“Trade and Financial Relations with the Soviet Union: A Risk Assessment”

Remarks of

Roger W. Robinson, Jr.
President, RWR, Inc.
former Senior Director for International Economic Affairs
at the National Security Council (1982-1985)

Before the Conference on
“Should You Build New Markets in the Eastern Bloc?”
sponsored by
Washington Publications

November 9, 1989
Hyatt Regency Hotel

(Washington, D.C.): I am pleased to have the opportunity to
speak before this conference sponsored by Washington Publications
on the high velocity changes within the East bloc and their
impact on Soviet “country of risk” considerations. With
the mini-summit between Presidents Bush and Gorbachev less than a
month away, it is a propitious time to take stock of conditions
within the Soviet Union and how they might affect the outcome of
this supposed “non-agenda” “non-summit.”

Perestroika’s Ledger

Many analysts have tried to catalogue developments over the
past 30 days or so on both sides of the perestroika ledger.
Looking at the brighter side, analysts typically point to a
number of events, notably:

• the Soviet admission that the Krasnoyarsk radar station
  is a violation of the ABM Treaty;
• an acknowledgment of the illegality of Soviet
  intervention in Afghanistan;
• the declaration of a “Frank Sinatra doctrine”
  to replace the Brezhnev doctrine in Eastern Europe;
• newly promised cuts in defense spending and conventional
  forces;
• the process of more contested elections, parliamentary
  proceedings, and historical debate;
• a more realistic conversion rate of the ruble — at least
  for tourists; and
• a “blueprint” for more radical reforms drawn up
  by leading Soviet economic advisors such as Deputy Prime
  Minister Leonid Abalkin.

On the darker side, we see:

• a 15 month ban on strikes for all essential sectors of
  the Soviet economy;
• a recent Soviet opinion poll which found more than 90
  percent of those polled believe the economic situation of
  the country is bad or critical with no short-term
  solutions likely;
• a chilling rebuke of press freedoms;
• further restrictions on the profits and activities of the
  private cooperatives;
• stepped up technology theft, disinformation, and
  espionage activities;
• continued modernization and deployment of strategic
  nuclear forces, including mobile ICBMs, and
• rising unemployment, shortages, inflation, indebtedness,
  and consumer dissatisfaction;

The international debate on the prospects for perestroika has
heated up considerably. The CIA and many experts on the Soviet
economy view those prospects as increasingly doubtful,
particularly subsequent to the debilitating strikes in the Soviet
Union in July. Intensified labor unrest and nationalities
problems have been exacerbated by flat to negative real economic
growth leading several Soviet commentators to express publicly
their anxiety over the consequences of a harsh winter.

In short, Mr. Gorbachev is running short of time — perhaps as
little as 12-18 months — to prevent events from reeling out of
control and jeopardizing the positive momentum of his reform
movement. It is likely that his urgent economic predicament and
the need for large-scale Western economic, financial, and
technology assistance is a prime mover behind the interim
December summit.

Press reports indicate that Gorbachev has put the Bush
Administration on notice that he wants “patience and
cooperation” when he is obliged to take steps which have
euphemistically been described as “seemingly inconsistent
with his goal of democratizing Soviet society.” Indeed, a
high-level Administration official just last week offered the
view privately that the chances of repressive Soviet behavior are
“increasing almost daily.” Hopefully this will not
occur, but the possibility, particularly over the course of this
winter, cannot be ignored.

December Summitry

To help mitigate Mr. Gorbachev’s increasing risk of social
upheaval, he needs both symbolic and substantive results from the
December summit in the Mediterranean. Perhaps foremost in the
summit communique is Moscow’s desire for a joint declaration
which states that, in effect, the Cold War has been dropped over
the side of the naval vessels with heavy weights attached.

Second, the importance to Mr. Gorbachev of “proper”
political signals sent by the United States to allied capitals,
particularly Tokyo, cannot be sufficiently underscored. The
principal reason for this is that the billions of dollars of
Western capital required by Moscow to jump-start its stagnant
economy are not expected to come from the United States due to
budgetary and other constraints. Rather, the benefit of a
forward-leaning U.S. posture toward helping ensure perestroika’s
success is its catalytic effect on “deep-pocket” allies
which can offer multi-billion dollar government guaranteed and
private credit facilities. In some cases, these American
political signals are required to offset an otherwise restrained
attitude toward greater trade and financial exposure in the
Soviet Union. For example, Japan evaluates Soviet commercial and
political risk more skeptically than the European allies and has
also held back, to date, on large government-backed credits
pending resolution of the dispute over the Northern Islands.

Third, the USSR wants to achieve a quiet settlement on
defaulted czarist and other debt to the United States, thereby
excluding Moscow from the restrictive provisions of the Johnson
Debt Default Act of 1934. This development would pave the way for
Soviet entry into the U.S. and other Western securities markets.
The Kremlin believes it is crucial for the Soviet Union to
establish itself in the securities markets now in the event that
perestroika begins to dip beneath the waves and access to private
credit markets is limited by deteriorating creditworthiness. It
would also be of immense political value for Moscow to recruit,
over time, powerful new constituencies in the West such as
securities firms, pension funds, insurance companies and private
investors which would have a financial vested interest in helping
underwrite perestroika’s success. To my mind, the extent to which
the Bush Administration is willing to look the other way or even
support the sale of Soviet bonds in the United States will be the
litmus test of how far the President is willing to go in helping
Gorbachev and perestroika with the funds of the American people.

Fourth, Mr. Gorbachev probably wants to discuss and resolve a
list of particulars which include some or all of the following:

• movement toward the waiver of the Jackson-Vanik and
  Stevenson amendments;
• a U.S. commitment to advance immediate Soviet observer
  status and eventual membership in the GATT, IMF, the
  World Bank and the Asian Development Bank;
• relaxation of export controls on militarily relevant high
  technology;
• U.S. support for near-term, limited ruble convertibility
  in advance of price reform; and
• an informal U.S. agreement to help with the exploitation
  of strategic Soviet energy resources and to ignore the
  International Energy Agency Agreement of May 1983 which
  places a ceiling on Soviet natural gas deliveries to
  Western Europe.

The U.S. Response

Given Gorbachev’s probable economic wish list, how will
President Bush likely respond? In reaction to congressional,
media, and allied charges of timidity and excess caution, the
President and Secretary Baker will probably seek to demonstrate
that they are indeed seizing this “historic
opportunity.” Accordingly, the Soviets will probably emerge
from the summit relatively satisfied that the desired tone and
substance of their summit objectives were acceded to by the Bush
Administration. Moreover, it is very plausible that the kind of
intense focus by the alliance and the Congress on the plight of
Poland and Hungary will be replicated with the USSR. A striking
feature of this probable U.S. activism toward the USSR will
likely be a greater emphasis on official, taxpayer-supported
credit and trade programs. Although private Western companies and
banks will continue to be encouraged by the G-7 governments to
expand business activities in the USSR, the volatile Soviet
economic and political situation will probably be somewhat
limiting.

Global Priorities

As changes in Eastern Europe are truly momentus in nature and
moving at a breathtaking pace, it is useful from an investor’s
standpoint to step back and examine the relative risks associated
with entering the markets of the USSR and Eastern Europe versus
opportunities elsewhere. This is particularly useful when one
considers that the resources of multilateral financial and trade
organizations, bilateral government credit programs, and private
capital flows are finite with many competing country claimants.

For example, most Western companies are appropriately focusing
their trade and investment decisions for the 1990s on the
“Big Three” — the U.S.-Canada free trade zone, the
European Community, and the Pacific Rim countries. Outside these
markets lie the so-called “higher risk” regions, such
as the Soviet bloc and the high debt developing countries,
principally in Latin America.

The conventional wisdom, as portrayed by the media and the
lending policies of many Western commercial banks, is that there
will be a greater return to lending in support of East-West
trade, than North-South. For example, the decision by three U.S.
money center banks to bolster by some $4 billion their loan loss
reserves for developing country loans has touched off a spate of
skeptical commentary on prospects for the Brady debt reduction
plan and North-South economic relations. As Willard Butcher, the
chairman of Chase Manhattan Bank, said succinctly during the
September IMF/World Bank meetings, “Debt forgiveness and new
money are incompatible.” If he is right, as the Mexican
package may illustrate, the Brady Plan is in serious trouble.

In my earlier days as a lending officer at Chase, I was
constantly schooled in the need to “get behind the
numbers” when dealing with sovereign borrowers — not
necessarily to accept the conventional wisdom, but examine the
hard realities. I am concerned that many Western commercial banks
and companies are ignoring this sage advice.

This is not just an academic exercise — there are potentially
huge stakes involved. At the heart of current policy
deliberations are multi-billion dollar decisions about where the
commercial banks will choose to extend new credits, where
companies will invest over the long haul, and where the stretched
resources of multilateral financial institutions and government
export support programs will be concentrated. Which region — the
East or the South — will receive the most favorable and flexible
treatment at the hands of creditors, and which will enjoy
priority access to OECD markets?

There are several signs of the new preferred treatment for
perestroika and East bloc countries. Already, the U.S. and some
EC governments are beginning to direct their trade development
programs, (such as the Overseas Private Investment Corporation)
and government-guaranteed credit lines toward Hungary, Poland and
the USSR. Poland will almost surely be awarded a generous
rescheduling of government debt in the Paris Club and large new
official credits without having first implemented an IMF
adjustment agreement — a concession with few precedents. Eastern
Europe since 1980 has generally benefited from lower interest
rates and easier terms than most sovereign borrowers in the
developing world. And some Western policymakers are calling for a
Marshall Plan equivalent of economic assistance for certain East
bloc nations and possibly the USSR.

Such policy maneuvers are having a substantial impact on
global trade and investment flows that may end up actually
reducing markets for many Western companies involved in
international trade. Rather than creating new business
opportunities, large-scale economic and financial assistance to
East bloc countries (including the Soviet Union) could, if not
properly managed, create a kind of sinkhole for precious Western
resources at the direct expense of many developing countries. For
example, just last month at the Third Annual Summit Meeting of
seven Latin American heads of state, President Alan Garcia of
Peru warned that the region’s $30 billion in annual debt service
payments could end up financing the East bloc. Such is the
growing competition for a limited pool of Western capital between
our neighbors to the South and the reforming nations of the East.

The most striking feature of this apparent shift in emphasis
— from North-South to East-West — is its departure from market
realities. The fact is that while systemic economic reform is
making real headway in several developing countries, notably
Mexico, not a single East European nation can point to sustained
economic progress from working with the IMF. If anything, the
rule seems to be that IMF programs in this region — such as
those in Yugoslavia, Hungary, and Romania — have, to date,
brought economic dislocation without laying the foundations for
more enduring prosperity.

Indeed, it is ironic that the healthiest economies in the East
bloc — East Germany and Czechoslovakia — are among the most
rigidly controlled. Far from applauding Stalinism, I am merely
pointing out — as Poland, Hungary, and the Soviet Union have
discovered the hard way — that half-way economic reforms can be
worse than no reforms at all. They raise false expectations,
impose painful social costs without measurable returns, and
squander valuable capital, time, political momentum, and the
goodwill of suppliers and creditors.

Shift in Western Economic Policy

As reality sets in, I think you will see a conservative shift
in Western economic policy toward the Soviet Union, as opposed to
the strategy of large-scale assistance originally crafted by FRG
Foreign Minister Hans-Dietrich Genscher. Many opinion leaders,
such as Senator Bill Bradley, are persuaded that major infusions
of Western capital and technology into the Soviet Union will
retard, not advance, genuine systemic reform. I share this view.
This game of “lowered expectations” is already being
played out in Poland and Hungary, which are experiencing the
limits of Western largesse, despite sincere and radical reform
efforts.

The West’s increased caution, which I believe will return
after a brief absence, will probably be based on a recognition by
finance ministers (not diplomats) that the IMF, World Bank, and
other multilateral institutions may well be powerless to
stimulate enduring systemic change in Eastern Europe and the
USSR. The absence of markets, the crushing embrace of central
planning emanating from Moscow under the auspices of the Council
for Mutual Economic Assistance (CMEA), and the region’s debt
burden are seriously stalling the reforms.

Whether Gorbachev can manage the turmoil within the Soviet
Union is anyone’s guess. His accommodation of the expensive
demands of Soviet miners — which Moscow’s budget clearly cannot
afford — could be interpreted by other industry groups as a sign
of weakness to be exploited. Failure to deliver on Moscow’s
promises to the miners, which is already in evidence, could spell
disaster. Should Mr. Gorbachev continue to try to sustain his
popularity through, in effect, buying off interest groups, his
reforms will likely collapse. Polish governments have been down
that dead-end road several times in the past.

A collapse of perestroika, at least as currently configured,
and its replacement by a more radical program — a kind of
perestroika II — may not be the worst thing that could happen.
For example, such a development could force Mr. Gorbachev or his
successor to come up with a systemic, market-oriented program
that looks beyond the failed Yugoslav model of market-socialism.
He might finally see the wisdom of dislodging the military
establishment from the commanding heights of the economy and
hence the priority recipient of high quality Soviet resources.
Cuba, Vietnam, and Nicaragua would probably lose much of their
subsidies, making them more amenable to settling regional
disputes. Eastern Europe might be freed from the debilitating
drain of thousands of CMEA trade obligations, thereby helping to
diffuse the region’s debt bomb and create new markets for U.S.
goods.

Conclusions

The scope of this talk has by no means touched on the full
range of so-called “country of risk” considerations
needed for a proper analysis of investment opportunities in the
Soviet Union and Eastern Europe. Among a number of other issues
requiring evaluation are:

Limited Soviet Income Potential

• Total Soviet hard currency income annually only
  represents about one-third of General Motors’ total
  yearly sales (roughly $ 35 billion);

Narrow Soviet Export Base

• 80-90 percent of Moscow’s total annual hard currency
  earnings stem from just four export items (oil, gas,
  arms, and gold), commodities which face substantial price
  and market volatility.

Questionable Strategic Gold Reserves

• According to a recent defector, Soviet leadership has
  reportedly been spending portions of its strategic gold
  reserves since the beginning of 1987 in expectation of a
  turn-around in perestroika’s fortunes which has not yet
  materialized.

High Debt Levels

• Moscow’s total gross indebtedness of between $46-$50
  billion is more than double the amount in 1984.

Rising Soviet Debt Service

• The USSR’s debt service ratio has nearly doubled since
  1984 to about 28%; and

Heavy Recent Borrowing

• Average new borrowing from the West in the first half of
  this year of roughly $1 billion per month (adjusted for
  exchange rates) is considerably higher than usual.

Deteriorating economic conditions within the USSR and the
possibility of sudden adverse changes, such as new strikes by
miners or transport workers and incidents of repression against
restive workers or ethnic groups, are beginning to be reflected
in slightly higher interest rates on Western credits. Moscow’s
heavier borrowing in the West may be signaling the gradual
abandonment of traditional Soviet financial conservatism. China’s
recent unexpected retreat from more developed economic reforms is
also a sobering lesson for Western business, particularly when
examining the issue of “irreversibility” in the Soviet
Union. Finally, the wholesale flight of East Germans to the West
and increasing political disarray in the GDR presents Mr.
Gorbachev with an immediate challenge that probably cannot be
finessed.

On the other hand, if genuine and enduring Soviet
liberalization becomes evident in concrete terms and Mr.
Gorbachev continues to prosper politically, he would be rewarded
handsomely by international markets, almost irrespective of U.S.
policy. For example, continued movement by Moscow in the
direction of conventional and strategic force reductions and the
steady conversion of military infrastructure to civilian
production would help bring about a truly “defensive
defense” posture in the USSR for the 1990s and beyond. Full
data disclosure across the spectrum of the Soviet economy and the
implementation of perestroika II — or the fundamental
transformation of the system called for by more radical Soviet
economists — would probably result in the reappearance of
increasing Western investment and lending confidence.

As far as Western governments are concerned, they should keep
two factors firmly in mind — precedents and market realities. As
some 40 hard-pressed developing countries are beginning to
scrutinize the levels of new money, debt forgiveness, and trade
preferences accorded the East bloc by G-7 governments, the
possibility of serious political resentment could well emerge.
Dr. Lawrence Brainard, senior vice president and economist at
Bankers Trust was pointing to such a possibility when he recently
stated, “U.S. security issues associated with debt in
developing countries have received much less attention than those
relating to Eastern Europe.” When it comes to market
realities, it is a matter of remembering in which region Western
and particularly U.S. exports and jobs have the largest stake.

Let us hope that over the period ahead, introspective
experimentation and boldness characterize the policy tools used
by Soviet leadership to affect great change in the USSR, not
repression and retreat. While tightly-structured smaller
investments in the Soviet Union could have near-term profit
potential, it may be wise for Western business to keep the
corporate powder dry on larger, longer-term exposure until it is
determined which path is selected by Moscow over the next twelve
months.