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.
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.
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).