Abstract
Real bank credit in Eastern European countries after their recent stabilization programs is shown to have fallen sharply, except in the case of Hungary. The meaning of the fall is discussed from the present value and liquidity perspectives. Moreover, it is shown that the hypothesis that the output contraction may partly owe to a credit contraction cannot be ruled out. The hypothesis is tested on a sample of 85 branches of industry in Poland. Also analyzed are the rationale for expecting a connection between credit and output and the policy options available to mitigate the liquidity crunch in postsocialist economies.
The collapse of output in Eastern Europe after the implementation of the recent economic transformation programs has greatly exceeded expectations. The basic view presented in this paper is that a large proportion of the fall in output can be explained by “trade implosion”: a situation in which trade is destroyed for lack of market institutions not simply as a consequence of textbook changes in relative prices or movements “along transformation frontiers.” The trade implosion view is relevant for explaining the collapse of both domestic and international trade (particularly trade among countries that belonged to the Council for Mutual Economic Assistance, or CMEA) and ultimately some part of the collapse in output.
We single out the credit market as one of the key underdeveloped institutions in Eastern European economies. We advance the hypothesis that the fall in output associated with monetary contraction may be significant when credit markets are underdeveloped. The conjecture that credit contraction may partly explain the output decline is examined for the cases of Bulgaria, Czechoslovakia, Hungary, Poland, and Romania, with special reference to Poland. Although results are highly tentative, we show that the credit hypothesis cannot be dismissed out of hand. On the contrary, statistical analysis for the case of Poland suggests that at least 20 percent of the output decline, during the first quarter of the stabilization program, can be attributed to the initial credit contraction.
I. Role of Credit: Basic Issues
In a centrally planned economy (CPE), bankers are a mixed breed of accountants and public notaries. They extend credit to firms in order for the firms to buy inputs to fulfill a program’s targets, and they take deposits from firms and individuals. Bank transactions are dutifully recorded, thus providing central planners with additional information about the flow of real transactions. Furthermore, since as a general rule banks’ management is kept separate from that of firms, banks’ incentive for hiding information from the central planner is low, which enhances their role in the program’s supervision mechanism (see Garvy (1972)).
By contrast, banks’ role in screening financially viable firms from nonviable ones is relatively minor, if at all relevant. Firms, as well as banks, are state owned. Therefore, managers have no control over firms’ revenues, let alone their profits. The central authority, for example, could confiscate a firm’s entire revenue from sales, making such firms technically bankrupt and unable to repay their bank debts. This poses no obstacle to the normal operation of firms, however, because next period the firm will get new bank credit to buy new inputs. Banks continue to lend because they are ordered to do so. And they can actually do so because loans are produced with negligible amounts of “real” inputs. In particular, the creation of new bank loans does not require previous loans to be served. Consequently, in CPEs, firms’ creditworthiness is taken for granted as long as managers comply with the dictates of the central program. Little firm-specific information needs to be collected by the bank extending credit, since no firm-specific collateral is involved in the credit transaction.
Evolution of Reform
Since the early 1980s, CPEs like Poland and the former Soviet Union gave enterprises more freedom with their profits. Firms became able to use their net profits (1) to accumulate fixed capital and inventories (occasionally composed of durable consumption goods for their workers, like imported freezers), (2) to hold bank deposits (including foreign exchange deposits), (3) to lend to other firms (interenterprise credit), and (4) to pay bonuses to their workers. As a counterpart, credit was less automatically granted and banks started to pay closer attention to the debtor firm’s collateral. This system—here called a “reformed centrally planned economy” (RCPE)—inherited many of the characteristics of the centrally planned economy. In particular, although managers and workers had greater control over firms’ profits, firms were not allowed to go bankrupt, and wages were set independent of firms’ profitability. The latter practice gave rise to perverse behavior, like shirking and absenteeism, low investment, and strong pressures to raise wages above sustainable levels—that is, those levels that are consistent with target growth and price stability. In particular, wage pressures became more acute in countries like Poland in which sustainable wages likely fell after the energy crises of the 1970s.
More recent developments in Eastern Europe have led to a higher degree of decentralization but have not yet succeeded in radically changing the distorted incentive structure. Bankruptcies, for example, are now allowed, but very few large enterprises have undergone bankruptcy procedures despite the sizable and persistent losses in output that many have experienced. Another innovation of the 1990s is privatization of state-owned enterprises. However, privatization has taken time and, so far, mainly retail and small shops have been privatized. Large enterprises remain in government hands.
Therefore, the newest regimes—here called previously centrally planned economies (PCPEs)—have most of the RCPEs’ fundamental distortions. In contrast with RCPEs, however, authorities have liberalized most prices and attempted to follow tight fiscal and credit policies for price stability. These policies have generally been complemented by incomes policies (such as wage ceilings) to help offset perverse incentives.1 It was hoped that if such policies were accompanied by substantial international trade liberalization, domestic relative prices would more closely reflect those prevailing in the rest of the world—thus, helping to achieve a more efficient allocation of resources. Unfortunately, the accompanying output loss and unemployment have shown surprising severity and persistence (Figure 1).
Real GDP Growth
Citation: IMF Staff Papers 1993, 004; 10.5089/9781451956986.024.A002
Source: Data provided by the authorities of the various countries.Interenterprise Credit and Output
An outstanding feature of RCPEs is that the basic structure of a “command economy” was maintained: the central authority designed and, to some extent, enforced a basic output plan involving output targets for individual firms. Under these circumstances, output was not allowed to fall for “financial” reasons, and, if necessary, more money was pumped into the system to keep firms afloat. This aversion to tight credit—to a credit crunch—was probably an important ingredient behind the inflation and shortages in RCPEs. Individual firms never lacked financial support and may thus have followed risky financial policies, eventually requiring bailouts from the central bank.
A financial innovation in RCPEs was the emergence of interenterprise credit. Greater autonomy in the use of profits allowed firms to lend to other firms.2 This facilitated not only the transfer of profits among firms but also the transfer of any momentary liquidity they possessed. A relevant aspect of this market is that it developed under the protection of the banking system, because production was not to be disrupted by financial trouble.
The presence of interenterprise credit complicated the task of monetary control. For example, attempts to control domestic credit tended to be quickly followed by offsetting expansions of interenterprise credit (see Kornai (1992) for the case of Hungary and Calvo and Coricelli (1992a) for the case of Poland). The expansions would momentarily increase the velocity of money, slow the effect of the stabilization program, and, most important, increase the financial vulnerability of the whole enterprise sector. Thus, continuation of the tight credit stance was accompanied by financial stress for some enterprises, particularly for net lenders. Because production targets had priority over other targets, the central bank was more often than not forced to follow a more accommodative policy than originally intended. Consequently, interenterprise credit may have aggravated steady-state inflation and generalized shortages.3
Despite similarities with RCPEs, PCPEs have exhibited large across-the-board output losses and unemployment, perhaps reflecting the fact that policymakers have welcomed structural adjustment even when accompanied by sizable output declines. Such a policy stance may have sent a strong signal to economic agents that the government would no longer rescue them in case they ran into financial distress.
In a certain sense, a PCPE is an orphan relative of a RCPE and, more distantly, of a CPE. It carries many of the same traits but has been thrown into a world in which markets—credit markets, in particular—are essential, without the benefit of central bank shepherding. Thus, PCPEs have been forced to develop “private” credit markets from a weak base, given that the past dependence on the official banking system provided implicit partial insurance against bad financial deals. Even where “private” credit existed—as with the active interenterprise credit market in Poland—the removal of previous guarantees probably caused firms to be more cautious about credit transactions, or for that matter about any transaction in which highly marketable goods were not being simultaneously exchanged. The mistrust surrounding transactions may have worsened in the socialized sector as a result of the big increase in domestic energy prices and trade liberalization. These shocks were strong and unprecedented in all Eastern European countries (except Hungary) and increased the relative price of energy in terms of the socialized sector’s output (excluding the energy sector). Therefore, in the early stages, domestic trade was probably seriously impaired, particularly in those PCPEs that followed a “big bang” approach.
Temporary trade impairment does not imply a sizable fall in output in the short run. Lower interenterprise credit could be partially compensated by (1) using up inventories, (2) falling into arrears, (3) lowering wages, and (4) borrowing more from the banking system, international lenders, and households. Although “solutions” 1 to 3 have been widely adopted, the first two solve the financial problem of one firm only by worsening that of another (unless inventories are exclusively composed of highly tradable goods). Also, the third “solution” is transitory at best, given that firms are run by workers and that stabilization programs have established “safety nets” that allow firms to lower their wage bill by charging some of it to the government budget (through layoffs and unemployment benefits)—thus reducing firms’ incentives to lower wages. The availability of solution 4 (the quotation marks have been removed because it is a viable solution) is a function of policy, access to the international credit market, and the existence of domestic nonbank credit markets outside the firm’s sector. The latter are likely limited because nonbank creditors have faced the same uncertainties that helped to paralyze interenterprise credit. The only real hope for a solution depends on greater short-run availability of bank credit. Such hope, however, may never materialize because larger bank credit could simply cause higher prices.
II. Role of Credit: Analytical Framework
The credit contraction in Bulgaria, Czechoslovakia, Hungary, Poland, and Romania, after the implementation of market-oriented transformation programs, can be described in several ways. Table 1 shows bank credit deflated by producer prices. In each country, credit falls substantially, but there is a wide variety of experience. Hungary exhibits a relatively small credit contraction of about 10 percent; the other countries show contractions of more than 20 percent, with Bulgaria having a spectacular fall of about 75 percent. Notice that, except for Hungary, actual credit contraction is substantially larger than planned. Also, except for Hungary, credit contraction is mostly due to actual inflation exceeding expected inflation. Another contributing factor for Bulgaria, Czechoslovakia, and Poland was that credit ceilings were not binding during the first few months of the transformation program, although real credit in those countries would have still fallen precipitously even if credit ceilings had been binding. Nevertheless, the connection between credit ceilings and the contraction of real credit remains interesting, and two main reasons have been suggested to explain it. First, especially in the case of Poland, interest rates may have increased so much that the demand for credit dropped below credit ceilings (Calvo and Coricelli (1992b) and Pinto (1991)). Second—and especially relevant for Czechoslovakia, where the central bank set ceilings on lending interest rates—commercial banks may have been reluctant to lend to enterprises in the first months of the reform program (OECD (1991)).
Real Credit and Money in the Enterprise Sector After Reform
(Percent change)
Quarterly data on Hungary are affected by seasonality. Gérard Bélanger has pointed out to us that seasonal factors account for a difference of 6–8 percent between enterprise deposits in the fourth and first quarters (with the latter being lower). The annual change reported may thus be more relevant.
Real Credit and Money in the Enterprise Sector After Reform
(Percent change)
| Country and period |
Credit to enterprises | Enterprise money |
Inflation | |||
|---|---|---|---|---|---|---|
| Actual | Target | Actual | Target | |||
| Bulgaria | ||||||
| (1991:1/1990:4) | –75.1 | –61.0 | –71.7 | 277.0 | 167.0 | |
| (1991:4/1990:4) | –67.0 | –61.0 | — | 338.0 | 234.0 | |
| Czechoslovakia | ||||||
| (1991:1/1990:4) | –28.3 | –11.4 | –34.4 | 39.5 | 25.0 | |
| (1991:4/1990:4) | –18.4 | –8.1 | 0.7 | 58.7 | 30.0 | |
| Hungarya | ||||||
| (1990:1/1989:4) | –12.0 | — | –6.9 | 15.0 | — | |
| (1990:4/1989:4) | –7.0 | –7.0 | 24.8 | 30.0 | 20.0 | |
| Poland | ||||||
| (1990:1/1989:4) | –49.0 | –10.0 | –38.2 | 129.4 | 45.0 | |
| (1990:4/1989:4) | 13.0 | 25.0 | –15.0 | 193.0 | 94.0 | |
| Romania | ||||||
| (1991:1/1990:4) | –16.0 | — | — | 31.0 | — | |
| (1991:4/1990:4) | –39.0 | –45.0 | — | 227.0 | 120.0 | |
Quarterly data on Hungary are affected by seasonality. Gérard Bélanger has pointed out to us that seasonal factors account for a difference of 6–8 percent between enterprise deposits in the fourth and first quarters (with the latter being lower). The annual change reported may thus be more relevant.
Real Credit and Money in the Enterprise Sector After Reform
(Percent change)
| Country and period |
Credit to enterprises | Enterprise money |
Inflation | |||
|---|---|---|---|---|---|---|
| Actual | Target | Actual | Target | |||
| Bulgaria | ||||||
| (1991:1/1990:4) | –75.1 | –61.0 | –71.7 | 277.0 | 167.0 | |
| (1991:4/1990:4) | –67.0 | –61.0 | — | 338.0 | 234.0 | |
| Czechoslovakia | ||||||
| (1991:1/1990:4) | –28.3 | –11.4 | –34.4 | 39.5 | 25.0 | |
| (1991:4/1990:4) | –18.4 | –8.1 | 0.7 | 58.7 | 30.0 | |
| Hungarya | ||||||
| (1990:1/1989:4) | –12.0 | — | –6.9 | 15.0 | — | |
| (1990:4/1989:4) | –7.0 | –7.0 | 24.8 | 30.0 | 20.0 | |
| Poland | ||||||
| (1990:1/1989:4) | –49.0 | –10.0 | –38.2 | 129.4 | 45.0 | |
| (1990:4/1989:4) | 13.0 | 25.0 | –15.0 | 193.0 | 94.0 | |
| Romania | ||||||
| (1991:1/1990:4) | –16.0 | — | — | 31.0 | — | |
| (1991:4/1990:4) | –39.0 | –45.0 | — | 227.0 | 120.0 | |
Quarterly data on Hungary are affected by seasonality. Gérard Bélanger has pointed out to us that seasonal factors account for a difference of 6–8 percent between enterprise deposits in the fourth and first quarters (with the latter being lower). The annual change reported may thus be more relevant.
A possible objection to using the change in the stock of real bank credit to measure the fall in real enterprise liquidity is that the initial price jump could actually improve firms’ net worth since their real debt to banks falls. This criticism does not appear highly relevant for the countries in question, however. Before reforms were implemented, either real interest rates were highly negative (Poland) or firms were not expected to service a large portion of their debt (Bulgaria and Romania). In the latter case, in which an initial stock of nonperforming bank loans to enterprises exists, any capital gain from previously performing loans goes to service previously nonperforming loans, leaving the firm in the same net worth position. Furthermore, economic transformation programs were aimed at generating positive real interest rates, and firms were to face bankruptcy if they did not service their debt. Therefore, although real debt fell, positive post-reform real interest rates implied that enterprises went from a situation in which they received net real transfers from banks to a situation in which firms were supposed to make real transfers to banks. Another argument against inflation mitigating enterprise debt is that firms’ capital gains were heavily taxed (as in Czechoslovakia and Poland). In addition, part of working-capital credit was held in the form of bank deposits, which were subject to the inflation tax. There are, therefore, no strong reasons to expect that firms greatly benefited from the initial erosion of their bank debt through inflation.
At any rate, even when a firm’s net worth increases as a consequence of the initial price jump, its “liquidity,” or its ability to purchase basic inputs, could decrease. As an illustration, consider the case in which, before reforms are implemented, a firm produces Q units of output at full capacity using inputs purchased in the preceding period. Let B indicate credit granted to that firm to purchase those inputs, and let us assume that the firm has no other means of purchasing them. We assume that, before the reform, prices of output and inputs equal unity and that the interest rate is zero.4 Thus, profits = Q – B. To ensure that before reform the firm depends entirely on credit, we further assume profits to be zero: Q = B. Let P > 1 and Pi > 1 denote the prices of output and inputs after the reform, respectively.
We examine the situation of the firm in the first period after the reform is implemented, assuming that the firm acquired credit at the pre-reform interest rate of zero. Thus, post-reform profits are PQ – B > 0, implying that the firm’s net worth has increased. Let us now examine the firm’s post-reform ability to buy new inputs (the firm’s real liquidity) under the assumption that nominal credit remains constant—that is, nominal credit remains equal to B. Hence, the firm’s real liquidity satisfies:
where τ is the profit tax, 0 ≤ τ ≤ 1. Clearly, if P = Pi(implying no change in relative prices) and τ = 0 (no profit tax), expression (1) equals Q = B, where equality follows from the pre-reform zero-profit assumption. Therefore, under these special assumptions the firm would still be able to buy inputs to ensure full-capacity output. However, this ceases to be the case if τ > 0 (there is a positive profit tax)—a highly realistic assumption—or if P < Pt (the price of output falls relative to the price of inputs)—also a realistic assumption for most non-energy-producing sectors. Notice that for a large profit tax, real liquidity could be approximated by real credit, B/Pi.5
An alternative, and more direct, way to estimate enterprise liquidity is to compute M2 in the hands of enterprises. According to Table 1, this approach yields the same orders of magnitude as those obtained using real credit as a measure. However, M2 is generally a less useful variable because stabilization programs have specified ceilings on credit not on M2. Furthermore, M2 does not necessarily measure a firm’s ability to purchase new inputs. Conceivably, an increase in credit to enterprises could be spent entirely on imported inputs or on inputs produced by other sectors, like agriculture, never taking the form of higher M2 held by enterprises.
However, one could still argue that bank credit to enterprises is an inadequate measure of enterprise liquidity because it does not take into account changes in fiscal variables and in interest rates and because a sizable share of outstanding loans could be nonperforming and their liquidation should thus have no deleterious effects on output. The following discussion tackles these issues.
In Table 2, we measure liquidity needs after the first quarter of the transformation programs under the assumption that firms had been able to operate at full capacity (at actual prices), taking into account the new interest rates and profit taxes.6 In this fashion, our liquidity definition is less vulnerable to the criticism that it reflects the fall in output and is an inappropriate variable for testing the hypothesis that enterprise liquidity affects output. For the cases of Bulgaria and Romania, we adjust the initial credit variable by an estimate of nonperforming loans, which appear substantial in these countries (partly explaining the sizable fall in credit registered in Table 1). Thus, estimates in Table 2 correct for the omissions noted above. Furthermore, by assuming full-capacity utilization, we can measure the liquidity squeeze before the output decline. These estimates, therefore, come closer to measuring the exogenous financing gap generated by credit policy.
Credit and Liquidity Requirements with Full-Capacity Utilization
(Percent of sales)
The credit stock for 1990 has been reduced by 50 percent to eliminate the share of nonperforming loans. For 1991, all the credit is assumed performing.
Data refer only to profit-making enterprises.
Credit and Liquidity Requirements with Full-Capacity Utilization
(Percent of sales)
| Bulgariaa | Czechoslovakia | Hungary | Poland | Romaniab | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Credit or liquidity measure |
1990 | 1991:1 | Percent change |
1990 | 1991:1 | Percent change |
1989 | 1990:1 | Percent change |
1989 | 1990:1 | Percent change |
1990 | 1991:1 | Percent change |
| Bank credit | 28.9 | 16.1 | –44.2 | 125.7 | 99.7 | –20.6 | 26.3 | 25.9 | –1.5 | 41.5 | 21.3 | –48.6 | 24.7 | 19.2 | –20.2 |
| Liquidity 1 | 62.5 | 20.7 | –66.8 | 131.5 | 101.7 | –22.6 | 33.1 | 31.0 | –6.3 | 63.5 | 29.3 | –53.8 | 26.4 | 21.0 | –19.5 |
| Liquidity 2 | 80.6 | 27.1 | –66.3 | 178.6 | 135.9 | –23.9 | 41.2 | 39.1 | –5.1 | 69.7 | 38.7 | –44.4 | — | — | — |
The credit stock for 1990 has been reduced by 50 percent to eliminate the share of nonperforming loans. For 1991, all the credit is assumed performing.
Data refer only to profit-making enterprises.
Credit and Liquidity Requirements with Full-Capacity Utilization
(Percent of sales)
| Bulgariaa | Czechoslovakia | Hungary | Poland | Romaniab | |||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Credit or liquidity measure |
1990 | 1991:1 | Percent change |
1990 | 1991:1 | Percent change |
1989 | 1990:1 | Percent change |
1989 | 1990:1 | Percent change |
1990 | 1991:1 | Percent change |
| Bank credit | 28.9 | 16.1 | –44.2 | 125.7 | 99.7 | –20.6 | 26.3 | 25.9 | –1.5 | 41.5 | 21.3 | –48.6 | 24.7 | 19.2 | –20.2 |
| Liquidity 1 | 62.5 | 20.7 | –66.8 | 131.5 | 101.7 | –22.6 | 33.1 | 31.0 | –6.3 | 63.5 | 29.3 | –53.8 | 26.4 | 21.0 | –19.5 |
| Liquidity 2 | 80.6 | 27.1 | –66.3 | 178.6 | 135.9 | –23.9 | 41.2 | 39.1 | –5.1 | 69.7 | 38.7 | –44.4 | — | — | — |
The credit stock for 1990 has been reduced by 50 percent to eliminate the share of nonperforming loans. For 1991, all the credit is assumed performing.
Data refer only to profit-making enterprises.
Table 2 confirms the findings of Table 1. Except for Hungary where real liquidity fell by only 6 percent, all countries show a fall in liquidity of more than 20 percent. Once again, Bulgaria shows the largest liquidity contraction (more than 65 percent), followed by Poland (about 40 percent), and Czechoslovakia and Romania (about 20 percent). As noted above, however, enterprises could partly offset their liquidity shortage by running down their stock of inventories, by borrowing (or falling into arrears) in the interenterprise credit market, or by borrowing from their own workers (by paying wages below the program’s ceilings).
We first note that, despite the fact that the fall in inventories in all these countries appears sizable (in Czechoslovakia and Poland it was between 20 and 30 percent), the extra liquidity created by the depletion of inventories covers only about 50 percent of the liquidity shortfall, except in Czechoslovakia which would have been able to cover the full shortfall shown in Table 2.7 However, the table does substantially underestimate the liquidity shortfall of countries like Czechoslovakia and Poland, because nominal capital gains on inventories, incurred from the initial price rise, were subject to taxation.8
Regarding the interenterprise credit market, the outcome after reform differs across countries, and information is sometimes skimpy; for example, in Czechoslovakia, Hungary, and Romania, available figures capture only interenterprise arrears. For Poland, where information is relatively good, the behavior of interenterprise credit appears to differ markedly from the past. Whereas contraction of bank credit had in the past been accompanied by an expansion in the interenterprise credit market, the two types of credit tended to move in the same direction after reform. This finding is confirmed by Figure 2, which depicts the relationship between changes in bank credit and changes in interenterprise credit (payables) across 19 industrial sectors in Poland during the first quarter of 1990. Therefore, interenterprise credit reinforced rather than cushioned the liquidity contraction provoked by lower bank credit—supporting the conjecture that firms perceived the 1990 program as a change of regime that meant lending firms would be less likely to be bailed out by the central bank if their loans were not repaid.9
Poland: Bank and Interenterprise Credit for 19 Industrial Sectors
(Percentage change from 1989:4 to 1990:1)
Citation: IMF Staff Papers 1993, 004; 10.5089/9781451956986.024.A002
Source: Authors’ calculations using data provided by the National Bank of Poland.“Borrowing from workers” cushioned enterprises in Bulgaria, Czechoslovakia, Poland, and Romania in the first few months following reforms. In all these countries, wages were set well below the norms established by government programs. By contrast, in Hungary, where enterprises in 1990 did not suffer a significant liquidity squeeze, this did not happen, and wages increased slightly above the program’s targets.10 Thus, tight liquidity conditions and wage behavior appear correlated in the countries examined.11
The evidence presented above suggests that, except for Hungary, the reform programs implied a sizable contraction of enterprise liquidity. Another relevant piece of information concerning the correlation between the output decline and the credit-liquidity squeeze comes from sectoral data available for Poland. Figure 3 shows a negative correlation across 19 industrial sectors between the change in output (measured by real sales) during the first quarter of 1990 and credit dependence at the end of 1989.12 Thus, those sectors with greater exposure to bank credit at the end of 1989 displayed larger declines in output. In addition, the cross-sectional data confirm, for the case of Poland, the positive correlation between credit conditions and wage behavior.13
Poland: Real Sales and Credit Exposure for 19 Industrial Sectors
(Percentage change from 1989:4 to 1990:1)
Citation: IMF Staff Papers 1993, 004; 10.5089/9781451956986.024.A002
Source: Authors’ calculations using data provided by the National Bank of Poland.III. Further Statistical Analysis
Previous sections show that credit, and more specifically enterprise liquidity, contracted sharply in the early stages of stabilization. Hungary has exhibited the smallest contraction and, interestingly, has also suffered the smallest output decline. Thus far, however, we have not established a strong line of causation going from credit to output. Indeed, credit could be following the decline in output, which in turn may have been caused by other factors, like the collapse of CMEA trade. To study this issue more closely, we examine the case of Poland, which launched its stabilization program one full year before the collapse of the CMEA trade.
We run cross-section regressions involving 85 branches of industry in Poland. First, we regress proportional changes in output against proportional changes in real credit from the last quarter of 1989 to the first quarter of 1990 (using the output price index of each branch as a deflator).14 Since credit ceilings were nonbinding in the first quarter of 1990, the proportional change in real credit is an endogenous variable. To correct for the endogeneity, we employ an instrumental variable—the ratio of working-capital credit to sales in the last quarter of 1989, which exhibits a negative correlation with credit growth of about 50 percent. The point estimate for this variable is about 0.2 (with a t-statistic of 2.1), meaning that a 10 percent contraction in real credit results in a 2 percent fall in output:15
Second, to check the robustness of our results with respect to the credit deflator, we run the same regression using nominal bank credit expansion as an independent variable (and instrument it in the same fashion).16 The results are similar:
Third, we regress the log of output on the log of credit for the first quarter of 1990. Once again, since credit is an endogenous variable we instrument it by the ratio of working capital to sales and by real sales, both for the last quarter of 1989. The point estimate is about 0.6 (with a t-statistic exceeding 8), meaning that a 10 percent fall in real credit results in a 6 percent output decline:
Therefore, the statistical analysis suggests that credit and output are positively related. The point estimates of the output-credit elasticity, however, vary widely from a low 0.2 to a high 0.6. Since real credit in the sample falls, on average, by 27 percent, the output decline that could be associated with a credit contraction runs from a low 5.4 percent to a high 15 percent. The average fall in output in the sample is about 24 percent. The analysis therefore suggests that the decline in output may have reflected a credit contraction but that other factors or mechanisms may be contributing to the process as well.
In particular, if the relevant elasticity were about 0.2, a large share of the output decline would be due to other factors or mechanisms. It is also worth mentioning that aside from direct effects, a credit contraction could have indirect output effects if prices and wages are not perfectly flexible downward. A credit squeeze, for example, may lead firms to deplete inventories. If inventories contain domestically produced goods, demand for those goods will fall, giving rise to a typical Keynesian impasse. Moreover, output from inventory-producing sectors will tend to be low until inventories reach their desired lower levels, helping to rationalize a prolonged contraction in output.
The credit view about the output decline in Eastern Europe can be challenged by pointing to developments in Poland after the first quarter of 1990. Table 3 shows that although real credit to enterprises fell by about 35 percent in the first quarter of 1990, it rose by about 70 percent from March 1990 to December 1990. However, gross enterprise output grew by only 9.6 percent over the same period. This suggests that credit expansion had a small impact on output, seemingly contradicting the econometric results above.
Poland: Credit to Socialized Sectors and Capitalization of Interest
(Percent)
Poland: Credit to Socialized Sectors and Capitalization of Interest
(Percent)
| Credit or output measure |
December 1989– March 1990 |
March 1990– December 1990 |
|
|---|---|---|---|
| Change in real credit | |||
| (deflated by PPI) | –34.3 | 71.6 | |
| Change in real credit | |||
| (deflated by CPI) | –35.1 | 45.6 | |
| Change in production | –32.3 | 9.6 | |
| Change in real credit as a | |||
| result of capitalization | |||
| of real interest | –18.0 | 18.9 | |
Poland: Credit to Socialized Sectors and Capitalization of Interest
(Percent)
| Credit or output measure |
December 1989– March 1990 |
March 1990– December 1990 |
|
|---|---|---|---|
| Change in real credit | |||
| (deflated by PPI) | –34.3 | 71.6 | |
| Change in real credit | |||
| (deflated by CPI) | –35.1 | 45.6 | |
| Change in production | –32.3 | 9.6 | |
| Change in real credit as a | |||
| result of capitalization | |||
| of real interest | –18.0 | 18.9 | |
There are several complementary arguments to reply to this criticism. In the first place, as the econometric results suggest, the reaction of output to credit may exhibit an elasticity well below unity, such as 0.2. Hence, credit expansion has a positive effect on output, but only 20 percent of the credit growth will be reflected in output growth. However, even if the credit coefficient were equal to 0.2, the criticism that output did not increase as much as expected would still carry some weight. Credit expansion from March to December 1990 was 72 percent, which, when multiplied by the 0.2 coefficient, implies that output should have grown by 14.4 percent—still somewhat larger than actual output growth (9.6 percent).
We now proceed to add another important ingredient to our response to the criticism regarding the impact of credit on output. Credit has to reflect actual purchasing power over inputs. Thus, it is not clear that the deflator used to compute “real” credit (namely, the output price index) is the relevant choice after the first quarter of 1990, because the removal of subsidies to some key inputs like coal and oil appears to have caused input prices to rise by much more than output prices. For example, if the consumer price index (CPI) were used as a deflator—an index that may better capture the effect of increases in administrative prices—real credit would increase by only 46 percent from March to December 1990 (see Table 3). Thus, if the output-credit elasticity is low (0.2), output growth in 1990 after March (9.6 percent) would have required a “real” credit expansion of about 50 percent, which exceeds actual real credit expansion if we use the CPI as a proxy for the input price index. Therefore, under those circumstances, the above-mentioned criticism would be fully answered by noting that output-credit elasticity is around 0.2 and that input prices rose much faster than output prices.
However, if we believe that output-credit elasticity lies on the high side of our range of estimates, say at 0.6, then actual output growth would still be substantially less than expected. We now introduce another ingredient to our reply to critics. We would like to stress again that the relevant credit variable should be directly associated with enterprises’ ability to purchase production inputs. For example, the credit view would attach no significance to an increase in credit that reflected capitalization of interest—that is, the refinancing of interest on outstanding loans. We suspect that interest capitalization may have played a significant role in the expansion of credit after March 1990, a suspicion indirectly confirmed by Sheng (1991), who shows that in 1990 from 18 to 28 percent of total bank portfolios were composed of “problem” loans. In what follows, we show that if interest payments were capitalized, then credit expansion—adjusted downward by interest capitalization—is substantially smaller and would result in the observed weak output growth in 1990, even though the output-credit elasticity is assumed equal to 0.6. This argument is somehow more speculative than the previous ones. However, it receives some support from the emergence of problem loans in 1990 and from the well-known fact (among observers of the Polish economy) that during 1990 banks capitalized interest at the beginning of each quarter, especially in April and July. The latter is quite apparent from the presence of spikes in the credit series at the beginning of each quarter, starting in April 1990.
To account for the 9.6 percent output growth in the period from March to December 1990, “real” credit must have risen by about 16 percent (9.6/0.6, where 0.6 is the output-credit elasticity). As shown in Table 3, interest capitalization may have augmented credit by about 19 percent. Thus, total credit expansion accounted for in this manner would be about 35 percent, which is very close to real credit expansion in the period March 1990–December 1990 if the CPI is used as a proxy for the input price index.
In sum, statistical analysis shows that critics of the credit view are likely to have a hard time proving that credit has little effect on output. In particular, the popular view that credit could not possibly be relevant for output—because strong credit expansion in the period from March to December 1990 in Poland led to only feeble output response—relies on several questionable assumptions.
IV. Conclusions and Policy Implications
The discussion above supports the hypothesis that credit may play a significant role in PCPEs’ output determination. This hypothesis, however, should not be taken to imply that credit policy would be able to restore output to socially optimal levels. As pointed out earlier, the new rules of the game in PCPEs could have led to a situation of “trade implosion” or “trade destruction,” which is not easily cured by infusing more credit into the system. The situation is further complicated by the collapse of the CMEA, which represented a serious blow to all of these countries.17 Strictly speaking, our econometric findings are confined to the first stages of the Polish stabilization program. Therefore, the finding that credit may affect output should not be taken to imply that credit alone will be able to maintain the initial high output levels in the medium term. In fact, Commander and Coricelli (1992) suggest that, despite the smaller credit contraction in Hungary than in Poland, the cumulative output decline after two years is about the same in the two countries.
There are different ways to ensure that firms have access to the necessary liquidity to operate at full capacity.18 The first obvious one is to adjust bank credit initially in order to ensure that “real” credit—in terms of input prices—stays unchanged. This step should, in principle, involve a once-and-for-all operation. Afterward credit could be kept as tight as necessary to ensure the achievement of low inflation targets. A common criticism of the initially easy credit policy is that it may impair the credibility of the overall stabilization program, making it more likely that the initial price jump escalates into persistent high inflation. A full discussion of this issue would go beyond the limits of this paper. However, it should be recalled that the price jump in Eastern European programs in the first quarter after their implementation was quite sizable (118 percent on average). Credit accommodation may have added more spring to the initial price jump, but if an 118 percent price jump does not destroy credibility, we do not see why a larger jump would.
A more persuasive criticism, however, is that credibility may be a function of credit tightness. For example, upon noticing that credit is sufficient to continue operations as they had been before reforms were implemented, managers may have little incentive to adjust. Firms may thus treat credit as a substitute for previous subsidies. As argued earlier, banks have no expertise in evaluating creditworthiness (and any expertise they had was likely wiped out by the sizable change in relative prices). Hence, banks may be unable to detect “bad loans” until it is too late, and the central bank—to avoid financial panic—is forced to monetize enterprises’ liabilities, jeopardizing the effectiveness of the stabilization program.
It is worth noting, however, that tight credit could have a negative effect on credibility, especially if it creates across-the-board financial difficulties. In isolation, tight credit conditions might lead a single firm to put its house quickly in order. However, if its managers realize that many other firms are in the same situation, they may decide to postpone adjustment in the expectation that the government will bail everyone out.19
An alternative approach to avoiding the initial fall in real credit—which is immune from the credibility problems of an accommodative credit policy—would be to act on the price level rather than on the stock of nominal credit. This possibility is highly relevant because the larger-than-anticipated price jump accounted for most of the initial sharp contraction in real credit. This initial contraction in real credit could therefore be avoided by limiting the price jump. This could be achieved by dismantling subsidies on key inputs, like energy, more gradually.20 As these input prices generally remain under government control even after reforms, the more gradual approach would affect the intensity but not the scope of price liberalization.
The smoother increase in input prices would yield a less violent credit shock. Consequently, firms would have more time to build up their liquid balances in anticipation of the future price rise. Moreover, in the presence of anachronistic pricing rules, such as rigid cost-plus pricing, smoothing the increase in key input prices may be an effective way to smooth the increase in the overall price level.21
Critics may point out, however, that gradualism detracts from policy transparency, leads to speculative behavior, and invites postponement of reforms.22 More basically, a gradualist policy may simply not be feasible. Subsidies may be so large that their maintenance could lead to ever-rising inflation.
Finally, another candidate for a solution to the credit-squeeze problem is a swap of government debt for enterprise debt. Through this operation, for example, firms buy treasury bills, which they pay for by issuing long-term corporate debt. Presumably since government debt is much less risky in the eyes of private investors than enterprise debt, enterprises may find it easier to borrow in private credit markets using their stock of government debt as collateral. Alternatively, enterprises could increase their liquidity simply by selling their stock of government debt in the market. However, this solution may not be effective for a PCPE because the markets for government debt instruments are not well developed.
REFERENCES
Barbone, Luca, “How Much Did the Fiscal Sector Gain in Poland from Hyperinflation? The 1990 Fiscal Surplus Revisited,” (unpublished; Washington: World Bank, 1992).
Blanchard, Olivier, and Richard Layard, “Post-Stabilization Inflation in Poland,” in Wage Policy During the Transition to a Market Economy, ed. by Fabrizio Coricelli and A. Revenga, Discussion Paper No. 158 (Washington: World Bank, 1991).
Blejer, Mario, and Gyorgy Szapari, “The Evolving Role of Fiscal Policy in Centrally Planned Economies under Reform: The Case of China,” IMF Working Paper 89/26 (Washington: International Monetary Fund, 1989).
Berg, Andrew, and Olivier Blanchard, “Stabilization and Transition: Poland 1990–1991,” paper presented at the Conference on the Transition in Eastern Europe, held by the National Bureau for Economic Research in Cambridge, Massachusetts, February 1992.
Bruno, Michael, “Stabilization and Reform in Eastern Europe: A Preliminary Analysis,” IMF Working Paper 92/30 (Washington: International Monetary Fund, 1992).
Calvo, Guillermo, and Fabrizio Coricelli (1992a), “Stagflationary Effects of Stabilization Programs in Reforming Socialist Countries: Enterprise-Side and Household-Side Factors,” World Bank Economic Review, Vol. 6 (January 1992).
Calvo, Guillermo, and Fabrizio Coricelli (1992b), “Stabilizing a Previously Centrally Planned Economy: Poland 1990,” Economic Policy, Vol. 14 (April 1992).
Calvo, Guillermo, and Jacob Frenkel (1991a), “From Centrally Planned to Market Economy: The Road from CPE to PCPE,” Staff Papers, International Monetary Fund, Vol. 38 (June 1991).
Calvo, Guillermo, and Jacob Frenkel (1991b), “Credit Markets, Credibility, and Economic Transformation,” Journal of Economic Perspectives, Vol. 5 (Fall 1991).
Commander, Simon, and Fabrizio Coricelli, “Output Decline in Hungary and Poland in 1990/91: Structural Change and Aggregate Shocks,” paper presented at the conference on Macroeconomic Situation in Eastern Europe, held jointly by the International Monetary Fund and World Bank in Washington, June 4–5, 1992.
Garvy, George, “The Monetary System and Payments Flow,” in Socialist Economies: Selected Readings, ed. by Alec Nove and D. M. Nuti (New York: Penguin Books, 1972).
Kopits, George, “Fiscal Reform in European Economies in Transition,” in The Transition to a Market Economy, ed. by Paul Marer and Stephen Zecchini (Paris: Organization for Economic Cooperation and Development, 1991).
Kornai, Janos, The Socialist System (Princeton, N.J.: Princeton University Press, 1992).
Lane, Timothy, “Inflation Stabilization and Economic Transformation in Poland: The First Year,” IMF Working Paper 91/70 (Washington: International Monetary Fund, 1991).
Lipton, David, and Jeffrey Sachs, “Remaining Steps to Achieve a Market-Based Monetary System,” unpublished paper, Harvard University, 1992.
McKinnon, Ronald, The Order of Economic Liberalization (Baltimore: Johns Hopkins University Press, 1991).
Organization for Economic Cooperation and Development, OECD Economic Surveys: Czech and Slovak Federal Republic (Paris: OECD, 1991).
Pinto, Brian, “Microeconomic Response to the Economic Transformation Program: Evidence from the Largest Polish State-Owned Enterprises,” (unpublished; Washington: World Bank, 1991).
Sheng, Andrew, “Bad Debts in Transitional Socialist Economies,” (unpublished; Washington: World Bank, 1991).
It should be noted, however, that incomes policies have also been tried in RCPEs, so they cannot be listed as a major innovation of PCPEs.
It should be noted that in CPEs interenterprise credit was forbidden by law.
This is a very partial account of the inflationary mechanism in RCPEs. As pointed out by Blejer and Szapari (1989) and Kopits (1991), for example, RCPEs tend to develop higher fiscal deficits under reform policies than under strict central planning because of the greater difficulty of collecting taxes in a more decentralized environment. This point has been further developed by McKinnon (1991).
Under the present assumptions, the real interest rate would also be zero.
Notice that in Table 1 we deflate credit by the producer price index, which likely underestimates the increase in input prices (the relevant prices for estimating B/Pt).
Furthermore, Table 2 assumes that previous liquidity-sales ratios, or output ratios, reflect normal liquidity needs and thus apply to the period after the transformation programs were implemented.
It should be noted that this fall in inventories in Czechoslovakia is an estimate by the authors. It was calculated by assuming that the revaluation of the stock of inventories on January 1, 1991, does not include January inflation.
In Czechoslovakia, firms were taxed on capital gains independent of whether inventories were actually spent on production. It is estimated that revenue from this tax amounted to about 3 percent of GDP in Czechoslovakia and to more than 10 percent of GDP in Poland. See Barbone (1992).
It is an open question whether the after-reform positive association between bank and interenterprise credit persisted after the first quarter of 1990.
It is worth noting that—in contrast with the sharp declines in the other four countries—real wages in Hungary increased by about 2 percent during 1990.
For Bulgaria, Czechoslovakia, Poland, and Romania, wage behavior partly explains the high profitability of enterprises given large increases in nonlabor input prices. However, the share of wages in total costs is relatively low in these countries, which are characterized by high energy and material intensity of production processes. Consequently, the liquidity that can be generated by borrowing from the workers is limited.
Credit dependence is measured by the ratio of bank credit for working capital to total costs.
Regressing proportional wage changes against the proportional credit increase for 85 branches of industry in Poland (as described in the following section), we obtain a credit coefficient equal to 0.33, with a t-statistic equal to 1.9.
This would be the proper deflator if input prices were highly correlated with output prices.
The equations were estimated using a two-stage least squares method and 85 observations. The instruments used were the constant and the ratio of bank credit to sales in 1989:4. A linear version of this equation is reported in Berg and Blanchard (1992). Using the same sample, they show that point estimates predict a negligible (although statistically significant) effect of credit on output. However, the linear restriction is not warranted by the underlying model that is being tested (see Calvo and Coricelli (1992a, 1992b)).
This would be the proper procedure if input prices across sectors rose at about the same rate.
The collapse of the CMEA could also be seen as partly reflecting the absence of credit markets across Eastern Europe and the former Soviet republics. Thus, one possible way to help CMEA trade recover (but not necessarily domestic trade) would be to expand international credit—an outcome that requires the cooperation of all countries concerned.
For the sake of brevity, the following discussion stays away from structural issues like privatization and the cancellation and socialization of enterprise debt, which are discussed in Calvo and Coricelli (1992b) and Calvo and Frenkel (1991a, 1991b).
See Calvo and Coricelli (1992b) for an application of this argument to Poland in the second half of 1990.
In the case of imported inputs, the increase in the domestic price can be contained by limiting the size of the initial depreciation of the exchange rate. This is relevant for countries like Czechoslovakia and Poland, which have adopted exchange-rate-based stabilization programs. The case for a smaller initial price shock, including initial depreciation, is argued by Bruno (1992).
That such anachronistic pricing rules were in force in the early stages of programs is argued by Lane (1991), Blanchard and Layard (1991) for the case of Poland, and Lipton and Sachs (1992) for the case of Russia.
Argentina in the early 1980s is a case in point. In 1976, Argentina’s authorities announced a gradual phasing out of import subsidies. The program was discontinued in 1981, and tariffs remained high until recently.
