Academic journal article Business Economics

Overview of East Europe's Debt: The Evolution of Creditworthiness in the 1980s

Academic journal article Business Economics

Overview of East Europe's Debt: The Evolution of Creditworthiness in the 1980s

Article excerpt

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Prior to 1989 only three countries in Eastern Europe were forced to reschedule their external debt; the other countries retained access to the international credit markets. U.S. banks were quite active in lending to Eastern Europe in the 1970s, but lending reversed after 1980 due to deteriorating credit conditions, slim profit margins and limited trade with the U. S. By contrast, West Germany and japan expanded their lending dramatically. Future bank lending strategies will depend on the perception of worsening credit risk due to political change and the increasing role of western governments in trade and financial relations. Unless economic reform accompanies political reform, western direct investment in Eastern Europe will be limited.

THE TOTAL FOREIGN debt of Eastern Europe, including the Soviet Union and Yugoslavia, is estimated to have grown from $95 billion at the end of 1981 to $146 billion at the end of 1988. Preliminary data for 1989 indicate a further rise in indebtedness to approximately $158 billion. In order to provide a perspective on the burden represented by such debts, Table I presents data on the net-debt-to-export ratio for each country, along with comparisons with China and fifteen highly indebted countries.

The debt-to-export ratio is a convenient measure of a country's total debt, net of hard currency reserves, compared with the country's earnings from sales of exports and services for hard currencies that are available to service the debt. As a rule of thumb, any ratio over 2.0 indicates an excessive debt burden (with a high probability of default and rescheduling), while a ratio below 1.0 indicates a modest debt burden. In order to draw any overall judgment on creditworthiness, however, these data must be supplemented with other information on a country's domestic economic policy and performance.

DEBT RESCHEDULING IN THE 1980s

During the period prior to the 1989 political upheavals in Eastern Europe, three countries were forced to reschedule: Poland in 1981, Romania in 1982 and Yugoslavia in 1983.

Poland was unable to generate sufficient foreign exchange to service the interest on its rescheduled debt after 1981, and as a result its total debt rose from $25 billion to $38 billion as interest arrears (primarily to government creditors) accumulated and were converted (after considerable delay) into new loans. Although interest service on debt owed to commercial banks continued current until September 1989, when the new Solidarity-led government defaulted on these obligations, only a few new trade-related credits from banks were forthcoming.

In spite of the Polish economic reform program introduced on january I of this year, banks do not view Poland as creditworthy. For this reason, the prospect of new bank lending in the foreseeable future is slim. The key issue with regard to the bank debt is whether a Brady-type debt reduction agreement is feasible. In negotiations earlier this year with the Bank Advisory Committee for Poland, Polish authorities proposed a buy-back of the bank debt at about 17 percent of par, or near the price of the debt in the secondary market. Because banks account for less than 25 percent of the total debt, any agreement along the lines of Mexico's debt reduction bonds would have to be accompanied with comparable debt reduction from official creditors, who hold the bulk of the debt. And, inasmuch as Poland expects to achieve a current account surplus of as much as $2 billion in 1990, most banks believe Poland could afford to pay the banks substantially more than is being offered. European banks, especially German banks, may be expected to take the lead in discussions with Polish authorities on these issues.

By contrast, Romania ran current account surpluses during the 1983-88 period and paid down its debt, reducing total debt from over $11 billion to under $2 billion and eliminating all long-term loans owed to commercial banks. …

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