This paper was prepared for the Vienna Institute for Comparative Economic Studies Workshop (Vienna, November 21-25, 1993) on “Transformation of the Eastern European Economies 1989-1993: Critical Assessments and Ways out of the Crisis”, We are grateful to Gérard Bélanger, Adrienne Cheasty, Ajai Chopra, Fabrizio Coricelli, Eduard Hochreiter, Mark Lutz, Donald Mathieson, John Odling-Smee and Mark Stone for helpful comments and suggestions, and to Nadine Orosa for excellent research assistance.
In Poland, for instance, private sector share of GDP increased from under 30 percent in 1989 to nearly 45 percent in 1992, while in former Czechoslovakia and Hungary respectively, the share increased from under 5 percent to 20 percent, and from 39 to 45 percent. (See Schwartz et al 1993).
In Poland, while there has been a proliferation of private banks, they collectively account for a very small share of banking activity.
Equivalently, one can think of production occurring at time t, when labor has to be paid, but sales revenues do not accrue until time t + 1.
For the time being, we will assume that firms intend to honor their contractual obligations.
Thus, the informal sector may not appear to be an adequate way of modelling the emerging private sector in these economies, since the latter is supposed to be more efficient than traditional enterprises. However, in the context of the present model, since the informal sector is more labor intensive, labor productivity might fall (even though total factor productivity might increase).
Under this interpretation, total output should also include output from the informal sector. However, given the productivity differentials between the formal and informal sectors pointed out above, output as given by equation (4) is positively correlated with the all-inclusive output measure (which includes informal-sector output).
Russia has recently been the paramount example of trying to employ the inflation strategy to prop up output, with no visible success.
This discussion has disregarded the fact that the existence of positive government subsidies to enterprises implies that firms will now exhibit positive profits. The latter would help to relax the liquidity constraint in future periods. This topic will be picked up in Section IV.
Although massive default may be counterproductive for enterprises, the individual firm may still find it optimal to default. This is so because the price level is determined by the market, not by the individual firm. The latter takes prices as given by the market, and in that context failing to repay bank debts adds to the firms’ liquidity and ability to employ labor. This rationalizes the possibility that atomistic firm behavior may result in massive default on bank credit, even though, at the end of the day, no firm benefits from such action.
This issue is discussed in detail in Section VI below where additional constraints on bank lending to firms are discussed. Here notice that even if, in principle, banks are capable of “riding the storm,” they would run against bank regulations. Experience shows that banks are likely to try hiding their “bad” loans from the regulator, but they are eventually caught (by the regulator or by reality).
In Poland in 1990 and the former Czechoslovakia in 1991 enterprise profits were artificially inflated by the revaluation of inventories, and, as there was little or no inflation adjustment in the profits tax, most of these paper profits were transferred to the government. As Schaffer (1992) shows, about half of the swing in Poland’ budget position, from a surplus of 3 percent of GDP in 1990 to a deficit in 1991 of over 5 percent of GDP, was accounted for by the fall in profit taxes (due in large part to a decrease in the inflation bias).
Even where the public can directly subscribe to government bonds, as for instance in Hungary, the share of government securities in total household savings remains very small.
In Russia too, similar factors have led to the banks keeping a large proportion of their assets liquid, but in the form of holdings of US dollars (see Easterly and da Cunha (1993)).
Quite apart from the distributional concern, there is a concern about the sustainability of current saving rates, especially given that some of the factors underlying the initial increase in private saving may now be waning. (See, for instance, Gomulka 1993).
The data for Hungary in Chart 3 are adjusted for various credit consolidations and changes in classification which inflated outstanding credit to government.
Section VI below provides some impressionistic evidence on the positive relationship between the lack of availability of credit and declines in output in Poland in 1992, consistent with the evidence provided for an earlier period by Calvo and Coricelli (1993).
The irony here is that barely a year or two ago, the development of government securities markets was regarded as likely to bestow significant benefits for financing fiscal deficits. (For a discussion of the issues, see Calvo and Kumar 1993).
There is by now a considerable literature on the portfolio problems of banks, and the policies which have been, or should be, adopted to deal with them. In addition to Calvo and Kumar (op.cit.), see Fries and Lane (1993), and Varhegyi (1993).
The difficulties in accurately assessing the bad loan problem arise, in part, from inadequate information about the current and prospective performance of enterprises, as well as simply inadequate bank auditing procedures.
It is worth noting that a substitution of bad loans for government bonds may not necessarily have any short-run implications for liquidity to the enterprise sector (banks would now receive interest which they may then use to buy more bonds) but it would have significant fiscal implications in the long-run.
The plan aims to increase capital to asset ratios for large banks to 12 percent or more. In addition to the bond issue, the plan may also draw on the $1 billion stabilization fund originally instituted in 1990 by bilateral donors.
For a discussion of issues relating to the role of equity markets in FSEs, see Brainard (1991), Borensztein and Kumar (1992), and Calvo and Kumar (1993). For a discussion of the issues relating to the importance of equity markets in developing markets see, for instance, Singh and Hamid (1992).
The important exception in this regard is the Czech stock market where since June 1993 shares have been traded in a large number of companies following their privatization through the voucher schemes.