVESTOR

81 INSTITUTIONAL INVESTOR

"Any forecast, with information presently available, is an act of faith."

bloc is a yawning gap. Much more secretive are the Soviet Union and Bulgaria; East Germany is even worse and Rumania is scraping the bottom. The situation for Rumania is so bad that two consultants, in an in-depth study for Wharton Econometric Forecasting Associates, wrote: "We would argue that any forecast at this time, with information currently available outside the country, is merely an act of faith."

A number of bankers say that current-account and other external figures are more accurate and trustworthy than internal economic data. "Internal figures are the most distorted," says a U.S. banker. "External monetary flows all go through one institution, while internal figures may be calculated by several different agencies, all with different methods." Projections of growth and capital inflows are often "entirely unrealistic," adds another. "I take all domestic data with a grain of salt." agrees a colleague.

Many of the distortions are characteristic of centrally planned economies, where factory managers tend to inflate their production figures to meet plan targets. What's more, the methods of calculation often change. Several experts say,

for example, that part of the sharp drop in Poland's coal production since 1979 is statistical error. The 1979 figures included rock and other impurities, they point out, while 1981 coal is weighed more accurately. "These countries are behind Western standards of data collection," says a U.S. banker. "Before, maybe they were weighing railroad cars of coal as they pulled out of the mine. Now maybe they are using more sophisticated methods." He concludes that "the figures may be misleading, but they are not out-and-out lying."

Adding to the confusion, statistics for centrally planned economies are often not comparable with Western statistics because what they are measuring is different. For example, East European statisticians use a different concept of national income than do Westerners. They measure neither gross national product nor gross domestic product, but "net material product," which essentially excludes government, most services and depreciation, although the exact definition of what comprises NMP varies from country to country.

Despite the many difficulties, Western economists have made fairly good estimates of the basic indicators, bankers say.

"Lots of people have worked with this data for a long time and are accustomed to dealing with it," notes a country analyst at one bank. When many of the latest figures were revealed in Poland, says a New York banker, "the numbers Western economists had been preparing were close enough. There wasn't a major surprise."

Still, when bankers are asked today whether they judge the current data sufficient to make sound credit decisions, each tends to have a different answer. Enough for all countries but Rumania, says one analyst; only for Hungary, in the opinion of one lending officer. Another lending officer evades the issue entirely: "If nothing else is available, decisions have to be made."

Does it really matter? "I have not heard of anyone refusing to go into a loan because he did not have enough figures," suggests one U.S. banker, "but it might be a natural development if lenders become more reluctant." Yet this banker has seen no evidence that countries are being forced to provide more and better data. "It is too early in the game to tell," according to another lending officer. "It may take a couple of years for these countries to get the statistics developed. We don't make credit decisions based on statistics and never have. Nor were we ever asked the traditional banking questions for Easter Europe. But in the future, if credit is re-stored, it could be that banks will be asking those questions." ■

All these securities having been sold, this announcement appears as a matter of record only.

European Economic Community

U.S. $25,000,000

15½ per cent. Bonds due 1993

S. G. Warburg & Co. Ltd.

Arab Banking Corporation (ABC)

Banque Bruxelles Lambert S.A.

Banque de Paris et des Pays-Bas

Kuwait Investment Company (S.A.K.)

Nomura International Limited

Orion Royal Bank Limited

82 JANUARY 1982