Forecasting a country's growth prospects a decade ahead is normally difficult and for Eastern Europe today it is almost impossible: the starting-point 1991 per capita income is unknown, since previous guesses based on purchasing power parity probably over-estimate the resources available in these now highly disorganized economies; and the transition from planned to market economies also involves enormous political uncertainties, which for the Soviet Union are further compounded by the heterogeneity of its 15 republics.

In Discussion Paper No. 539, Research Fellow Daniel Cohen argues that these uncertainties are so extensive that they may `simplify' the analysis: since they cannot be properly taken into account, one may justifiably ignore them completely and proceed with a naïve analysis of these countries' solvency, comparing their stocks of debt with their levels of resources and growth prospects. Recent literature in development economics indicates that a large debt/GDP ratio need not imply a large sovereign risk if a country's growth prospects make the rescheduling of its debt worth while.

Cohen finds that Hungary is the largest per capita debtor in Eastern Europe by a wide margin (at $4,261 more than 50% above the comparable Bulgarian or Polish figures). He estimates the potential trend growth for all East European countries to be about 4% per annum, with the noticeable exception of Hungary at 2.9% on account of its demographic decline. He estimates all the per capita growth rates to lie within the range 3.0-3.5%, which indicates that Eastern Europe will take about 25 years to catch up with Western Europe. The new growth theory derived from development economics indicates that such convergence will take place only if education is of an adequate standard and that convergence is usually very slow. Eastern Europe may grow more rapidly than the poorest countries, whose growth has averaged 3.3% per annum over the last 25 years, because of its higher level of educational attainment; but its GDP which is critical to solvency can grow only slowly because of unfavourable demographic conditions.

Cohen also calculates a `growth-adjusted' measure of the East European countries' 1989 debt burden in terms of the `debt per capita equivalent' for the USA in 1980 with zero growth prospects. According to this measure, Hungary has a per capita debt of $3,041 comparable to Argentina. Poland and Bulgaria, with figures of $1,704 and $1,573 respectively, are also large debtors broadly comparable to Turkey or the Philippines. These results are rather surprising, since Hungary is viewed on the secondary markets as one of Eastern Europe's better risks (essentially because it has never rescheduled its debt). Cohen also reports econometric estimates of secondary market prices which show that Hungarian debt is over-priced and Polish debt under-priced relative to the other countries considered.

The Solvency of Eastern Europe
Daniel Cohen

Discussion Paper No. 539, March 1991 (IM)