Gorbachev’s Empire on the Cheap

By ROGER W. ROBINSON
The Wall Street Journal, MARCH 16, 1990

Moscow has shown its hand in Lithuania. Mikhail Gorbachev’s demand for hard currency compensation equivalent
to roughly $33 billion from a nation of some 4 million people speaks volumes about how far the Kremlin is prepared to
go to preserve its fragmenting economic base. This is just the beginning of a new Soviet strategy of siphoning hard currency
from Eastern Europe and the Baltic states while simultaneously increasing Western financial, trade, technology. and energy-related contributions to Moscow. Mr. Gorbachev will also rely on economic leverage to sustain Soviet influence in the
region. The West is planning to give it to him — in the form of the European Bank for Reconstruction and Development.

Unfavorable Prospects

This is not to imply that the Soviet Union’s prospects for the preservation of empire in the l990s are favorable. The
accelerating deterioration of Soviet creditworthiness in Western financial markets, despite the new resources to be drawn
from Eastern Europe, could be Moscow’s undoing. Reports of serious payment delays to Western suppliers totaling as
much as $500 million by key Soviet enterprises, such as Mashinoimport and Syuzkhimexport have already triggered the
need for some Western governments (ea. Britain, France, and West German ) to intervene with Moscow on behalf of their
companies. Meanwhile, several prominent Western suppliers to the Soviet market have halted deliveries pending the
elimination of arrearages.

To combat further slippage in Western private sector confidence in the Soviet Union, the leadership is vigorously
constructing a financial safety net drawing on Western and Eastern Europe, Japan and the U.S. Eastern Europe and the
Baltic republics are being told to pay in hard currency for oil and gas deliveries. The West will probably provide
substantial credit through the proposed development bank and loan guarantees. Japanese and American investors are being
offered Soviet bonds and other debt instruments. A limited ruble convertibility may also be proposed, prior to price reform
and full Soviet data disclosure.

Energy: With the exception of Romania, Eastern Europe is almost completely dependent on the Soviet Union for its
oil: Bulgaria 88%; Czechoslovakia 99%; East Germany 123% (East Germany imports more Soviet oil than It consumes
and reexports the surplus), Hungary 99%; Poland 93%; and Romania 28%. Czechoslovakia already has been informed
that Moscow will be able to deliver only 18% of this year’s contracted amount of crude oil in the first three months of 1990.
The Soviets are promising to make up the shortfall later in the year, but the Czechs have their doubts.

If Eastern Europe and the Baltic republics were to pay world prices for Soviet oil and gas, Moscow would earn an
additional $14.6 billion annually — a sum that could swell its annual hard currency income by some 40%. A large share
of Western assistance to Eastern Europe will likely exit out the back door to Moscow in the form of energy and other trade
and service payments. As a result, the Soviet Union will become a major, if unintended, beneficiary of Western efforts to
assist economic revitalization in Eastern Europe.

Development Bank: The Soviets have long regarded their East European allies as targets for exploitation. Now they
appear to be ready to exploit those countries again, this time as conduits to Western largesse. The European Bank for
Reconstruction and Development, a multilateral institution being created at the instigation of French President Francois
Mitterand, is a probable Soviet vehicle.

The bank’s mandate, as originally conceived, was to help fund economic revitalization in Eastern Europe along the lines
of the postwar Marshall Plan. Since Mr. Mitterand first floated the idea last December, Moscow’s objectives toward the
bank have been clear: Mr. Gorbachev in tends to put the Soviet Union in a position to influence decisions on the allocation
of bank funds and to receive credits itself.

The Bush administration recognized this danger from the outset. It initially opposed granting the Soviets any
participation in the new institution at all, much less a presence in both the board room and at the teller’s window. Japan
stood firmly with the U.S. Unfortunately, the Western Europeans insisted not only on full bank membership for the Soviet
Union but on Moscow’s right to borrow from the bank. In the face of European pressure, Washington’s resistance quickly
collapsed and Tokyo found itself isolated.

Now the U.S. is urgently trying to limit the damage by demanding that the percentage of bank funds that the Soviets
be permitted to borrow not exceed 6%-the same proportion as Moscow’s contribution to the bank’s capital. Reportedly
fearing pressure from U.S. conservatives, Treasury Secretary Nicholas Brady has gone so far as to threaten U.S. withdrawal
from the bank if this demand is not satisfied.

The final decisions on the scope, management and lending policies of the bank are scheduled to be made early next
month. Current plans call for the bank to be capitalized at $8.3 billion, with the U.S., France, West Germany, Italy, Britain
and Japan each contributing 8.5%. As things stand, Moscow can count on full membership in the institution and eligibility
to receive concessionary loans.

U.S. Trade Concessions: The development bank is not Moscow’s only hope for hard currency from the West. The
Soviet Union intends to use the U.S.-U.S.S.R. Trade Agreement to be signed in June to eliminate two major legislative
obstacles to its financial strategy: the restrictions on access to U.S. Export-lmport Bank credit programs and to the U.S.
securities market. Access to Eximbank credits and guarantees would transfer Soviet credit risk
from private U.S. lending institutions onto the shoulders of American taxpayers. This “risk transfer” would represent a new
U.S. subsidy to Moscow by artificially lowering the cost of credit to the Soviet Union.

Should the U.S. agree to settle the Soviet Union’s old czarist and Lend-Lease obligations for a few cents on the dollar,
the Soviet Union would be legally permitted to issue debt instruments to U.S. pension funds, insurance companies, leasing
firms and even individuals. These loans will not only expand Moscow’s borrowing base, they will bring into being
powerful new constituencies with a vested interest in economic and, inevitably, political conces- sions to the Soviet Union.

Ruble Convertibility: Of course, those investors may demand early convertibility of the ruble. But this can be handled
adroitly. Just as Moscow began to issue bonds to Western lenders in 1988 without meeting standard data disclosure
requirements, it will probably be able to get away with limited ruble convertibility. For example, a batch of gold and/or
oil-backed rubles could appear in the next 12-18 months that would, in a way insulated from the Soviet domestic economy,
transform virtually worthless rubles (or rubbles as they are known) into West German marks, Swiss francs and yen.

There are things that can be done to forestall Mr. Gorbachev’s strategy of absconding with Western financial aid to
Eastern Europe and the Baltic republics. The newly elected governments of Eastern Europe and the Baltic states should
immediately diversify their energy sources. The West could help them to hold Soviet supplies to 30% of their total oil and
gas consumption mirroring the intent of the International Energy Agency Agreement of May 1983 for Western Europe’s
dependence on Soviet gas.

Secure Energy

During the vulnerable period of supply diversification, potential Soviet energy supply shortfalls could be covered by
the creation of a Contingency Energy Fund for the countries of Eastern Europe and the Baltic states. The development bank
might also be assigned the job of accelerating indigenous energy development and access to more secure Western energy
sources.

Western governments should be extending credits and guarantees only to countries that are genuinely committed to the
paths of free markets and political pluralism. If private Western lenders and investors want to do business with and in the
Soviet Union, that is their right. But tax payers should not be asked to provide yet another subsidy to the Soviets. In any
case, untied, general-purpose lending to sovereign borrowers has proven to he commercially unsound.

As Lithuania is discovering the hard way, Moscow has already developed its policies of economic leverage. The West
in general — and the U.S. in particular — should have its own cards ready to play in the event that Mr. Gorbachev continues
down the road of not-so subtle financial extortion.

Mr. Robinson, a Washington consultant, was National Security Council senior director for international economic affairs
in 1982-85.