Many argue that the East European economies currently in transition from central planning to the market must implement at least `internal' convertibility (on the current account, for residents) as part of the minimal initial package of reforms needed to establish credibility for the regime change. In Discussion Paper No. 500, CEPR Director Richard Portes proposes `robust sequencing' as an organizing framework for a sequence of reforms that must be both credible and able to withstand both external shocks and errors in assessing agents' behavioural responses. Portes argues that a commitment to early convertibility if backed by international institutions and viewed as a key element of the reforms may `raise the stakes'. By increasing the costs of reneging both perceived and actual such a commitment may enhance policy- makers' credibility and help secure popular acceptance of the `preconditions' convertibility requires.

Portes suggests that an (infrequently) adjustable peg will prove the best means of maintaining convertibility, by reconciling the need for stability with the flexibility required to cope with major relative price changes and real-sector shocks. Capital account convertibility must follow the freeing of current account transactions, in order both to avoid capital flight and to maintain control over inward flows.

An open trade policy will be sustainable only if both imports and exports respond to prices: `elasticity pessimism' was clearly justified in response to the partial reforms of the 1970s, and price responsiveness will take time to develop even now. That delay may be tolerable, but delays in macroeconomic stabilization are not. Imposing financial discipline on enterprises is essential to the achievement of current account convertibility, which will not be sustainable if enterprises can borrow unlimited domestic currency at low real interest rates to purchase foreign currency. Once financial discipline is established, however, adopting a single fixed exchange rate will eventually make it transparent which activities and firms are profitable and which not.

Implementing and sustaining convertibility in the face of the 1990 oil shock, the 1991 shift to world market prices in CMEA trade, the structural disintegration of East European trade with both the former East Germany and the Soviet Union, and heavy debt burdens in some cases will require large reserves of readily available external liquidity and substantial debt relief. If Western governments and institutions believe that Eastern Europe's transition to convertibility must be effected quickly to underpin its reforms, they should be willing to back the final stage with ample financial resources.

The Transition to Convertibility for Eastern Europe and the USSR
Richard Portes