Ebook Can Governments Mandate Hard Budget Constraints? Bank Lending and Financial Isolation in Romania
In the early days of transition the question of macroeconomic stabilization stood out among all reform priorities in transition countries. Unquestionably, the countries that achieved stabilization by a steady monetary policy (mostly in Central Europe and in the Baltic States) succeeded in restarting the growth process, while elsewhere monetary instability was accompanied by a protracted slump. Since all countries attempted stabilization, a critical policy issue is why stabilization was maintained in some countries and was reversed (often repeatedly) elsewhere. While macroeconomic indicators are often used to assess the performance of a country's reform process, microeconomic adjustment is the sole guarantee of progressive stabilization and performance.
A tight credit policy that reduces inflation may be unsustainable when credit available is used to cover- losses in the industrial sector. As enterprises fail to generate an appropriate return and decapitalize by paying insiders most of their surpluses, in the medium term the banking sector reveals its insolvent state, requiring massive recapitalization and thus lax monetary or budget policies. The importance of a timely assessment on the quality of bank lending is thus essential to assess progress in restructuring incentives and in the reallocation of credit to better producers.
The initial stages of financial policy in Romania seem to fit well with early transition models which focused on the endogeneity of reform policy credibility (Roland and Verdier, 1995; Perotti, 1998).
In these models, an insufficient microeconomic restructuring response to the threat posed by reform policies may lead to collective inertia based on an increased likelihood of policy reversals. In Perotti (1998) the possibility of massive (mutual) default endangering economic activity and social stability may lead to a reversal to reflationary policies to bail out all arrears, which in turn justifies the ex ante inertial response and the creation of arrears. This model formalizes what Janet Mitchell (1997) classifies as the "too-many-to-fail" strategy of resistance to adjustment.
The argument about "too many to fail" fits well the facts in the first few years of transition in the Eastern Balkan states and in the FSU countries outside the Baltic States. Collective (that is, indiscriminate) bailouts of firm arrears funded with monetary emissions took place in Russia in 1992 and to a lesser degree in 1993; in Romania in 1991 and 1993; in Bulgaria in 1994. However, governments (and firms) realized soon that collective bailout offered an insufficient degree of real compensation for arrears. The main reason was that, given a weak fiscal position, the only resources available to the government to perform a bailout were monetary emissions; as a result, the real value of the clearing of arrears was depreciated by the clearing itself. The immediate inflationary impact and strong IMF pressure convinced the government to stop such measures.
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