The Multinational Monitor

JUNE 1991 - VOLUME 12 - NUMBER 6

F I N A N C I A L   F O L L I E S

Capital Goes East

The Role of the IMF
In Eastern Europe

by Paul Hockenos

BUDAPEST, HUNGARY--Every third month, an International Monetary Fund (IMF) delegation calls on Hungary's economic policymakers. It is a day of reckoning for the National Bank and Finance Ministry chiefs in Budapest. They know well that their progress on the IMF's economic stipulations holds the key to the country's financial solvency.

For Hungary, as for all of the former communist countries, IMF approval of its free market transition policies is critical to its short-term survival. Should the IMF deem the policymakers too lenient in the application of the austerity programs, loans would be halted, and the financially strapped countries would be forced to default on their looming debts.

Such a cutoff of loans, government economists claim, would extinguish any hopes of economic recovery. The IMF's word not only determines countries' access to its own reserves, but functions as a seal of approval, esteemed by all major private and government creditors, as well as investors. The fragile Eastern European economies could plunge into chaos if foreign loans were cut off.

Facing massive debts and politically committed to the free market principles of the IMF, Eastern Europe's new heads of state have not resisted the hard terms of the IMF's tight monetary packages. All of the post-communist governments, whether IMF members or not, have dutifully implemented the general conditions of the IMF recipe: monetary restriction, price liberalization, deregulation and privatization. Top among the demands of the prescribed "shock therapy" are massive cuts in domestic expenditures--from investment to food subsidies--in order to meet balance-of-payment (the level of imports versus exports) targets.

While every government in the former East bloc ascribes to the ultimate goal of a free market transition, the issue is how radically to proceed. The unspoken question is how great a burden the people will bear without rebelling. The austerity policies combined with the demise of the East bloc market have sparked falls in living standards, sharp drops in output and rising inflation and unemployment. The net domestic product last year dropped in every East European country, from 3.1 percent in Czechoslovakia to 13 percent in Bulgaria and 19.2 percent in East Germany. The tight domestic budget targets allow no funds for programs to address soaring homelessness, crime and drug use.

The IMFs role has been to discipline governments which waver in their commitment to push forward with the transition. When, for example, Hungary's 1989 budget, under the reform communist government, showed an unexpectedly large negative balance of payments and budget deficit, the IMF halted stand-by loans. The government quickly drafted an emergency mid-year budget and loan access was restored.

While the exact terms of IMF contracts are secret, the influence of the Fund's money managers is plain to see. "When one reads between the lines," says economist Laszlo Andor of the Hungarian Trade Unions' Institute for Economic Research, "it's clear that the IMF is practically dictating Hungarian monetary policy." When politicians are challenged about the latest cuts in education or medical subsidies, for example,they openly admit that the IMF has tied their hands. "The IMF policies embody the full logic of Reaganomics, and one hears that in politicians' language," says Andor.

The power of debt

The IMF's influence in Eastern Europe stems largely, although not exclusively, from the region's massive indebtedness. Eastern European countries desire IMF contracts which guarantee annual loans they need to help service their debts. Even the less indebted countries, in part because of their desire to be in the IMF's good graces and receive loans from the Fund, generally adhere to the IMF's policy prescriptions. Romania, for example, with almost no debt, has eagerly applied a radical version of the IMF calculus to its ailing economy. Along with Poland, Hungary, Czechoslovakia and Bulgaria, Romania as of April 1991 can negotiate credit and reform packages with the IMF. The country's first reward: a $295 million loan from the Export Deficit and Crisis Fund to soften the fallout resulting from cutbacks in Soviet aid and oil shortages caused by the Persian Gulf War.

With the exception of Romania, where the government pushed the people to starvation in the 1980s to cover the country's debts, all of the former East bloc countries suffer heavy indebtedness. Poland boasts the largest Central European debt at $47 billion and Hungary the highest per capita debt at $21 billion total. I Bulgaria, whose foreign debt has more than doubled from $4.7 in 1986 to $10.8 billion, defaulted in spring 1990. Czechoslovakia stands in somewhat better shape with $8 billion outstanding. Yugoslavia and the Soviet Union owe foreign creditors $17 and $52 billion respectively.

While each country's case varies, the pattern of Eastern bloc indebtedness has its roots in the early 1970s. The East Europeans, along with the Third World countries, borrowed heavily, taking advantage of the rock-bottom interest rates which lasted until the mid-seventies. The plan was to use the borrowed funds to switch to import-led growth strategies, fuelling domestic growth through technology and capital imports from the West. In theory, the export of the derivative manufactured goods back to the West would cover the accrued debts.

The expected export payoff on the world market never materialized, however. Industrial goods were peddled instead to the Soviet Union for rubles, leaving balance-of-payment deficits in internationally traded currencies. When the oil-price shocks hit, followed by the 1979-1982 world recession, the Eastern Europeans, Africans and South Americans plunged together into an abyss of debt. As interest rates skyrocketed, debtors' foreign deficits, of which only a fraction had ever been invested, soared. Hungary, for one, had invested only $3.5 billion of the $12 billion that it owed by 1981.

Trapped in debt

When the debt crisis came to a head in the early 1980s, Hungary and others sought out the IMF for help. The structural adjustments and debt-financing schedules began a vicious circle of borrowing that would double and triple the East Europeans' debts during the decade. Hungary continued to borrow, paying off its early 1980s principle three times over, while the total amount of its debt doubled. Poland also paid back its initial debt at least once, as its total indebtedness increased dramatically.

Hungarian sociologist Andrea Szego sees the dilemmas of the East European countries as classic examples of the "international debt trap." Governments take out new credits simply to finance old ones, and countries' entire economies then become geared toward exports. "Once a country is stuck in the debt trap, it is forced to export at any cost for foreign currency. The forced growth of exports leads to domestic losses that are taken out at home," she says.

The credit provided directly or indirectly by the IMF failed to translate into any significant growth in the debt countries, Szego explains. "After the first period of borrowing, the vast majority of funds went directly to financing debt payment. The debt-servicing plans were simply implemented to protect the international monetary system from collapse." She notes as well that the Hungarian Communist Party's attempt to sell the conservative IMF adjustment policy as a Marxist-Leninist program of renewal precipitated its fall. "This caused not only their own defeat, but the crisis of Marxism as well."

Today, the nationalist-conservative Hungarian Democratic Forum (HDF) government grapples with the same tight conditions as the communists. Hungary's pact with the IMF stipulates that the country's export surplus and tourism revenue must cover $1.6 billion in interest payments if it is to receive $2.35 billion in loans to pay off part of the principle on its debt.

The president of the Hungarian National Bank optimistically points out that the country's debt service ratio (servicing costs as a percent of total export earnings) has fallen to "only" 40 percent from 70 percent three years ago. But the collapse of the COMECON trade bloc and conversion to dollar- based trade with the Soviet Union (particularly for oil) has the government predicting a 14 percent drop in the terms of trade for 1991. Hungary's trade with the Soviet Union accounted for 30 percent of its total trade in 1980 but only 20 percent last year. The 10 percent increase in the volume of 1990 hard-currency exports to the West helped offset a 26 percent decline in ruble trade. But with the East now competing with the West on an equal basis for Soviet markets, the boom in westward exports will not cover Hungary's losses this year.

According to IMF rationale, the only recourse is harsher austerity at home. Last year, the additional 5 percent of gross domestic product extracted from the Hungarian economy to bolster the balance of payments came in large part from workers' pockets. With over a third of the population living at or below the poverty line, the government cut real wages through a calculated inflationary policy. The closure of "inefficient, centralized" industries--the same targets of investment cuts in the 1980s--is another means to trim the domestic budget. The much-heralded privatization of the industrial sector, which government economists hoped would bring in foreign currency, has fallen catastrophically short of expectations. Western investment is only a trickle, leaving the countries in the lurch, falling more than $10 billion short of anticipated totals.

"The economy is expected to [shoulder the] burden [of] higher and higher financing costs from a stagnating GDP," says Andor. "In the long run, the chances of repayment could only be improved if the economy developed competitive, productive industries. But, with these restrictive monetary policies, there's no chance for development. Internal investment is almost non existent because everything is going to the debt."

The human costs of austerity are daily more visible on the streets of every East European city. Domestic consumption fell last year in Czechoslovakia, Hungary, Poland, the Soviet Union and Bulgaria. The drops have forced even mid-level wage earners to take second or third jobs. Inflation jumped high above estimates in every country, with the exception of Hungary and East Germany. In Budapest, the train and subway stations are filling with homeless people and families. Slowly, economists and citizens alike are recognizing that the "belt-tightening" that politicians in 1989 promised would last only three to five years will be a fact of life for much longer.

Alternatives to austerity

Despite these consequences, opposition to the IMF's policies is almost nowhere to be seen. In Hungary, the entire spectrum of parliamentary parties backs prompt debt servicing and adherence to the general terms of the IMF contract. Politicians feel that "there's no alternative." The ruling HDF-led coalition has resisted the all-out "shock therapy" that IMF bankers pushed through in Poland. Yet, their somewhat more "gradual" approach is only a revised version of the same economic program that all of the parties endorse.

The major opposition party, the former dissident-led Free Democrats, supports even more draconian policies. The party's top economist, Attila Soos, sees the IMF role in Hungary as positive. In contrast to Andor and Szego, he charges that mismanagement and waste, not the debt cycle, are at the heart of the country's economic woes. "The IMF has been essential in pushing the government toward a capitalist market economy," he says. "Much of the HDF program is accepted only under IMF pressure." A year ago, he notes, the HDF advocated a "third way between capitalism and socialism. It was the IMF that pressured them to abandon this idea."

But Andre Gunder Frank, of the University of Amsterdam, recently in Prague to discuss the debt crisis, and others dispute the contention that there is "no other alternative" than to suffer from austerity measures implemented under the yoke of debt. "Debts have come and gone for ages," says the expert on debt issues. He sees three ways in which Third World and East European debts could be reduced or eliminated. The first is to pay them back, the path taken by Romania's dictator, Nicolas Ceausescu, with its well-known consequences. The second avenue is to default, which many countries did in the 1920s and 1930s. Another alternative is for creditors to write debts down or forgive them entirely. This option is not without precedent. The Allies wrote off West Germany's remaining war debt at the 1948 London Conference. East Germany's domestic debt was simply taken over last year by West Germany.

The most dramatic breakthrough in this regard came in spring 1991, when the Paris Club, an informal grouping of the world's 17 leading industrial countries, announced that it would halve Poland's enormous debt and reduce accumulated interest by 80 percent. The creditor governments agreed that economic recovery for Poland was inconceivable without substantial debt reduction. Unlike Hungary and the other East European countries, an unusually high proportion of Poland's debt was owed directly to foreign governments rather than banks or multilateral agencies.

The decision, however, was no act of charity. The Western countries knew well that Poland had no prospect for full repayment. The wave of strikes and strike threats against the government's "shock therapy" dangerously jeopardized the reform process. The finance ministry finally convinced the IMF and member states that the population would not endure the crisis without greater support. As the London-based Economist warned, "Debt relief is a reward and an incentive, not a right ... When a company nears bankruptcy, creditors will reduce its debts only if they think doing so stands a chance of making the firm able to survive in the longish term and this to repay or service those debts that remain. It is the same with countries.... Debt relief could be--and was--made conditional on those reforms staying in place during the next four years."

The mechanism for that control is the gradual lifting of debt burdens. In the first phase of three years, 30 percent of the agreed sum of $33 billion will be dropped. A further 20 percent will go in 1994 if Poland's recently sealed pact with the IMF is deemed "successful," states the Paris Club communique.

Until then, Poland must haggle with the individual governments as well as private banks over the exact terms of reduction. Germany and Japan have put up the fiercest resistance. The "Polish precedent" piqued no one more than the German banks, which hold the lion's share of Poland's debt as well as that of many other East European countries. The United States' elimination of 70 percent of Poland's debt to U.S. banks upon President Lech Walesa's March visit raised a furor in Vienna and Frankfurt. "The whole $3.8 billion that Poland owes the USA is only a fifth of what the country owes little Austria," complained the Vienna daily Die Presse. "It will be difficult now to prevent a chain reaction [across Eastern Europe]."

Already, the "Polish precedent" has triggered the feared murmurs of dissent in Hungary. A leading politician's claim that the government was "split over asking for a debt reduction" unleashed a storm in the Budapest financial community. Politicians, bankers and experts rushed to deny the charge. "The government," a spokesperson reassured the press, "is fully united on the question of debt repayment."

Closing the third way

In the immediate aftermath of the 1989 revolutions, proponents of neo-classical free market reform were just one voice among many. From Berlin to Sofia, somewhat vague but nevertheless different ideas of "third ways," "social market systems" and "social ecological economies" were bandied about by the parties now in office. But the IMF moved fast to see that these alternatives never saw the light of day. In a spring 1990 brief on Eastern Europe policy, the IMF managing director wrote that "any attempts to find a third way between central planning and a market economy" must be ruled out. The debt trap ensured the IMF the leverage that it needed to encourage countries to follow a free-market trajectory. The results may please Western governments, bankers and industrialists, but the consequences have been devastating for the people of Eastern Europe, who, having earned a measure of political freedom, are finding themselves under the thumb of a new tyrant.

Paul Hockenos is the Eastern Europe correspondent for the Chicago-based In These Times.

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