At a Washington discussion meeting with the IMF External Relations Department on 23 May, Richard Portes called for the accelerated integration of the Central and East European countries (CEECs) and those of the former Soviet Union into the international monetary system, with a high priority to current account convertibility. Portes is Director of CEPR and Professor of Economics at Birkbeck College, London. His talk was based on his CEPR Occasional Paper No. 14, `Integrating the Central and East European Countries into the International Monetary System', published in April as part of the Centre's research programme on `Economic Transformation in Eastern Europe'.The views expressed by Portes were his own, not those of the IMF nor of CEPR, which takes no institutional policy positions.

Portes noted that the CEECs have incurred major costs as well as benefits in opening their economies rapidly and radically. He called for the introduction of uniform but non-trivial tariffs to allow them a period of `senile industry protection' in which to break up monopolies and privatize enterprises at the lowest possible cost to output in the transition. All the CEECs have experienced sudden disintegration of their previous trade links and a collapse in the volume of that trade, together with a remarkable expansion in their exports to the West, although the extent of this shift appears largely unrelated to the degree of their integration into the international monetary system.

Portes supported the early introduction of current account convertibility for CEECs' residents. Convertibility permits importing a new price structure, imposes competition on highly concentrated industrial structures, and eliminates bureaucratic influence over the allocation of foreign exchange. The CEECs should not open their capital accounts, however, since uncontrolled inflows and outflows entail serious risks, and inconvertibility on the capital account need not threaten foreign investment provided investors are free to remit profits on the current account. The CEECs' eventual successful opening to capital account transactions will require positive real interest rates, a realistic exchange rate and deeper domestic financial markets.

Portes argued that the best strategy for the CEECs to achieve convertibility is to go first to a fixed peg and subsequently to a crawling peg. An excessive initial devaluation can inflict severe macroeconomic costs arising from serious overshooting, as the Czechoslovak and Polish cases have demonstrated. This occurs because the initial distortions are too great for any reliable calculation of an equilibrium exchange rate, so policy-makers opt for the pre-liberalization `free market' rate as the only observable standard which is always and everywhere deeply undervalued. And even the `correct' equilibrium rate suggested by purely monetary considerations may be significantly undervalued for many reasons: the fall in the CEECs' exports to each other releases resources for export elsewhere; the fall in output reduces import demand; the elimination of distortions increases the efficiency of trade; Western countries are relaxing their trade restrictions towards the CEECs; and the necessary expansion of non-traded services should be led by a rise in the relative price of services and hence by a real exchange rate appreciation. The choice between a peg and a crawl is in effect a choice between a nominal anchor for monetary stability and a real exchange rate target for external balance. While the need for stabilization is initially paramount, a subsequent real appreciation is inevitable, so it is best to announce ex ante that the peg will be relaxed when the real exchange rate is judged to be in an appropriate range for the longer run.

Portes noted that post-war Western Europe's experience of the Marshall Plan demonstrated the importance of external assistance and debt consolidation in transformation and recovery. It is therefore regrettable that the major Western countries' severe budgetary constraints have made large-scale grants unrealistic, and debt relief has been quite inadequate. Neither the international monetary system nor the IMF has provided much help to the CEECs in coping with their debts to date. While the IMF has been active in the design of macroeconomic stabilization programmes and in lending to support them, coordination with other international organizations has been inadequate. The leading role of the Fund has also led to an undue emphasis on macroeconomic conditions, which the extent and depth of remaining microeconomic distortions have rendered quite inappropriate.

Finally, as the `new regionalism' gains further ground in monetary and trade policy-making, the CEECs are likely to be better off integrating jointly with the EU than just with each other, but this need not rule out regional cooperation. Those CEECs that have signed Europe Agreements could first extend to each other the preferential market access they have already granted the EU and then form with the EU a group with rules like those of the EU-EFTA European Economic Area but without the free movement of labour.