DROWNING IN A SEA OF IOUs
Lajos Bokros is sitting on a time bomb. Like most East European bank chiefs, he is stuck with hundreds of millions of dollars in bad loans to state enterprises left over from the communist era. But instead of waiting for a miracle turnaround to bail out his balance sheet, Bokros, chairman of the state-owned Budapest Bank, is trying a radical cure. With the little spare cash he can muster, he is buying out delinquent debtors, firing old-line managers, and trying to clean house himself. His latest target: the Hungarian capital's Ganz Danubius shipyard. "It's risky," Bokros concedes. "If I fail, I lose $13 million," 20% of the capital of his bank.
Bokros is one of a new breed of bankers struggling to clean up the financial mess that communism's central planners left as their legacy. Despite the progress that Czechoslovakia, Hungary, and Poland have made over the past three years in freeing prices, controlling inflation, and promoting private enterprise, the toughest job is just beginning.
That's because it's proving far tougher than anyone dreamed to lead these three former Soviet satellites down the path to something akin to market capitalism. Their financial systems suddenly loom as the toughest nut to crack. If the region's $24 billion in bad domestic debts aren't tackled soon, a wave of bankruptcies and bank failures could snuff out entire industries and choke off the economic recovery that now seems close at hand (tables, page 112). Even a successful resolution of the lending morass will force a painful restructuring on state and private borrowers, leaving many money-losing industries starved for precious credit. Thus, it's no wonder that Russia and other former Soviet republics (page 104) are watching Eastern Europe's lending crisis with trepidation.
Despite $7 billion in foreign investment, the enormous weight of old debt has been a persistent drag on Eastern Europe's financial system. To keep companies afloat and citizens working, its banks have poured billions into dog-eared state industries already deeply in debt even before communism's collapse in 1989. That has left banks with nearly half their assets worthless, which has stalled lending for industrial restructuring and slowed privatization and the growth of capital markets.
OLD-FASHIONED. Worse yet, save for a few small-scale demonstration projects, major foreign banks have been unwilling to fill the gap that was left by the hard-pressed local lenders. So government officials, Western consultants, and local bankers are now rushing to craft strategies that they hope will bring the debt mess to an end by the mid-1990s. Says Slawomir Sikora, the Polish Finance Ministry's banking-reform chief: "We can't succeed unless we restructure industry and banks at the same time."
While the Warsaw bourse boasts an electronic trading system that has been modernized, retail banking is still mired in communist times. Take Michal Rozycki, a Warsaw translator, who recently drove all the way to Paris just to pick up a $1,000 check. Although the round-trip took 30 hours, "it would have taken months to deposit the check through the mail."
Perhaps because of such torpor--not to mention the region's biggest foreign debt and worst economic problems--Poland is taking the most aggressive tack in remaking its banks. A law working its way through the Polish Parliament would give the nine large state-owned banks a onetime capital injection of at least $1.9 billion if they force delinquent debtors to restructure or liquidate within one year. That would mean each bank puts the screws to about 250 large borrowers, from ailing coal mines to bankrupt shipyards. If they don't, officials vow, the banks--and their borrowers--could be left to fail.
Finance Ministry officials insist their program will be more effective than letting government bureaucrats decide which companies will live or die. They reason that a bank that is itself fighting to survive won't be as vulnerable to outside pressure as a government that can be easily voted out of office. New governments in Czechoslovakia, Hungary, and Poland have all learned that lesson. Removing bank and industry reform from direct government control was the logic behind Czech Prime Minister Vaclav Klaus's "coupon privatization" scheme. Launched earlier this year, the first round will put 1,450 state-owned enterprises, including state banks, in private hands by Dec. 31. As in the Polish plan, company managers, rather than bureaucrats, will be left with the task of restructuring. However, to help banks prepare for private life, Czechoslovakia has set up a version of America's Resolution Trust Corp. Dubbed Consolidation Bank, it has assumed $3.7 billion in loans, cut interest rates, and stretched out repayment terms.
TAX BREAKS. Of the three major Eastern European economies, Hungary is furthest along the restructuring curve. But that's little cause for celebration. A tough bankruptcy law took effect in May, forcing more than 3,000 companies into receivership. So, banks are being forced by regulators to downgrade loans that they had been pretending were healthy. "Companies that don't deserve to survive are no longer taking capital from those who can grow," says Andras Simor, managing director of Budapest investment bank Creditanstalt Securities Ltd.
The government plans to privatize state banks by reducing its stake to 25% by 1997 from about 90% now. To prepare the banks for the sell-off, the government has guaranteed $140 million in bad loans made before 1988. It's also giving lenders tax breaks if they put profits into building reserves. But additional help may still be needed.
The banking gridlock driving lenders and borrowers to desperation is spawning novel financial experiments aimed at keeping markets running until capital starts flowing again. The most ambitious is Czechoslovakia's move to sell consumers coupon books tradable for shares in privatized corporations. Some 8.5 million Czechs and Slovaks bought the books earlier this year at a giveaway price of $39 apiece, hoping to make a killing when trading starts early next year. But many consumers have already exchanged their books for shares in mutual funds. One fund manager, 28-year-old Petr Kellner, snapped up 117,000 books, exchanging them for interests in construction and machinery companies. Another, Viktor Kozeny, has parlayed a debt-collection and consulting business into a fund with big stakes in utilities, tobacco, and Komercni Bank, the country's largest lender.
Poland is now crafting a similar privatization scheme. And after two years of hesitation, venture capitalism is even gaining a toehold. Milena Cerna, a Czech emigre and director of the Prague-based PlanEcon Capital Group Inc., is one of several bankers now trying to raise $10 million to $20 million each to invest in industrial and consumer-goods ventures in Czechoslovakia and Hungary. "You can turn companies around with that size fund," says Cerna. "You don't need $100 million to do it."
If only turning the entire region's financial system around were so simple. Although venture capitalists and mutual-fund investors are beginning to sally forth, Eastern Europe is still a long way from financial stability. In country after country, bureaucrats and bankers are coming to realize that not facing up to the challenge will only prolong the East's economic agonies. Their success in working out the region's crippling debt overhang will determine the pace at which private enterprise can expand and economies can grow.Gail E. Schares in Budapest