Abstract
This paper reviews Romania’s experience with interenterprise arrears during 1991 with the purpose of extracting lessons that might prove useful for other economies in transition to market-based systems. The rapid growth of interenterprise arrears poses a serious policy problem in many of the transforming economies of Eastern Europe, as well as in the republics of the former Soviet Union. Among the more striking cases is that of Romania, where gross interenterprise arrears grew almost 18-fold (to about 50 percent of GDP) in only one year. This paper discusses the development of these arrears and the policies implemented by the authorities to try to resolve the problem.
The rapid growth of interenterprise arrears poses a serious policy problem in many of the transforming economies of Eastern Europe, a phenomenon that is now evident as well in the republics of the former Soviet Union.1 Undoubtedly, some part of these arrears can be considered “voluntary” credits, in the sense that they represent credit extended by one enterprise to another as part of normal business practice, much like trade credit is used in market-based economies. However, it is generally acknowledged that most of the arrears are involuntary, with enterprises simply not making payments to each other (or to the banks and government), and creditors unwilling or unable to enforce the due payments. Given the interlocking nature of enterprises in Eastern European countries—a legacy of the centrally planned system—such involuntary credits can rapidly balloon out of control, as they have in several of these countries.
Many reasons have been advanced to explain the phenomenon of interenterprise arrears in the transforming economies. They range from financial underdevelopment and credit market failures, which cause enterprises to assume banking-type functions (Begg and Portes (1992), Ickes and Ryterman (1993)); tight credit policies, which create a liquidity crunch (Calvo and Coricelli (1992)); lack of credibility of the government’s reform program (Rostowski (1992)); and the particular structure of industry in a command economy, which is based on chain links between enterprises (Daianu (1993)). It is clear that no one explanation dominates, and it would be fair to say that interenterprise arrears are due to a combination of factors, the relative weights of which vary from country to country.
If allowed to grow unchecked, interenterprise arrears can, as argued recently by Begg and Portes (1992), place the entire reform process in jeopardy. In particular, hard budget constraints are softened for enterprises, and relative price changes become less meaningful. As a result, enterprises continue to behave as in the past and the restructuring to conform to market realities is delayed. This delay in the structural transformation of the economy and the weakening of contract enforceability are perhaps the most important adverse effects of interenterprise arrears.
In addition, interenterprise arrears have significant macroeconomic consequences. First, arrears can undermine monetary control and thus limit the effects of tight credit policy on inflation and the balance of payments. More specifically, recourse to arrears to finance expenditures can lead to shifts in the demand for bank credit and in the income velocity of money, making it more problematic for the authorities to design and execute monetary policy. Second, interenterprise arrears can lead to inefficiencies in, and the eventual breakdown of, the payments mechanism, with obvious adverse effects on production and output. As enterprises bypass the banking system and arrears begin to reach a level they consider undesirable, cash transactions become more and more prevalent. This “cash-in-advance” constraint on transactions becomes binding and, if the authorities are unwilling to provide the needed currency, production begins to suffer.2 Finally, the arrears of state-owned enterprises represent a potential fiscal liability of the government. At some point in time, the government would have to cover these quasi-fiscal deficits, thereby affecting private sector behavior both now and in the future.
Since large-scale restructuring, involving closures and privatization, does not seem to be in the cards in the short run—indeed it is the absence of such restructuring that has caused arrears to emerge and grow as they have—the government has to find a solution. But it is very important that this solution not give rise to a moral hazard problem. A generalized “bailout” runs the risk of creating expectations of future bailouts, with enterprises having an incentive to run up arrears again. Of course the government could ignore the problem, letting it resolve itself over time as arrears eventually stop growing and some type of adjustment occurs, but this adjustment is bound to be disorderly. All enterprises, viable and nonviable alike, would suffer from the chain reaction of closures that would occur. Widespread production collapses and soaring unemployment would certainly create difficulties for the reform process. Thus, governments in the transforming economies are placed in the position of having to find an optimal solution that falls somewhere between the two undesirable extremes of a general bailout and doing nothing.
While the interenterprise arrears problem is evident in other Eastern European countries, the case of Romania during 1991 is perhaps the most striking.3 Gross interenterprise arrears grew almost 18-fold4—from lei 100 billion to nearly lei 1,800 billion—in a span of only 12 months, giving rise to many of the adverse consequences mentioned above: inflation was substantially higher and output much lower than had been expected at the beginning of 1991. Also, at the end of the year the authorities were forced to take actions to clear these arrears. This paper reviews the Romanian experience of 1991 with the express purpose of extracting lessons—both positive and negative—that might prove useful for other economies in transition.
I. Developments in Interenterprise Arrears
This section reviews the history of interenterprise arrears in Romania during the centrally planned regime and subsequently.
Practices Under the Centrally Planned Regime5
Under the strict system of central planning that operated in Romania until December 1989, the Government had virtually complete control over enterprise management and finances. The authorities also had complete discretion in determining the tax burden on individual enterprises. Thus, the distinction between whether state-owned enterprises—which covered virtually all means of production except for a small proportion of land cultivated by private farmers—were actually paying taxes or just transferring to government the profits that already belonged to it in its capacity as owner of the enterprises was not clear.
The tax burden of enterprises steadily increased during the 1980s as the Government needed to generate large fiscal surpluses as part of the policy to repay the external debt.6 As a result, enterprises were left with inadequate funds to finance current operations and investment, and often with substantial after-tax losses. These losses were financed by the extension of bank credit, but to the extent that these loans were unserviceable the quality of the banks’ balance sheets eroded. In addition, bank credit was typically extended to clear domestic payments arrears. Thus, under the centrally planned regime there were no interenterprise arrears as such. All arrears were to banks since they automatically provided credit to those enterprises that were unable to make their payments to other firms and creditors. The arrears, then, simply showed up as bad debts on the books of the banking system.
Developments Since 1990
From December 1989, policymakers in Romania have had to deal with the twin problems of bad debts of enterprises to banks and arrears with other enterprises.
Unserviceable Bank Loans
After the change of government in late 1989, the bad debts of enterprises to banks resulting from the practices of the centrally planned regime started being written off against government bank deposits from past fiscal surpluses. In this way, all enterprise bad debts from before 1989 and most from 1989 (a total of lei 265 billion) were eliminated. After government deposits were exhausted in mid-1990, lei 96 billion of bad debts from 1989 remained on the books of banks carrying a 0.5 percent interest rate. These credits were refinanced by the National Bank of Romania (NBR) at the same rate. Part of the debt (about lei 5 billion) was cleared in the last two months of 1990, leaving lei 91 billion of the bad 1989 debts (already refinanced by the NBR) with banks.
Enterprises realized further losses in 1990, some of which (especially in the mining and energy sectors and in the food industry) were covered by budgetary subsidies. The subsidies did not cover all enterprises, however, and lei 41 billion of 1990 losses was left. This balance was mostly covered by automatic bank credit (about lei 31 billion), as in the past. Thus, at end-1990, there were about lei 122 billion of enterprise bad debts to banks (lei 91 billion from 1989 and about lei 31 billion from 1990). In 1991, the amount of bad debts outstanding declined as enterprises were forced to clear their overdue bank debts using the proceeds from sales of revalued stocks.
In order to increase the effectiveness of credit policy and to ensure that the past losses of enterprises were not a burden on the financial system, the authorities decided to eliminate the remaining amount of 1989 and 1990 unserviceable bank loans from bank balance sheets with the issuance of long-term government debt instruments. This operation began in August 1991 and was formalized on February 5, 1992, when the Romanian Parliament approved Law 7, transforming 90 percent of these claims on enterprises into a special public debt account. The other 10 percent of the loans were charged off against banks’ profits. The sale of state assets and the recovery of outstanding claims of enterprises are to cover the principal and interest payments.
Interenterprise Arrears
Starting in late 1990, enterprise payments difficulties—in addition to the problem of bad debts to banks—appeared in the system. They were reflected in mounting interenterprise payments arrears, which on a gross basis at end-1990 reached an estimated lei 100 billion.7 As banks became more selective in granting credit, partly because of the tight credit policy implemented through bank-specific credit ceilings, enterprises started to run arrears among themselves as a way of financing current operations. By end-March 1991, interenterprise payments arrears reached an estimated lei 400 billion (see Table 1 and Figure 1),
Romania: Money, Credit, Interenterprise Arrears, and Industrial Production
(In billions of lei)
Index, December 1990 = 100.
Excludes the effect of the global compensation of December 1991.
Includes the effect of the global compensation of December 1991.
Romania: Money, Credit, Interenterprise Arrears, and Industrial Production
(In billions of lei)
| Period | Broad money | Credit to non government | Interenterprise arrears | Industrial productiona |
|---|---|---|---|---|
| December 1990 | 514 | 684 | 100 | 100.0 |
| January 1991 | 519 | 703 | 206 | 79.8 |
| February | 546 | 731 | 307 | 79.8 |
| March | 517 | 756 | 400 | 86.1 |
| April | 525 | 765 | 482 | 90.0 |
| May | 568 | 788 | 550 | 90.6 |
| June | 567 | 811 | 600 | 92.6 |
| July | 595 | 839 | 637 | 83.8 |
| August | 600 | 806 | 691 | 80.9 |
| September | 602 | 749 | 800 | 81.3 |
| October | 671 | 839 | 1.000 | 77.9 |
| November | 815 | 899 | 1,317 | 70.1 |
| December | 885b | 954b | 1,777b | 68.2 |
| January 1992 | 1,066c | l,312c | … | 69.8 |
Index, December 1990 = 100.
Excludes the effect of the global compensation of December 1991.
Includes the effect of the global compensation of December 1991.
Romania: Money, Credit, Interenterprise Arrears, and Industrial Production
(In billions of lei)
| Period | Broad money | Credit to non government | Interenterprise arrears | Industrial productiona |
|---|---|---|---|---|
| December 1990 | 514 | 684 | 100 | 100.0 |
| January 1991 | 519 | 703 | 206 | 79.8 |
| February | 546 | 731 | 307 | 79.8 |
| March | 517 | 756 | 400 | 86.1 |
| April | 525 | 765 | 482 | 90.0 |
| May | 568 | 788 | 550 | 90.6 |
| June | 567 | 811 | 600 | 92.6 |
| July | 595 | 839 | 637 | 83.8 |
| August | 600 | 806 | 691 | 80.9 |
| September | 602 | 749 | 800 | 81.3 |
| October | 671 | 839 | 1.000 | 77.9 |
| November | 815 | 899 | 1,317 | 70.1 |
| December | 885b | 954b | 1,777b | 68.2 |
| January 1992 | 1,066c | l,312c | … | 69.8 |
Index, December 1990 = 100.
Excludes the effect of the global compensation of December 1991.
Includes the effect of the global compensation of December 1991.
Romania: Broad Money, Interenterprise Arrears, and Consumer Price Index
Citation: IMF Staff Papers 1993, 002; 10.5089/9781451973259.024.A009
Sources: Romanian authorities and IMF staff estimates.Romania: Broad Money, Interenterprise Arrears, and Consumer Price Index
Citation: IMF Staff Papers 1993, 002; 10.5089/9781451973259.024.A009
Sources: Romanian authorities and IMF staff estimates.Romania: Broad Money, Interenterprise Arrears, and Consumer Price Index
Citation: IMF Staff Papers 1993, 002; 10.5089/9781451973259.024.A009
Sources: Romanian authorities and IMF staff estimates.The growth of arrears accelerated sharply in the second half of 1991, primarily because of two factors. First, price increases resulting in part from the elimination of price controls and the removal of subsidies were much higher than projected, while credit expansion through September was kept on target (consistent with the lower projected rate of inflation). Real credit thus declined far more than had been envisaged and enterprises came under considerable strain. Second, from about midyear it became increasingly evident that the Government would need to arrest the progressively deteriorating economic situation. Output continued to fall, and its slide was partly attributable to the so-called blockage of the payments system brought about by interenterprise arrears (see Table 1).8 In July, for example, industrial production fell by nearly 10 percent, and again in August by another 3.5 percent. Enterprises were very vocal at the time in blaming the financial payments blockage for these developments and began pressing hard for a resolution. Thus, a bailout looked likely, and by September-October the issue was even being discussed in Parliament. Enterprises therefore had an incentive to increase arrears further, and did so in the expectation that they would receive government assistance to cover their debts.
On a gross basis, arrears rose to lei 1.777 billion at end-1991, representing about 50 percent of GDP valued at December 1991 prices. Net arrears—the amount of payments owed by net debtor enterprises to net creditor enterprises, plus arrears to the state (largely for tax payments)—were lei 426 billion at end-1991.9 (The tax arrears amounted to about lei 40 billion.) The growth of gross interenterprise arrears closely matched the rise in the consumer price level during 1991 (Figure 1). Indeed, it appears that the arrears were implicitly indexed to the price level, in that when creditor enterprises were not paid on time they would rebill the debtor enterprises at the new, higher prices.
Reflecting a tight monetary policy stance, broad money grew by 17 percent through September 1991, while bank credit to the nongovernment sector grew by 10 percent (inflation was 132 percent over the period). Starting in October, however, the NBR began to allow an expansion of bank credit to enterprises to reduce the problem of interenterprise arrears, and bank-specific credit ceilings were suspended. Through December 1991, broad money grew by 71 percent and credit to the nongovernment sector grew by 40 percent (compared with a cumulative inflation of 223 percent). At end-1991, gross interenterprise arrears were equivalent to 208 percent of broad money and 194 percent of credit to the nongovernment sector.
The income velocity of broad money rose from about 1.8 in 1990 to 4.0 in September 1991 before falling back to 3.7 in December 1991 (Figure 2). Interenterprise arrears were, of course, also liquidity being provided to the system in addition to the normal money supply. The effects of the additional liquidity can be judged by adding interenterprise arrears to broad money. The ratio of GDP to the sum of gross interenterprise arrears and broad money was 1.2 in December 1991 (Figure 2). A similar calculation using net interenterprise arrears yields a value of 2.5, which is close to the average velocity observed during the early 1980s and considered to be “normal” velocity.
Romania: Income Velocity of Money, 1980-91
Citation: IMF Staff Papers 1993, 002; 10.5089/9781451973259.024.A009
Sources: Romanian authorities and IMF staff estimates.a Monthly data for 1991.Romania: Income Velocity of Money, 1980-91
Citation: IMF Staff Papers 1993, 002; 10.5089/9781451973259.024.A009
Sources: Romanian authorities and IMF staff estimates.a Monthly data for 1991.Romania: Income Velocity of Money, 1980-91
Citation: IMF Staff Papers 1993, 002; 10.5089/9781451973259.024.A009
Sources: Romanian authorities and IMF staff estimates.a Monthly data for 1991.II. Policies to Control and Clear Interenterprise Arrears
To combat the interenterprise arrears problem, a series of selective measures was considered and adopted starting in May 1991, culminating in a generalized scheme, termed “global compensation,” in late December 1991.
Early Attempts
To reduce the interenterprise arrears problem, on May 8, 1991, the NBR opened a refinancing line of lei 15.5 billion for banks, which were instructed to extend credit to net debtor enterprises. These credits were extended through special accounts, so that the banks could ensure that the credits were used solely for the clearance of arrears. The operation was to last through June, by which time banks were to have closed the special accounts and repaid the lei 15.5 billion to the NBR. In the two weeks following the scheme’s introduction, lei 10.5 billion of credits were extended to enterprises. The operation did not work as expected, however. About lei 65 billion of gross arrears were cleared by end-June, but the special NBR credits—plus an additional lei 5 billion extended through the same special accounts in June—were not repaid as planned. In effect, the arrears shifted from the enterprise sector to the banking system and ultimately to the NBR. By the end of June 1991, gross interenterprise arrears had reached an estimated lei 600 billion.
In July, the authorities developed another plan to clear interenterprise arrears. The new scheme aimed to cover all losses and arrears through bank credit refinanced entirely by the NBR and extended through special accounts. After banks recorded all enterprise claims against each other (a process that was to be completed by end-July), they were to extend as much credit as necessary to enable all enterprises to service the claims against them through a special “compensation” account. The settlement of interenterprise claims was to take place in the first two weeks of August. By August 15, all enterprises were to have no claims outstanding against each other. As a result, some would hold a net creditor position in their compensation accounts with banks; others would hold a net debtor position. By August 28, banks were to close the compensation accounts by consolidating them with the current accounts of enterprises. Net creditor enterprises would then find their overall bank debt reduced by the amounts available to them in their compensation accounts, whereas compensation credit extended to net debtor enterprises would be reclassified as regular credit, and normal interest rates would apply. It was estimated that clearing the interenterprise arrears through this scheme would require a net infusion of credit on the order of lei 150-300 billion.10
The authorities decided not to implement the scheme, however, until more accurate estimates of the size of interenterprise arrears were available. The NBR was instructed to collect data on gross interenterprise arrears and to reconcile them with independent estimates from the Ministry of Industry (which were substantially smaller). It was then to estimate the net position of the enterprise sector vis-à-vis the banking system and the Government, as well as to identify the “worst offenders”—those enterprises with large net debtor positions. Once this information was available, the NBR was to determine the amount of bank credit needed for the operation. Moreover, the compensation scheme was to be combined with the closing down of insolvent enterprises.
A scaled-down version of the arrears-clearing scheme was implemented in late August 1991. Affected enterprises deposited 10 percent of their current receipts into a special account, which was used to clear overdue payments between enterprises.11 These deposits, together with certain payments by the Government and very short-term credits extended by banks, were used to clear about lei 150 billion of gross interenterprise arrears. However, the authorities estimated that arrears continued to rise, so that the balance of gross arrears at the end of September was about lei 800 billion. In the authorities’ view, the operation was not a success because it was basically a voluntary operation on the part of enterprises and the net amount of credit that was injected into the system was considered too little.
Global Compensation
On December 23, 1991, Parliament passed Law 80 calling for a generalized expansion of bank credit to clear all interenterprise arrears. This operation, termed “global compensation,” was completed on January 27, 1992, Under the global compensation scheme, enterprises were asked to list their arrears to other enterprises and to the state, and banks were instructed to expand credit, carrying a government guarantee, to clear the gross amount of interenterprise arrears.12 The initial bank credit extended under the scheme was lei 1,777 billion. All payments under the scheme were made as overdrafts from special “compensation accounts,” and the same accounts were also debited with the payments received by enterprises. Thus, the gross amount of credit extended was automatically transformed into the net amount. The net amount of arrears—lei 426 billion—was retroactively reflected in bank balance sheets as of end-December 1991. Of the net credit extended under the global compensation scheme, only lei 163 billion was refinanced by the NBR at the normal refinance rate; the rest was financed by banks out of deposits. The compensation credits had a six-month maturity with interest rates at market levels.13 Because many enterprises that were net creditors to other enterprises were net debtors to the banking system, much of the net credit extended under the scheme went initially toward reducing overdrafts with banks.
Some enterprises—mostly agricultural cooperatives—chose not to participate in the scheme since they were receiving, in effect, an interest-free loan in the form of arrears. It is believed, however, that the number of debtor firms that refused to participate in the global compensation was small, and all large enterprises participated in the scheme. As a result, almost all known interenterprise arrears were eliminated.
Following from the global compensation operation, the money supply increased by an additional lei 149 billion in December to reach lei 1,033 billion by year end. Thus, the increase in broad money over the year was 99 percent. Also, through end-December, the net domestic assets of the banking system increased by lei 522 billion. The rise in prices over the year was 223 percent, compared with a projected increase of 105 percent.
Resolving the Liquidity and Moral Hazard Problems
The first order of business after the global compensation scheme had been completed was to sterilize the injection of liquidity to prevent an upsurge of inflation. In February 1992, the authorities introduced a 10 percent reserve requirement on deposits in the banking system. This move was followed by additional measures, including requiring some enterprises and banks to repay certain credits that had not yet matured and requiring importers to make payments to cover letters of credit that had been guaranteed by the Government. As a result of these sterilization measures, the money supply rose by only 4 percent from December 1991 through April 1992 in the face of cumulative inflation of 54 percent. Bank credit to the nongovernment sector declined by 6 percent over the same period.
Although controlling the expansion of liquidity was necessary, the moral hazard problem was the more serious consequence of the global compensation. At issue was how to convince enterprises that there would be no future compensations and that the Government was determined to control interenterprise arrears. Toward this end, the authorities instituted a system to monitor arrears and introduced legislation designed to control the arrears.
As part of a general reporting system established in 1991, all of the 6,000 state-owned enterprises are required to provide the Ministry of Economy and Finance with operating accounts on a monthly basis, balance sheets on a quarterly basis, and more detailed accounts annually. This reporting system was expanded in 1992 to cover arrears. The buildup of new arrears is now reported on a monthly basis for domestic suppliers (interenterprise arrears), foreign suppliers, other credits (including wage arrears), and foreign services (such as freight charges). Overdue payments to domestic suppliers are reported in three categories: more than 30 days overdue, more than 90 days overdue, and more than one year overdue. Information on arrears on loans to banks is reported monthly by commercial banks through the NBR. With these reporting systems in place, the authorities have up-to-date information on the financial position of each enterprise, including any arrears, and thus can take selective action against those enterprises running arrears.
Possible actions are spelled out in a new law on enterprise financial discipline (Law 76).14 This law specifies the procedures to be followed by all enterprises irrespective of their form of ownership. The more salient items in the law include the following:
i. Economic agents with overdue payments obligations that remain unsettled for more than 30 calendar days after the due date shall be considered insolvent. Payments insolvency must be communicated to the debtor by any creditors, including the state, after the period of 30 days has expired (Article 9).
ii. Following a court decision confirming insolvency, creditors can take action to “liquidate” the unsettled claims they have on their debtors. Economic agents having unsettled claims shall be sued and subjected to “forced” payment or the sale of their assets in the following order: monetary means, including deposits in banks; inventories of raw materials and finished products; claims and fixed assets; and other estate items (Article 10).
iii. The list of economic agents declared insolvent shall be made public (Article 12).
As passage of Law 76 by Parliament took considerably longer than expected, the Government adopted two decisions (Decision 82 and Decision 162) to enforce the provisions of the new law. Under these decisions, if enterprises are unable to reach agreement on overdue payments, creditors can initiate bankruptcy proceedings against debtors under the provisions of the existing commercial code, with the Government actively involved in the process. The largest and most important arrears problems can be considered by the Cabinet, which can decide on measures to be taken against the defaulting enterprise—including accelerated privatization, full or partial liquidation, directed labor shedding, financial restructuring, and management changes. The Government also launched a public campaign to convince enterprises that arrears are to be avoided and no further bailouts are likely.15
The delays in the passage of the law on financial discipline, and more fundamentally the inability and unwillingness of the Government to move forcefully and quickly to improve the financial discipline of enterprises, meant that the moral hazard issue was not resolved. Enterprises continued to behave largely as before, presumably confident that the Government would do nothing drastic in terms of closures or downsizing and that there was every likelihood of future bailouts. Arrears, therefore, grew once again in 1992, although at a somewhat slower pace as compared with the previous year. By December 1992, gross interenterprise arrears were approximately lei 1.9 trillion (20 percent of GDP valued at December 1992 prices). This time, however, the Government has not contemplated any kind of global compensation and has made public statements to this effect. Also, in mid-1993, the Parliament passed an amendment to Law 76, which would impose interest penalties on overdue obligations and establish an expedited judicial procedure to enable creditors to obtain payment. Nevertheless, the question of how to resolve the stock problem of existing arrears and the flow problem of new arrears is again confronting the Government. More generally, changing the culture of nonpayment, which was pervasive in 1991 and continued through 1992, remains the major task for the Romanian Government.
III. Conclusions
Transforming the enterprise sector in Romania, as in other formerly centrally planned economies, has proved a much slower process than originally expected. Three years into the reform effort, a network of large state-owned monopolies still dominate the economy. The downsizing, restructuring, technological upgrading, and reorienting required of Romania’s production sector remain to be done.
One of the major fallouts of the slow transformation was the phenomenal rise in interenterprise arrears in 1991. Enterprises, faced with a new environment in which banks were no longer willing to supply credit passively, in effect created their own means of payment. Running arrears became a substitute for bank financing, with obvious adverse implications for the stabilization effort. Output eventually suffered as the payments system became progressively inoperative and cash transfers became the principal means of settlement.
The global compensation scheme implemented by the Government at the beginning of 1992 was successful in clearing most of the interenterprise arrears and thus in unblocking the payments system. The particular way this scheme was designed minimized the net injection of liquidity into the economy, and even that liquidity was largely sterilized by the authorities. All in all, the monetary consequences of the operation were fairly small relative to the size of the gross interenterprise arrears. To combat the moral hazard consequences of the global compensation scheme, the Government introduced a new law that laid out specific procedures for controlling any future interenterprise arrears and thus the need for any further compensation operations. The provisions of this law, however, have yet to be effectively implemented, and the problems with arrears remain,
A permanent solution to the problem of interenterprise arrears must involve the restructuring and privatization of state-owned enterprises. The Government of Romania is proceeding in this direction. It has selected a number of major enterprises for restructuring, primarily in the chemical, metallurgy, and machine-building sectors, and is implementing the Law on Privatization, which was passed in 1991. Under the law, “vouchers” for 30 percent of the share capital of enterprises were distributed in 1992 to Romanian citizens. Further, the State Ownership Fund (which holds the Government’s 70 percent share) and the National Agency for Privatization are responsible for developing the privatization strategy with the aim of promoting a more competitive industrial structure through enterprise restructuring.
Jointly, the restructuring and privatization plans are expected to restore the financial health of enterprises in Romania. Once they are achieved, and the appropriate legal framework established and operative, the interenterprise arrears problem will presumably take care of itself, as in Western economies (Begg and Portes (1992)). This is not to suggest that government-sponsored bailouts will never occur. Even in the most developed market economies, governments have needed to intervene financially to support financial sector institutions and other large enterprises. This intervention has been selective rather than industry wide, however, and can be rationalized on a variety of grounds.
The Romanian experience of 1991 with interenterprise arrears and the attempts to resolve the problem have lessons for other countries that bear spelling out.
The problem of interenterprise arrears is a serious one; if not addressed, arrears can explode and create serious difficulties for the stabilization and reform efforts. As the owner of the enterprises running arrears against one another, the state has a direct responsibility to intervene; it cannot take a hands-off approach.
However, once the government has decided on a course of action to resolve the arrears situation, it should proceed rapidly to implement the chosen measures. Public discussion over an extended period of time, as the Romanian experience shows, creates obvious incentives for enterprises to run larger arrears.
The selected scheme should aim to clear most or all arrears or it should not be undertaken at all. Too limited a scheme will leave the problem unresolved and set up expectations of further extensions and repetitions.
In any scheme to eliminate arrears, the monetary consequences of the operation must be taken into account. It must also be clear who is to pay for the operation—enterprises, the banking system, or the budget. Otherwise, behavior will not change, as each group will expect the others to bear the cost.
The scheme also must be designed so that credits are extended only toward the clearance of arrears and so that there are no leakages. The use of special compensation accounts in the Romanian operation prevented enterprises from using credits to finance current expenditures and make wage payments.
To minimize the moral hazard problem, a method of ensuring that arrears do not reappear must be adopted in conjunction with any chosen scheme. Closing down a large, nonviable enterprise may provide an important signal of the government’s commitment to enforcing financial discipline. This step has proven extremely difficult in all transforming economies, however. Nonetheless, some way must be found to demonstrate that the government’s statements about future bailouts are credible.
The government will have to take the lead in initiating bankruptcy proceedings against defaulting enterprises. Experience has shown that banks and other creditors are highly unlikely to take debtor enterprises to court. Regardless of the fact that the state owns the enterprise, the government must become involved anyway when it comes to enterprises considered “too big to fail,” In Romania, for example, past policies have emphasized the geographical dispersion of enterprises, leaving many towns hostage to the fortunes of one or two large enterprises. Liquidation of these large “Kombinats” would cause serious unemployment and severe regional distress, making government intervention necessary anyway.
Ultimately, privatization is the solution—the faster this occurs, the faster arrears will disappear. In a largely private system, interenterprise credits will be part of normal business, and overdue payments will be handled appropriately through the legal system.
REFERENCES
Begg, David, and Richard Portes, “Enterprise Debt and Economic Transformation: Financial Restructuring in Central and Eastern Europe” (unpublished; Centre for Economic Policy Research, 1992).
Borensztein, Eduardo, Dimitri Demekas, and Jonathan D. Ostry, “An Empirical Analysis of the Output Declines in Three Eastern European Countries,” Staff Papers, International Monetary Fund (March 1993), pp. 1 —31.
Calvo, Guillermo, and Fabrizio Coricelli, “Stabilizing a Previously Centrally Planned Economy: Poland 1990,” Economic Policy, Vol. 14 (1992), pp. 176 –226.
Daianu, Daniel, “Inter-Enterprise Arrears in Post Command Economy: Thoughts from a Romanian Perspective” (unpublished; International Monetary Fund, 1993).
Demekas, Dimitri, and Mohsin S. Khan, The Romanian Economic Reform Program, Occasional Paper No. 89 (Washington: International Monetary Fund, 1991).
Ickes, Barry W., and Randi Ryterman, “Inter-Enterprise Arrears and Financial Underdevelopment in Russia” (unpublished; International Monetary Fund, 1993).
Rostowski, Jacek, “The Inter-Enterprise Debt Explosion in the Former Soviet Union: Causes, Consequences, Cures” (unpublished; International Monetary Fund, 1992).
Eric V. Clifton, Deputy Division Chief in the European I Department, holds a doctorate from Indiana University.
Mohsin S. Khan, Deputy Director of the Research Department, is a graduate of Columbia University and the London School of Economics and Political Science.
The authors are grateful to Daniel Daianu, Luis Mendonca, and Erik Offerdal for helpful discussions and comments.
See, for example, the studies by Begg and Portes (1992) for Czechoslovakia, Daianu (1993) for Romania, Ickes and Ryterman (1993) for Russia, and Ros-towski (1992) for Poland and Russia.
Although lack of credit may be a factor in the decline in output, as argued by Calvo and Coricelli (1992), arrears can compensate for this, at least partially. Eventually, however, it is the lack of currency that becomes the relatively more important factor.
In many respects, as argued by Rostowski (1992), the Romanian situation is more akin to that of Russia than to the other Eastern European cases of Czechoslovakia and Poland.
Gross arrears are the total stock of arrears before netting out bilateral and multilateral payables and receivables.
For details of economic developments and policies during the pre-reform period, see Demekas and Khan (1991).
This tax came to be known as the “Ceaucescu tax.”
No information is available on interenterprise credits as distinct from arrears. Starting in late 1990 direct payments between enterprises stopped being documented by the banking system.
As mentioned earlier, cash transactions became more prevalent. For example, the ratio of currency to deposits rose from 20 percent in January to 32 percent by September-October. For a discussion of the factors behind the decline in output, see Borensztein, Demekas, and Ostry (1993).
Historically, net arrears have been approximately 20-30 percent of gross arrears.
Gross interenterprise arrears were estimated at the time to be around lei 600-700 billion (Table 1).
The affected enterprises covered all but 100 of the some 6,000 enterprises in Romania.
Basically Law 80 was closely related to the July scheme that had been considered and then rejected by the Government.
It is worth noting in this regard that at end-1992 some of these credits were still outstanding.
The full title of the new law is “Concerning Measures to Reimburse Credits Extended in Connection with the Global Compensation Operation, to Introduce a New Regime of Payments for Economic Agents, to Prevent Payments Insolvency and Financial Blockage.” It was enacted on July 16, 1992.
In addition, a World Bank Structural Adjustment Loan also puts a condition on the level of arrears for second-tranche release—the ratio of arrears of state-owned enterprises to state-owned enterprise turnover should not exceed 7.5 percent. Since turnover is approximately twice nominal GDP, this condition would imply that gross arrears could not exceed 15 percent of GDP (as compared with 50 percent of GDP in 1991).
