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Eastern Europe and the international banks: Commercial bank lending and the magnitude of debt and debt service

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
December 1982
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Richard C. Williams and Peter M. Keller

Events in Eastern Europe have given rise to a large body of commentary, analysis, and opinion on the longer-term consequences for banking flows to Eastern Europe and, more generally, for international banking per se. The Polish debt crisis became the focal point of attention, as there were prospects for a rescheduling on a thus far unprecedented scale and, more important, serious doubts began to surface regarding that country’s ability to meet interest payments on outstanding loans.

Some observers had been caught unawares by the rapid expansion of international bank lending to some of the Eastern European countries and even more were startled by the speed with which the situation turned into a major crisis. The events in Eastern Europe have undoubtedly served to sharpen international banks’ perceptions of both the economic and political implications of country risk. Questions arose whether the “umbrella” theory of an implicit guarantee by the U.S.S.R. for borrowing by other Eastern European countries had ever been valid. Against the background of tensions with official debtors, the best course of action for creditor banks was also subject to much debate: should the banks increase their exposure further by providing new credits to help meet interest payments on outstanding loans or would it be more realistic to write off at least some of the credits?

These questions deserve extensive analysis but cannot be answered adequately at this early juncture. Hence, it is not the purpose of this article to add yet another view on the causes or consequences of the circumstances that have emerged, but rather to provide some quantitative historical perspective on banking flows, bank exposure, and the extent of the external debt and debt service for the Eastern European countries involved.

Between 1976 and 1981, the outstanding debt of Eastern Europe to commercial banks in the reporting area of the Bank for International Settlements (BIS) grew, in terms of U.S. dollars, at a compound annual rate of about 21 per cent. This masks, however, a marked change that took place in the latter part of the decade. Between 1976 and 1978, debt to these countries was growing at an annual rate of 30 per cent; by 1979–81 the pace had slowed to 12 per cent (Table 1). The data summarized in this study suggest that this slowdown was associated with Poland’s debt servicing difficulties, superimposed on and contributing to East-West tensions. This combination of circumstances led banks to be wary of all Eastern Bloc borrowers by 1981, regardless of the diversity of their economic circumstances and policies. Even countries outside the Council for Mutual Economic Assistance (CMEA) trading area, such as Yugoslavia, were affected by these events.

Table 1Eastern Europe: debt to banks in the BIS reporting area1
Debt outstanding
1975Growth in bank debt2
(In billions of

U.S. dollars)
1976–811976–78

(In per cent)
1979–81
Eastern Europe21.620.730.012.0
Albania
Bulgaria1.66.224.7-9.5
Czechoslovakia0.350.688.220.5
German Dem. Rep.32.627.433.621.4
Hungary2.224.542.88.6
Poland3.926.744.212.3
Romania0.933.540.626.8
U.S.S.R.410.112.319.014.6
Sources: Bank for International Settlements (BIS), Quarterly Press Releases.

Indicates zero.

The BIS reporting area comprises banks in Austria, Belgium, Canada, Denmark, France, the Federal Republic of Germany, Ireland, Italy, Japan, the Netherlands, Sweden, Switzerland, the United Kingdom, and the United States, as well as branches of U.S. banks in the Bahamas, the Cayman Islands, Hong Kong, Panama, and Singapore.

Compound annual growth rates. Data for 1979–81 are adjusted for exchange rate changes.

Excludes debt to banks in the Federal Republic of Germany.

Includes a residual for Eastern Europe, which is mainly Council for Mutual Economic Assistance (CMEA) banks.

Sources: Bank for International Settlements (BIS), Quarterly Press Releases.

Indicates zero.

The BIS reporting area comprises banks in Austria, Belgium, Canada, Denmark, France, the Federal Republic of Germany, Ireland, Italy, Japan, the Netherlands, Sweden, Switzerland, the United Kingdom, and the United States, as well as branches of U.S. banks in the Bahamas, the Cayman Islands, Hong Kong, Panama, and Singapore.

Compound annual growth rates. Data for 1979–81 are adjusted for exchange rate changes.

Excludes debt to banks in the Federal Republic of Germany.

Includes a residual for Eastern Europe, which is mainly Council for Mutual Economic Assistance (CMEA) banks.

While the magnitudes of the cumulative net flows between 1976 and 1981 from the BIS banks to Eastern Europe were significant, they represented, on average, only about 13 per cent of total banking flows to all developing and planned economies—approximately US$304 billion—during the same period. In 1981, this proportion declined to 7.5 per cent. But while lending to Eastern Europe may not have figured prominently in the balance sheets of the banks, the flows represented the bulk of international lending to Eastern Europe. In 1977–80 net flows from banks in the BIS reporting area accounted for about 70 per cent of the cumulative net financing to Eastern Europe in convertible currencies, the remaining 30 per cent mainly being intergovernmental credits and lending by banks from outside the BIS area.

An unknown, but probably significant, portion of these private banking flows received official support from export credit insurance and other governmental agencies in the countries where the banks had their headquarters or where the loan originated. Data available for Poland, for instance, show that almost one half of Polish debt to BIS banks in mid-1981 was covered by some form of official guarantee (although this proportion of guaranteed debt may not be fully representative of Eastern European lending in general).

The pattern of net financing flows to individual countries changed considerably between 1976 and 1981 (Table 2). (Net flows are defined as disbursements less principal repayments.) Flows to Poland, the U.S.S.R., and the German Democratic Republic accounted for two thirds of the cumulative net flows over this period. Net lending to Poland fell sharply in 1980, and Bulgaria continued a policy of reducing its debt to banks. These reductions tended to offset increases for Czechoslovakia, the German Democratic Republic, and the U.S.S.R. As a result, aggregate net flows in 1980 showed no change from the previous year. In 1981, however, these net financing flows moderated significantly and were negative for many countries in the group. The U.S.S.R. was the only country in the group with sharply increased bank borrowing; aggregate net flows to other countries declined by nearly $5 billion to just over $1 billion.

Table 2Net financing flows to Eastern European countries from banks in the BIS reporting area, 1976–811(In billions of U.S. dollars)
197619771978197919801981
Eastern Europe7.64.69.37.27.24.8
Albania
Bulgaria0.40.30.6-0.2-0.2-0.4
Czechoslovakia0.60.40.50.70.9-0.1
German Dem. Rep.1.00.51.31.32.31.3
Hungary0.91.11.70.90.30.6
Poland1.51.22.63.00.90.5
Romania0.20.51.11.41.4-0.2
U.S.S.R.2.70.31.2-0.21.23.6
Residual0.30.30.30.30.4-0.5
Memorandum item:
Eastern Europe, excluding U.S.S.R.
4.94.38.17.46.01.2
Sources: Author calculations based on Bank for International Settlements (BIS), Quarterly Press Releases.

Indicates zero.

For 1976–78, net financing flows are measured by the change in the stock of bank claims in current U.S. dollars. For 1979–81, the net financing flows were derived from stock figures adjusted for exchange rate changes by the authors.

Sources: Author calculations based on Bank for International Settlements (BIS), Quarterly Press Releases.

Indicates zero.

For 1976–78, net financing flows are measured by the change in the stock of bank claims in current U.S. dollars. For 1979–81, the net financing flows were derived from stock figures adjusted for exchange rate changes by the authors.

Aggregate new publicized medium-term bank credit commitments began to decline significantly in 1980, a year before the sharp slowdown in actual net flows. There was a further pronounced decline in commitments in 1981. This lag between the initial decline in commitments and that in net flows partly reflects the fact that these countries continued to draw down already committed funds that were not yet disbursed, so that the actual decline in lending in 1980 and 1981 was much less marked than one might assume from Table 3. But the reduction of funds in the pipeline limits prospective flows, at least for the immediate future. Between the end of 1979 and the end of 1981 the ratio of undrawn commitments to outstanding bank debt for Eastern Europe was cut by one third to less than 12 per cent. This is a very low ratio in comparison with that of other borrowing countries outside the BIS reporting area (Table 3). Recently, virtually no new publicized medium-term funds have been committed, and there have probably been few commitments of any maturity that are not either officially guaranteed or otherwise supported by the country in which the loans originated.

Table 3Eastern Europe: net position vis-à-vis banks(In per cent)
Ratio of undisbursed

bank commitments to

loans outstanding
Ratio of desposits

to bank loans
Proportion of bank

loans of one year’s

maturity or less
Dec.

1979
Dec.

1980
Dec.

1981
Dec.

1979
Dec.

1980
Dec.

1981
Dec.

1979
Dec.

1980
Dec.

1981
Eastern Europe17.716.111.827.325.424.042.139.042.0
Albania
Bulgaria8.416.724.521.227.134.741.136.348.1
Czechoslovakia9.78.36.734.335.426.047.143.137.6
German Dem. Rep.16.515.216.224.721.620.142.738.642.6
Hungary5.28.44.615.517.411.447.442.940.4
Poland24.623.911.87.44.05.039.033.136.1
Romania18.318.29.47.05.16.750.542.735.3
U.S.S.R.21.712.812.167.763.853.138.441.950.3
Memorandum item:
All countries outside the BIS reporting area other than Middle Eastern countries1
24.723.419.350.045.241.641.143.144.5
Source: Bank for International Settlements (BIS), The Maturity Distribution of International Bank Lending.

Indicates zero.

The BIS definition of Middle Eastern countries comprises: Egypt, Iran, Iraq, Israel, Jordan, Kuwait, Libyan Arab Jamahiriya, Oman, Qatar, Saudi Arabia, United Arab Emirates, Yemen Arab Republic, and the People’s Democratic Republic of Yemen.

Source: Bank for International Settlements (BIS), The Maturity Distribution of International Bank Lending.

Indicates zero.

The BIS definition of Middle Eastern countries comprises: Egypt, Iran, Iraq, Israel, Jordan, Kuwait, Libyan Arab Jamahiriya, Oman, Qatar, Saudi Arabia, United Arab Emirates, Yemen Arab Republic, and the People’s Democratic Republic of Yemen.

There are additional indicators of the increasing strain on external financing and the liquidity of the Eastern European countries. For instance, there has been a decline in the already low ratio of bank deposits to bank debt to 24 per cent by the end of 1981—less than 14 per cent, excluding the U.S.S.R. (Table 3). In comparison, for other borrowing countries outside the BIS reporting area—even excluding the Middle Eastern countries, which maintain a strong liquidity position—the ratio of deposits to loans was well over 40 per cent. One of the implications of this very low and declining ratio for Eastern Europe is that the banks’ exposure (defined as outstanding loans less deposits) in these countries is higher and grew faster than suggested by Tables 1 and 2. The developments on an aggregate level are, however, somewhat misleading as levels of and changes in the deposit-loan ratio varied considerably among the Eastern European borrowing countries. Moreover, the year-end data hide a major turnaround during 1981: in mid-1981 the aggregate deposit-loan ratio had declined to less than 14 per cent, but it recovered in the second half of the year. This reflected primarily movements in the deposits of the U.S.S.R., which fell sharply in the first half of 1981 but were rebuilt in the second half, partly through short-term borrowing.

The slackening of new commitments to Eastern Europe in 1980 may have reflected, in part, a sharpened awareness of lending risk associated with rising East-West tension. On the other hand, total net financing from the BIS banks in that year remained basically unchanged at just over $7 billion (although lending to individual countries varied). The pronounced general retrenchment that became apparent in 1981 appears to have been closely associated with Poland’s debt servicing difficulties and the implications of political unrest there for East-West relations. The continuing sharp decline in medium-term syndicated credit commitments and a pronounced drop in net financing flows, despite the drawdown of funds in the pipeline, support this thesis. Poland and Romania, in particular, were faced with a significant fall in undisbursed commitments, as was the U.S.S.R. The pipeline of undisbursed commitments to the latter country was drawn down from $5.2 billion at the end of June 1979 to about $1.7 billion by the end of 1980, and remained below $2 billion at the end of 1981.

The dimensions of debt

Most commonly used indicators of external indebtedness have not proved very useful in predicting debt servicing problems. Moreover, while some insights can be gained by analyzing the development of certain indicators for a particular country over time, they are generally less meaningful for cross-country comparisons. The main reason is that each external debt indicator generally only focuses on one dimension of the debt situation and is static and void of policy content, and hence difficult to interpret in isolation. At best, such indicators can serve to direct attention to countries whose economic situation would seem to require a more comprehensive and thoughtful analysis. Nevertheless, they can provide some perspective on the relative magnitudes and trends of external indebtedness and debt service.

The level and growth of debt are both relevant indicators (Tables 1 and 2). Total convertible debt grew in 1972–80 for most countries in this group; Bulgaria experienced the lowest growth rate—mainly because it has recently maintained a policy of reducing its external debt—and growth was highest for Poland.

These countries’ convertible external assets also increased but, in the aggregate, more slowly than outstanding debt. The ratio of external convertible currency deposits to outstanding loans declined from 32 per cent at the end of 1972 to about 24 per cent at the end of 1981—a low ratio by international standards. The external deposit-loan ratio declined for each Eastern European country except Bulgaria. The range of deposit-loans ratios was wide, being highest for the U.S.S.R. at the end of the period and lowest for Poland and Romania (Table 3).

There were also wide divergences among the countries in the growth of external debt relative to exports that earned convertible currencies. The debt-export ratio declined for the U.S.S.R. and was little changed for Bulgaria, but for most other countries this ratio increased significantly; the greatest increase being for Poland whose ratio went from 0.9 to 3.3.

For most countries, the debt-GNP ratio grew significantly between 1972 and 1980 (Chart 1). By this measure, the external debt appears very small for Czechoslovakia and the German Democratic Republic, and negligible for the U.S.S.R. However, generating national product and transforming part of it into foreign exchange earnings to service external debt are different matters, and considerable attention is therefore usually given to the ratio of debt service to export earnings. The data available on convertible currency debt service ratios extend only through 1979; for most of the countries it is likely that the ratios increased somewhat in the past two years if measured in terms of scheduled rather than actual service payments.

Chart 11Debt to GNP ratio: 1972 and 1980

Source: Fund staff estimates.

1 Points above the 45° line represent a decrease in the ratio of debt to GNP; all those below represent an increase. The amount of the increase between 1972 and 1980 is the horizontal distance between the 45° line (connecting all points of no change) and the position of the particular country.

The debt service ratios of Poland and Romania demonstrate how two countries with very different debt positions have had similar difficulties in raising private funds from the West because of international uncertainties. In Poland, the ratio of debt service to exports rose rapidly and steadily, reaching the very high level of 92 per cent in 1979. On the other hand, Romania’s debt service ratio was considerably higher than Poland’s in 1972 but actually declined to 22 per cent in 1979, and was even fairly modest in relation to other more developed market borrowers. Yet Romania, as well as Poland, encountered debt servicing difficulties. The deterioration in East-West relations, and in particular the events in Poland, have had a major negative impact on recent bank attitudes toward lending to Eastern Bloc countries in general, regardless of the fact that their economic circumstances, policies, and management are quite diverse. In the case of Romania, the banks’ retrenchment in lending was an important factor in the intensification of financial pressures to a point where delays on external debt service payments emerged and the banks were approached for a rescheduling of the debt.

Chart 21Debt service ratio: 1972 and 1979

Source: Fund staff estimates

1 Points above the 45° line represent a decrease in the debt service ratio; all those below represent an increase. The amount of the increase is the horizontal distance between the 45° line (connecting all points of no change) and the position of the particular country.

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