Approaching Convertibility in Eastern Europe and the Soviet Union

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Approaching Convertibility in Eastern Europe and the Soviet Union

The most important event in Europe, perhaps in

the world since World War II is what is happening

in Eastern Europe, which is unravelling

before our very eyes.

Francois Mitterrand October 24, 1989

Introduction

Eastern Europe and the Soviet Union have been in the headlines of American newspapers, magazines, and scholarly journals almost without cease since the beginning of the 1980s. The year 1989 will be remembered as the time when one Communist regime after another fell from power in a dramatic "people's revolution." What do the economic and political reforms occurring in Eastern Europe and the Soviet Union mean for U.S. business people? What do the prospects for convertibility of Eastern European and Soviet currencies mean for U.S. exporters and multinational corporations? In particular, they mean: (1) a de-emphasis on counter-trade, a form of bartering to exchange product for product and (2) an assurance that letters of credit will be paid upon submittal without having to be subjected to unusual delays.

Problems associated with black market currency transactions would be eliminated through the eventual full convertibility of Eastern European and Soviet currencies. The devaluation of these currencies to real market levels most likely will make U.S. exports to these countries more expensive in the short term until the convertibility situation stabilizes and the currencies reach their unsubsidized market level.

Joint ventures may be a means superior to direct exports to penetrate the markets of Eastern Europe and the Soviet Union. United States firms simply are not successful in competing for their fair share in these markets, dominated by Austria, Switzerland, the United Kingdom, and West Germany. In fact, West Germany, with its exceptionally strong deutsche mark, its reunification and currency union with East Germany, and its historical and commercial ties in the East, may benefit the most from the long term economic potential in Eastern Europe.

Hungary

Hungary has been at the forefront of economic reforms in Eastern Europe since the early 1970s. Since the arrival of Mikhail Gorbachev on the scene in 1985, the Hungarians have increased their economic overtures by encouraging private entrepreneurs and a small but energetic stock market. For a truly dynamic indication of the willingness of the Hungarians to reform their system, one had to look only at the faces of 18,000 East Germans who used Hungary as a conduit to freedom in the West during one week in September 1989, when Hungary dismantled its Iron Curtain bordering Austria. Also in 1989, the Hungarian Communist Party became the Hungarian Socialist Party; Hungary was declared a republic; and the Hungarian parliament authorized the formation of independent political parties that competed in parliamentary elections in March 1990. However, Hungary's foreign indebtedness of $20 billion is the highest per capita in Eastern Europe, and this debt could act as a long term, negative drag on Hungary's economic reforms.

The principal aims of the Hungarian economic reforms are the creation of additional performance incentives, the adaptation of domestic prices to world market conditions, and a greater decentralization of economic decision making. At the beginning of 1987, Hungary reformed her banking system. The National Bank of Hungary is now to concentrate on central banking, having previously combined these functions with commercial operations. It has at its disposal the monetary instruments used in Western countries, including powers of refinancing, the setting of interest rates, minimum reserve ratios, and open market operations. It also remains responsible for controlling foreign exchange movements.

Since January 1988, all economic enterprises in Hungary have been permitted to carry out foreign trade in convertible currencies after having registered with the Ministry of Trade. …