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Guillermo A. Calvo is a Professor of Economics, and Director of the Center for International Economics, at the University of Maryland. At the time of writing this paper, he was a Senior Advisor in the Research Department of the IMF. Manmohan S. Kumar, a Senior Economist in the Research Department, is a graduate of the London School of Economics. He received his Ph.D. from Cambridge University, where he also taught prior to joining the Fund. The authors are grateful to Gerard Belanger, Adrienne Cheasty, Ajai Chopra, Fabrizio Coricelli, Eduard Hochreiter, Mark Lutz, Donald Mathieson, John Odling‐Smee, and Mark Stone for helpful comments and suggestions and to Nadine Orosa for research assistance.
In Poland, for instance, the private sector share of GDP increased from under 30 percent in 1989 to nearly 45 percent in 1992, whereas in the former Czechoslovakia and Hungary, respectively, the share increased from under 5 percent to 20 percent, and from 39 percent to 45 percent (see Schwartz, Stone, and van der Willigen (1993)).
In Poland, although private banks have proliferated, they collectively account for a very small share of banking activity.
Equivalently, one can think of production occurring at time t, when labor has to be paid, but sales revenues do not accrue until time t+1. It is worth noting how the presence of initial liquidity and initial inventories change the main argument of the paper. Regarding initial liquidity, it is assumed that there was a liquidity crunch at the beginning of the transition process; if there was no crunch, there is little left to explain. Regarding the initial stock of inventories, at least for Poland, there is no evidence that this stock in the hands of manufacturing firms at the beginning of the transition process was unduly large (see, for instance, Calvo and Coricelli (1992)).
For the time being, we will assume that firms intend to honor their contractual obligations.
Thus, the informal sector may not appear to be an adequate way of modeling the emerging private sector in these economies, since the latter is supposed to be more efficient than traditional enterprises. However, in the context of the present model, since the informal sector is more labor intensive, labor productivity might fall (even though total factor productivity might increase).
Under this interpretation, total output should also include output from the informal sector. However, given the productivity differentials between the formal and informal sectors pointed out above, output as given by equation (4) is positively correlated with the all‐inclusive output measure (which includes informal sector output).
The analysis does not assume that there was a shift in the demand for money. Rather, the main argument is based on the fact that there was a decline in M/P; at the beginning of the transition process owing simply to the sharp increase in prices following their decontrol combined with monetary restraint.
Russia has recently been the paramount example of trying to employ the inflation strategy to prop up output, with no visible success. This discussion has disregarded the fact that the existence of positive government subsidies to enterprises implies that firms will now exhibit positive profits. The latter would help to relax the liquidity constraint in future periods. This topic will he picked up in Section III.
Although massive default may be counterproductive for enterprises, the individual firm may still find it optimal to default, because the pnce level is determined by the market, not by the individual firm. The latter takes prices as given by the market, and in that context failing to repay bank debts adds to the firms’ liquidity and ability to employ labor. This rationalizes the possibility that atomisticfirm behavior may result in massive default on bank credit, even though, at the end of the day, no firm benefits from such action.
This issue is discussed in detail in Section V below where additional constraints on bank lending to firms are discussed. Here, notice that even if, in principle, banks are capable of “riding the storm,” they would run against bank regulations. Experience shows that banks are likely to try hiding their “bad” loans from the regulator, but they are eventually caught (by the regulator or by reality).
In Poland in 1990 and in the former Czechoslovakia in 1991, enterprise profits were artificially inflated by the revaluation of inventories, and, as there was little or no inflation adjustment in the profits tax, most of these paper profits were transferred to the government. As Schaffer (1993) shows, about half of the swing in Poland’s budget position, from a surplus in 1990 to a deficit of over 5 percent of GDP in 1991, was accounted for by the fall in profit taxes (owing largely to a decrease in the inflation bias).
Even where the public can directly subscribe to government bonds, as in Hungary, for instance, the share of government securities in total household savings remains very small.
Russia, also, similar factors have led to the banks keeping a large proportion of their assets liquid, but in the form of holdings of U.S. dollars (see Easterly and da Cunha (1993)).
In addition to the distributional concern, there is concern about the sustainability of current saving rates, especially since some of the factors underlying the initial increase in private saving may now be waning (see, for instance, Gomulka (1993)).
The data for Hungary in Figure 3 are adjusted for various credit consolidations and changes m classification that inflated outstanding credit to the government.
Section V below provides some impressionistic evidence on the positive relationship between the lack of availability of credit and declines in output in Poland in 1992, consistent with the evidence provided for an earlier period by Calvo and Coricelli (1994).
The irony here is that barely a year or two ago, the development of government securities markets was regarded as likely to bestow significant benefits for financing fiscal deficits (for a discussion of the issues, see Calvo and Kumar (1993)).
Considerable literature now exists on the portfolio problems of banks and the policies that have been, or should be, adopted to deal with them. In addition to Calvo and Kumar (1993), see Fries and Lane (1994) and Varhegyi (1993).
The difficulties in accurately assessing the bad loan problem arise in part from inadequate information about the current and prospective performance of enterprises as well as inadequate bank auditing procedures.
It is worth noting that a substitution of had loans for government bonds may not necessarily have any short‐run implications for liquidity to the enterprise sector (banks would now receive interest that they might then use to buy more bonds), but it would have significant fiscal implications in the long run.
The plan aims to increase capital to asset ratios for large banks to 12 percent or more. In addition to the bond issue, the plan may also draw on the $1 billion stabilization fund originally instituted in 1990 by bilateral donors.
For a discussion of issues on the role of equity markets in former socialist economies, see Brainard (1991), Borensztein and Kumar (1992), and Calve and Kumar (1993). For a discussion of the issues about the importance of equity markets in developing countries, see, for instance, Singh and Hamid (1992).
The important exception in this regard is the Czech stock market where, since June 1993, shares have been traded in a large number of companies following their privatization through the voucher schemes.