THE SOVIET BLOC FINANCIAL PROBLEM AS A SOURCE OF WESTERN INFLUENCE (NIC M 82-10

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Directorate of Intelligence

Soviet Bloc Financial Problemource of Western Influence (u)

Nalional Intelligence Council Memorandum

Information available as2 Hat been uied In the preparation of this report

This memorandum wai coordinated within thcIntelligence Council and the Directorate of Intelligence. Comment* arc welcome and miiv be addressed to ihe auihor, Maurice Ernsi. Nauon.il Inlelligence Officer fee Economics,Ul

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The Soviel Bloc Financial Problemource of Weslern Influence (u)

KeyUSSR and Eastern Europe are encountering serious hard currency

problems caused by systemic deficiencies, accumulated hard currency debt, weak Western markets, and the Polish crisis. Private sources of long-term credit to Ihe Bloc have largely dried up. Poland and Romania arc unable lo meel iheir hard currency obligations and most of the Easi European countries will be forced lo curtail imports. The USSR slill has substantial shon-icrm flexibility bui its long-term hard currency earnings' piospecis are poor.

These problems give ihc Wesl an unusual opportunity lo influence Soviet Bloc developmenls, allhough there exists little direct leverage on ihese countries' policies. The main instruments of influence arc lhe volume and terms of new government-guaranteed credits and Ihe rescheduling of existing obligations. These actions can affect the Soviel Bloc's ability to finance hard currency imports both directly and through their impact on the willingness of private bankers to lend at their own risk.

Western financial restrictions would further curtail the USSR's abilily lo pay for hard currency import* innd would thereby increase Moscow's difficulty in coping wiih worsening economic problems,an already massive and rising defense burden. Hard currency shortages might force Moscow io weigh financial costs more carefully before embarking on foreign assistance programs or adventures. Such restrictions, however, would not force Soviel concessions in important areas of foreign or defense policies, such as Afghanistan. They could influence indirectly thc evolution of Soviet policies, although Ihc Soviet reaction might be eilher aggressive or accommodating.

Wiih respect to Eastern Europe, Western financial instruments -notably the handling of Polish and Romanianbe used as slicks ortrongly restrictive policy could trigger widespread debl default, which would hurl thc East European economies, force Ihe Soviet Bloc economics closer together, increase the burden on Moscow of supporting its empire, and also create risks for the stability of the international banking system. On the olheriberal Western financial policy would allow Hungary, andesser extent Poland, some flexibility in thc choice of economic and social policies, and Romania some limited independence in foreign policy. By the same token. Moscow's economic burden would be somewhat relieved

in

The West's ability to use what potential influence its financial instruments provide is substantially restricted, however, by differences between the United States and our West European allies as to lhe role and importance of trade with Ihc Fast The Europeans view this Irade as providing jobsime of severe unemployment and as creating mutual interdependencics that will tend to limit Soviet adventurism and provide bargaining chips with Eastern Europe. The European governments, like thc private bankers, arc concerned about excessive financial exposure to Soviet Bloc countries bul arc not willing to severely restrict trade with these countries.

Nevertheless, Ihe common ground which exists may be sufficient to support an informal agreement now that has the effect of limiting thc volume of new government-guaranteed credits and of lightening their terms. Such an agreement would not significantly reduce the USSR's import capacity. It could, however,ossible increase in imports by (I)egative political signal to private lenders, thereby strengthening their reluctance to make long-term loans to thc USSR;eading off possible attempts by West European governments to compensate for reduced private credits throueh larger or longer term government-guaranteed lending.

The Soviet Bloc Financial Problemource of Western Influence (u)

rends in East-West Economic Relation* Poliucal dcienle inelped toassive increase in the volume of East-West trade -morehreefold increase for ihr USSR andoubling for Eastern Europe. Trade with the West abo grewhare of most Eastern countries' total trade, with the most dramatic increase occurring foi the USSR. Thc importance of trade with lhco thc Eastern Bloc economies is greater lhan its share in their GNP would suggestercent in Eastern Europe and lessercent in tbe USSR) These countries all rely on thc West for critical imports of food, steel, and high-quality equipment.

The expansion of East-West trade wis aided by formal and informal encouragement byoosening of export controls,assive expansion of credit. In the, most of the Western credit was in tbe form of government-guaranteed loans for machinery and equipment sales. As trade surged, however, andmultiplied, ihe USSR and the East European countries entered private Wcsiern financial market*uch larger scale than before. For example, (he USSR and several East European countries adjusted to lhc unexpccled drop in foreign exchange earnings during5 recession by borrowingarge scale in the Eurodollar market. Encouraged by the detente atmosphere, the Communist OMntrics'payments record, thc belief that Communis) governments had thc power to undertake anyadjustment that financial circumstances might require, and thc assumption that tbc USSR would play the role of lender of last resort for Eastern Europe, Western banks competed with each other for loans to the Eastern Bloc By the end0 Eastern Bloc hard currency debtillionwith onlyillion1 J, or nearly SIOO billion if the debt of lhc CEMA banks ts included

Poland has incurred thc largest debt,illion The other East Fur opean countries have been more cautious, but Romanian, East German, and

Table 1

Deb*

Soviet Bloc Hard Currency Debt and Debt Service Ratio

Oiou Hard Currency Debt

OOO

uof bird currency

on medium- ,ad

MfWU

debt at a

table rt Secret.

Hungartandebt ranges betweenillionillion Tbe Soviet hard currency debt surged from less than S2 billion1 to over H0 billion in the, leveled off in thet about SIS billion as Moscow restricted its hard currencyand then began to rise again toillion (sec

The Soviet Bloc Hard Currency Problem- Areassessment of tbe risk of lending to Soviet Bloc countries has curtailed those countries' access to Western private credit and made some oflows vulnerable to new negativeThe Soviet hard currency position hasgreatly in recent months and long-term prospects are poor. Most East European countries cither cannot meet their hard currency obligations or must make severe economic adjustments to do so.

!

Thc severe deterioration of lhe Soviei and European hard currency positions has been due to the following factors:

Increasingly evident systemic deficiencies, resulting in declining growth of productivity and poor export performance.

Thc iogichl implications of Ihe rapid accumulation of hard currency debt in pastprocess which obviously could not continue unless hard currency earnings were also growing rapidly, which they arc not.

In the Soviet case, andesser extent in the East European countries, event) outside their control (Western recession, bad crops, lower oil and gold prices, high interest rates).

Thc Polish political crisis and economic collapse and its fallout

Tbe general worsening of East-West relations,in the past year.

These factors ledundamcnlal rcavtessment of ihe risk of lending to Soviet Bloc counlries, which in turn has curtailed those countries' access to Western private credit and made some of the remaining credit flows vulnerable to new negative developments. In tbe past few months, the possibility that Westernmight restrict or discourage credit to Eastern Europe has created added uncertainty in financial markets and has further discouraged bank lending.

The Sonet Problem. Thc Sovicl hard currencyhas worsened greatly in Ihe lastonths because of falling oil prices, bad crops, weak markets for other capons, and aid to Poland, and probably will remain difficult in the foreseeable fvlire. Last >ear. Moscoward currency assetsangerously low levels and has since had to sell large amounts of gold, expand ils ihort-icrm borrowing, and cutimports. With large gold reserves 'world somebillionold pricen ounce) and small fixed debt obligations (equal to less thanercent of

exportoscow has substantial flexibility to deal with its foreign exchange problems in the short run. Longer term prospects for increasing hardearnings, however, are poor.

The chances are that lhc volume of Soviet hard currency exports will stagnate or decline during the coming decade. Specifically:

Thc volume of Soviet crude oil exports has been declining for three years and, with domestic oil produclion likely to be at best constant and at worst in steady decline, it will be extremely difficuli lourther drop, and eventuallyomplete cessation, of oil exports for bard currency.

Gas exports will continue to increase, but notarge scale until the Yamal pipeline can bcwill probably not be before thc latter part of thc decade. Even then the increase in gas exports will probably less than offset thc decline in oil exports.

Arms exports for hard currency appear to have leveled off for lack of large new clients. Even current large customers, such as Libya, may have to pare purchases if oil export revenues continue to decline.

Other Soviet exports (wood, metals, manufactures) Uie likely to stagnate because of supply limitations and Soviet inability io adapt to Western market needs.

Without the Yamalizable decline in exports would be inevitable, even if Moscowsome of the gas lo ils own and Eastern Europe's use in order to free some oil for export lo the West With the pipeline and some good luck in oilthe volume of hard currency exports may be held about constant.

Moscow's main hope for sieable increases in hard currency earnings would be another large jump in thc prices of oil, gas, andthe case ofoil. an event that appears unlikely in Ihc next two or three years, but increasingly likely during the second half of.

2

Sovicl hard currency earning* arc stable orin the long lerm.! need to greatly increase its new borrowing from the West toecline -even more lo achieve an increase in its hard currency import capacity. But. unless thc new credits were on very easy terms, with long maturities, thc Soviel debt service ratio would reach dangerouswithinew years For example, with average maturity of new credits (other than forof five years, and continuation of recent interest rates, hard currency borrowings sufficient to raise import capacilyear would push up debt service ratios to betweenndercent5 and overercent or more

The Bail European Problem. Fast Europeanhard currency problem is far more severe than the USSR's. Their gold and foreign exchange assets are minimal and their debt service obligations are enormous. Leaving aside Poland, which islass by itself. East Germanyebt service ratio aboveercent, and the rest, except Czechoslovakia, arc all aboveercent These ratios put tbe East European countries in tbe same class as Braril. Mexico, and Chile, countries wiih far more flexible economies and generally rapidly increasing export earnings

Allhough1 private debt rescheduling agreement finally has been signed, Warsaw has next to no chance ofrge trade surplus or obtaining enoueh debt relief and credits io2 debt service burden of SIO billion. None of lhc possible outcomes to Poland's financial mess is likely to improve the prospects for borrowing by other East European countries.

Romania also is in de facto defaultroblem which, like Poland's, has hurt other Easi European counlries' ability to borrow. Bucharest's effori to reschedule its debt with banks is offmoother start, but several obstacles must be overcome to conclude an agreement Even with debt leltcf.wouldarge financial gap. After sharp import cutshere is less scope for adjustment without damage to the already strained demesne economy. Reserve* arc low and Romania is reluctant

to draw from its gold slock perhaps because some of il has been used as collateral for loans. Large, additional cuts in imports would set in motion an economic decline, such as has occurred in Poland.

East Germany and Hungary have multibillion-dollnr borrowing needs Ibis year, and they are virtually shut out of Western capital markets Banks have been reducing their medium- and long-term exposure for the past year, and, in recent weeks, some West European banks have reduced ibeir short-term lines of credil. Even if the cutbacks are modest. EastHungary, and Yugoslavia will face serious problemsut they might be able to get through by recourse to government-guaranteed loans, supplier financing, reserve drawdowns, and sharp import cuts.

Even if <listing debt were rolled over, the East European economies would at best limp along with little or no economic growth for tho next several years. It is important to keep in mind that Western credits played an important role inarge increase in investment in nearly all Easi European counlries during, and that Ibis investment was an important factor in sustaining tolerable. If generally slow, growth rates. Tbis important prop for inefficient economics bas disappeared

The Poteniial For leverage and Influrnce on the So-iel Blue

The Soviet Bloc's hard currency problems coupled with deteriorating economic performance throughout the Bloc preseni thc West with an opportunity toegree of influence over the USSR aod its Warsaw Pact allies. Sovicl Bloc dependence on Westernfor food, equipment, and technology gives the West thc opportunity lo use credits as an instrument of influence.

A reduction in the availability of Western credits to lhe Soviet Bloc would at least temporarily affect theapacity lo import Western goods. Fordeclining hard currency imports would pose serious problems. Inlower economic

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, l mil present lhc Soviet leadership withlough ind politically painful choices in resource allocation and economic management. Annuallo national output will be too small tomeel mourning investment requirements, maintain growth in defense spending at the rates of the nasi, and raise Ihc standard of living. Simply staled, something will have to give. Thc Soviet need for Western goods and technology will therefore increase greatly. Import* can relieve some economic problems by raising tlie technological level of key Soviet industries and by reducing shortages of grain and such important industrial materials as steel. Western equipment and know-bow will beimportant lo raising productivity in the critical machine-building and energy industries Tbe Soviets must continue importing large amounts ofproducts and will probably expand their purchases of steel and some other industrial materials

The main Western government policy instruments affecting the flow of capital to Soviel Bloc countries aie the volume and terms of government-guaranteed

credits, interest rate subsidies; rescheduling of pan government-guaranteed credits; and pressure onbanks Moreover, any official financial actions would surely have an indirect effect on the willingness of tbe private sector to lend at their own risk to tbe Soviet Bloc. Credits financed or guaranteed bygovernments make up about one-third of the Soviet Bloc's total hard currency debt- -with Poland, Ihc USSR, and East Germany having relied the most on sucb credits (see

Iht Direct Uvm. Western governments have at theirumber of direct measures lo influence Ihe flow of capital to lbc USSR and/or its Warsaw Pact alho

To illustrate tbe iirta impact of some such measures

A Jperceot increase in interest rates charged on lhe new government-guaranieedIbe recent increase in OECD Consensus rates for the

ruble 2

US S

llloc Dependency on Western Government-Backed Credits1

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at1 annual level would gradually increase interest payments for the USSR byear,ive-year repayment schedule and no grace period inThc cumulative effect ofolicyyear period, for example, would resultolal increase of interest payments of someillion for the USSR5 billion for thc Soviet Bloc, excluding Poland. It should be noted, however, the aggregate numbers slill pale in face of an East Bloc financing requirement cf hundreds of billions of dollars for al) of.

Ai tbeoratorium oo new government-guaranteed credits to Soviet Bloc countriescredits for the Yamal pipeline) would reduce tbe net flow of Western capital by amounts equalercent of1 level of hard currency imports. The effects would take some three to five years to be fully felt is the government-guaranteed creditsexisting commitments were drawn down.

Western creditors could also declare Poland in default of its obligationsesult of the initiatives of either private banks or Western government, but formal default would not of itself have much impact on Poland's capacilymport from the Wesl It would cause substantial but short-lived disruption* of Polish exports, thereby reducing earnings. Polish default could have severe repercussions for other East European counlries. and for Western banks. Private bankers* willingness to lend toother East European countries would bc even furtherNot only Romania, but also Hungary and East Germany could be forced into debtor. failing this, into de facto default.

The Indirect Impact. The greatest potential effects of Western government credit restrictions arc ofiteei nature Tbcy would come from the political signal restrictions on government-guaranteed credits would convey io private lenders II is highly unlikely that Western banks would be willing to resume unguaranteed long- and medium-term lending if Western governments were imposing politicallylimits on government-guaranteed credits Short-term lending might also contract, depending partly on

thc creditworthiness of the individual countries. To some extent, this effect has already been felt by the Bloc.

As things now stand, no Soviet Bloc country has received any mid- or long-term unguaranteed bank credit forear. Shorter term credit is available (except to Poland and Romania) but on less favorable lerm* than in the past. To dale, credit restrictions have come entirely from Ibe privateand noi from any specific Western government action. The current discussion over credit restrictions has contributed lo an atmosphere of uncertainty for lhe private banking community, however.

Pressure on ihe USSR could also be exened via Eastern Europe. Soviel trade with Eastern Europe helps to knit tbe Soviet empire together All the East European countries, except Romania, depend on the USSR for one-third or more of iheir trade (see tablencluding tbe bulk of supplies of oil, gas. and otber critical commodities. But Moscowigh price for this close relationship. By denying Easi European countries the possibility of developing economies and economic systems that could be reoriented mainly toward thc West. Moscow has little choice but to provide some direct and indirect forms of aid. Thc direct aid Is in the form of credits on bilateral account. Thc indirect aid takes the form of delivery of undervalued Soviet raw materials and foods in return for overvalued East European manufactured goods. Many of the commodities lhe USSR exports to Eastern Europe are also sold on the world market, generally at higher prices. The most important Sovietsold to Eastern Europe far below world market prices. Most of tbe Easi European exports can be sold on world markets only at severe discounts, if ai all, but the Soviets pay world market prices for them.

Before the Polish crisis and its negative impact on Soviet Bloc creditworthiness. Moscow had planned to reduce its price subsidies on oil exports to Eastern fcurope. thereby forcing painful economic adiusiments in those countries. The Bloc hard currency crisis reopens the issue of Soviet support.

Wr-rt

Table 3

Sotlei Bloc Trade Patterns0

fc'ipofu To

Countries

MJ

J*5

2)7

169

From

USSR

Prfinit

t: ill 'I,

Crcchcalavikii

rv

'iiigi na

TSii table in Unclassified.

worsening of the tail European hard currency and economic situation ii bound to impose additional burdens on thc USSR Moscow simply cannot afford to let thc East European countries go begging to the West byr alternatively lo let their economics deteriorate to tbe point lhat senousconsequences could follow Additional Sovietto Eastern Europe may or may not take thc form of hard currency, but, even if it did not, there would bc indirectly an unfavorable impact on the Soviet hard currency position. By lhe same token, an improvement in thc East European economic situationmake it caster for Moscow to reduce some of its economic burden of empire.

The Limitation'age and Influence on tht USSR. Ihi is not to sa> the West could force the Soviet Union to reverse btsx policies through the use of credit levers. Although Moscow could make good

use of increased imports from thc West to help relieve its serious and growing economic problems andaid lo Easternserve to reduce the Soviets' burden. Western credit policy used eitheregative or positive fashion would provide little direct leverage on the USSR. Il would be difficuli lo find any specific linkages between Western credit policies and Sonet militaryreign policies The East-West interface is simply not broad enough to permit policy quid pro auos which might be feasible given thc nature and limited scope of tbe economicand at tbc same time do not engage central issues of nalional power and prestige. On these central issues there is little chance that Western economic pressure on thc USSR would induce Moscow to beeenrc more accommodating For eaample. the thie.ii of Western credit resit tenons,romise to lift them once tbcy have been imposed, could not

6

SeertT

Moscow io withdraw from Afghanistan, or allow Poland to slip oul of thc Soviel power orbit, or concede significant military advantages to the West. Moreover, the Soviet economic problems archomegrown, and cannoi be greatly worsened by Western actions.

On thc other side, Western economic pressure could provide hardline Soviet leaders with an excuse for economicustification for continuingmiliiary growth at thc expense of tbe Soviet consumer,olitical rationale forore aggressive stance in foreign areas io show defiance of Western actions. There alsolight possibilityharp curtailment of Western credits could provoke Moscow tooratorium on the repayment of thcillion worth of debt to the Wesl.

Within these limits, there remains Ihe possibility that sustained Wctcrn economic pressure could influence Soviet policy choices. Restrictions on government-guaranteed credits, coupled wiih the likely negative reaction of private lenders, would increase the cost to the USSR of both civilian and miliiary programs and thereby exacerbate the worsening economic trends. It is reasonable to expect that the negative impact would fall particularly hard on Soviet programs requiring large foreign exchange expenditures. Such as foreign aid to or other involvements in Third World countries. Moscow might then give greater weight to costin their policy decisions concerning such programs Eventually, growing economic stringencies could lead to major changes in Soviet policies and priorities, although we see no sign tliat such changes are in ihe offing.

Leverage and Influence on Eastern Europe. Western economic leverage directed toward East European countries is potentially larger than that on the USSR because of their far greater dependence on economic relations with the West (tablend Iheir lesser concern with national power and prestige. Butleverage on Eastern Europe is also severelyby the present threat of Soviet military control and the self-interest of Communist leadership and elites in protecting thc existing political syslem. leverage.

Table

Soriet Bloc Imports From tbe De.eloped West

a Shan ot Total Imports

a Stare o( GNP

i

"

0

Germany

)

nclaWficrf

moreover,wo-way street. For example, West Germany for decades has traded economicto East Germany in return for limited rights of travel and access, and to Poland io return for ihe repatriation of ethnic Germans,

Poicntial Western leverage or influence in Eastern Europe varies from country to couniry. It is small in Czechoslovakia and Bulgaria, both countrieselatively small hard currency debt, close economic ties wiih the USSR and hardline political leaderships. Although West German economic leverage has been employed on East Germany, that country's central role in sustaining the USSR's East European empire and military position in central Europe leaves room for little political flexibility in relations with the West. Thc possibilities for Western leverage and influence are greatest in Poland. Romania, and Hungary. It should be noted, however, that realizing this influence requires use or both carrot and stick, for under present circumstances positive Western government actions will be necessary iourther curtailment of Western trade with these countries.

The potential for Western political influence inhas been greatly reduced by thc imposition of martial law and the political dynamics lhal ihis

aieerrt-

critical step scl in motion. Thc present Polishis unwilling lo share power in any meaningful way with the workers* movement, and the Soviets probably would not allow them to do so. This means ihai Western actions can affect only those aspects of thc Polish scene that arc considered politically safe by bolh Warsaw and Moscow. There remainsuncertainty, however, as to how Poland canorkable, if not efficient economy,olerable form of polilical control. Although theof martial law give the hardline elements in the Polishlear advantage for the present, competing political factions will push for diverse solutions, and there will be considerable uncertainty as to what will work, what is politically safeand what will bc acceptable to Moscow.

These uncertainties provide the West not so much with direct leverage on Ihc Polish Government, asotential for indirectly influencingmall way Polish internal policies. So long as formal default, and thc consequent legal scramble for Polish assets, can be avoided, reformist elements in Poland can hold out the hope of some new Western assistance in the future. Evenescheduling by Westernof2 official debt obligations, and/or acceptance of Poland as an IMF member, would provide clear signals of support for Polish policies if these were seen by thc West as moving in the right direction. By the same roken, formal default would probably foreclose these options and would leave Poland no alternative but to seek even greater Soviet support and economic integration into rite Sovicl Bloc. Allhough Moscow might welcome these added restraints on lhc restive Poles which would comeormal Polrsh default, it would bc very unhappy ai the prospect of adding to what it regards as an already excessive level of economic assistance.

The degree of Western influence on Poland should not bc exaggerated. Western actions cannot affectforeign policies in any significant way, its military position in thc Warsaw Pact, or itspolitical system. Even the politicallyscope of economic reform would be far less in Poland at this stage than in Hungary. Hungary was able toubstantial economic decentral-

ization, but only years after Kadar hadtable political base By contrast, Poland could expect any substantial decentralization of economicto quickly become highly politicized, and toa major threat to the party's monopoly ofpower.

In Romania, as in Poland, the mam Western policy issue is whether or not to reschedule debt service obligations, and on whatuccessfulwill not eliminate Romania's bard currency problems, which arc dccp-scatcd, noirastic slowdown in economic growth. But It could give Romania some options otherubstantialof its trade from the West toward the Soviet Bloc. In recent years, someercent of Romania's foreign trade has been with non-Communist counlries and less thanercent with the USSR. Should Romania be forced to makehift, the limited freedom of action Bucharest has been able to exercise in its foreign policy will almost cenainly be greatly curtailed. These expressions of Romanianfrom Moscow, allhough on largely peripheral issues, have been useful to the West On the otber hand, accommodating Romania's economic needs would involve substantial economic costs to ihe USSR

Hungary has developed broad economic linkages with thc West as well as the CEMA counlries andnique amalgam of central planning with elements of market economy without in any way threatening thc Communist Party's monopoly of political power or ihe country's altachmenl lo Moscow in foreign policy. There arc few indications thai Moscow has opposed Budapest's relatively liberal economic policies or would welcome an opportunity to reverse Ihem.lack of access to Wutera credits couldharp curtailment of Hungarisn trade with the West and consequently greater economic dependence oe Moscow. Hungary depends little oncredits,reat deal on medium-term private credits, and these are highly vulnerable to changes in market psychology Membenhip in thc

flint

would provide both an important new source of Itard currencyoost to market confidence in Hungary.

West European Perspectives and Interests The differences of perspective and interests between the United States and its European allies concerning economic relations with the East make it difficult to find common ground on which to base joint financial restrictions aimed at the East and thus limits our abililyxercise that leverage which exists.

The broadest agreement among the allies is in thc private sector. Bankers throughout the West are concerned aboul their financial exposure to Soviet Bloc countries and would like to reduce it. They consider themselves particularly overexposed inEurope but also have become increasingly aware of the extent ofthe USSR's long-lerm hard currency problem. Moreover, they see the severe worsening of East-West relations in Ihe past two years or so as substantially increasing the political risk involved in any long-term lending lo the Bloc.

To some degree the reduction in thc East Bloc's creditworthiness tn the private sector is reflected in thc attitudes of Western governments. As mentioned before. Western governments do not want lo be saddled with thc heavy budgetary costs that would be entailedarge-scale bailout of private bank exposure under government guarantees. Moreover, most Western governments probably agree that they have excessively encouraged credit to the Bloc in the past and would prefer to reduce or eliminate the Subsidy element in ihis lending in thc future.

This common ground becomes severely limited,by the following considerations:

Trade with the East is still viewed by Ihe Europeans .is promoting Ihcir economic, political, and strategic interests West Europeans view this trade asjobsime of severe unemployment and as creating mutual interdependences which will lend to limit Soviet adventurism and provide bargaining chips with Eastern Europe.

They give little weight to lhe argument lhal East-West trade buttresses Soviet military power because of its small size in the overall Soviet economy and the long-established priority given to the Soviet military

They are even more reluctant to reduce trade with Eastern Europe than with thc USSR because of their greater bargaining power with thc Eastcountries, the close bilateral economic,and cultural tiesumber of them, and the belief (or rationalisation* ihat Western influence can spread through Eastern Europe and eventually to the USSR.

Moret-West trademall role in thc West European economies but is important to certain industries. Even for West Germany, which accounts for aboul one-fourth of OECD exports to tbe Soviel Bloc, sales to the East amount to onlyercent of total exports and direclly provide jobs farercent of tbe labor force- The relative importance of trade witb the Soviet Bloc increased sharply in the, but has since beenand is now nearly bach to what it was0 (see table 51

Nevertheless, Ihe West European countries consider tbeir trade wiih lhc East lo be important for both economic and political reasons:

mall part of total trade, trade wiih ibe Soviet Bloc is one of tbc most important sources of expon earnings from outside the EuropeanIn the case of West Gennany and France, exports to the Bloc about equal those to the United Stales and are far larger than exports to Japan.

About one-half of Wesl European export! to the Soviel Bloc and the USSR consist of machinery and sieel The Soviet Bloc, especially the USSR, is an important market for West European steel and for some types of machinery For ctamptc, it accounts for aboutercent of West German and 12

TaWe5

Soviet Bloc Share of WesternW

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1

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1

s

5

A

2

J

i

1

ublc ii UniUiitflcil

of Italian Heel exports. Some Westplanls are almost exclusively depcndenl on thc Sovicl Bloc market

During thc current Western economic recession, there are few alternative markets for exports to the Soviet Bloc The United Slates and Western Europe are giving priority to fighting inflation Many less developed countries, facedassive debt burden and depressed prices for their primaryexports, art forced to curtail imports Falling oil revenues are greatly slowing giowth of tbe OPEC market. Consequently, any source of increased or sustained demand is important to thc WestMoreover, the steel industry is in secular decline, so that orders from ihe Soviei Bloc arc important in cushioning thc needed adjustment in employment and plant capacily.

Perhaps rnoal imporliinl, the Europeans see lhcir political and security inicresls besi served byeconomic conlacts with Eastern Europe and lhc Soviet Union to promole polilical and economic stability there and toeb of interdependence between East and Wesl. For West Germany, moreover, lies with the Easi are vitally important in keeping alive thc ideal of German reunification andigh level ofcontacts between West and Easi Germans.

Although some groups within the Weal European countries such as certain conservative political par-

ties and thc miliiarysympathetic to the view that Western exports to the East Bloc have at leasl indirectly supported Soviet military efforts, these particular groups generally have bad little say in trade and credit matters. European business interests and trade officials have consistently promotedtrade with thc East as has most of tbe foreign policy esiabluhmeni

For all these reasons tbe West Europeans lookon iradc *itb tbc East and are reluctant to restrict this trade except where its specificto Soviet miliury strength can be demonstrated. Among our major allies. Wesl Germany and France have the strongest economic and political stake in economic relations with the Soviei Bloc Italy loo has substantial lies with Ihe Bloc UK interest isless, however, and Japan's is smaller than that of any Wat European country.

Thc major West European countries have usedcredits as an important means of increasing exports lo lhe Soviet Bloc. These credits are particularly important in financing exports to the USSRarge ptoportion of ihose exports are for major projects, such aseline* and chemical planu. which requite long-term credit financing. Aboulercent of exports to tbe USSR, including Ihe bulk ol exports of machiner. and steel from the major West European countrieseen financed

Aanii

by government-guaranteed credits. At least Tor the next few years, thc Western governments willilemma. They are loath lo increase an already large budgetary exposure to bank credits which arc seen as increasingly risky for both economic and political reasons. On the other hand, they are under pressure al least to maintain exports to the Bloc by providing increased credits under government guarantees to offset the decline in Soviet Bloc access to the private credit markel.

For alt these reasons it is highly unlikely that our European allies will accept any restrictions oncredits lo the USSR or to Eastern Europe which would have tbe effect of forcing sizable reductions of East-West trade. They may be willing to accept some sort of dc facio ceiling on credits or on debt exposure and some further reduction in interest subsidies, but any such agreement is likely to be informal and flexibly applied.

The European governments are extremely concerned withpread of the Polish financial crisis lo thc rest of Eastern Europe. They would very much like lo see Poland's and2 debt service obligations rescheduled and generally would like both Hungary and Poland to join the IMF. In addition, the West Germans warn to avoid any public discussion of East Germany's precarious financial posilion, for fear thai they will have to confront much more openly and dramatically thc inconsisiencies between economic actions designed to maximize contacts with East Germany and West Germany's key role in lhealliance and lhc European Community.

The strong West European views on proteciing their economic tics wiih Eastern Europe give the United States some potential leverage with its allies, since ihese may be willing to trade off some moderate restrictions on credits lo thc USSR in return for some (IS cooperation on Polish and Romanian rescheduling and Polish and Hungarian IMF membership

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