Working Paper: CEPR ID: DP695
Authors: David Begg; Richard Portes
Abstract: Throughout Central and Eastern Europe (CEE), there is a widespread failure of enterprise debtors to make scheduled payments of principal and interest to creditors, who in turn have strong incentives not to declare bankruptcy. In such circumstances, the price mechanism does not properly guide the reallocation of resources. The normal process of exit in a market economy is suspended, and the disproportionate share of bank credit effectively going to refinancing of incumbents impedes entry. We argue that this may be the single most important obstacle to economic restructuring in CEE. We discuss the scope of and reasons for this problem; the inefficiencies it creates; and how to deal with it. We propose a sequencing of recapitalization of banks and of enterprises that is designed to be credible and robust to the incentive failures identified. We then assess the fiscal consequences of such a reform package and how it affects the conduct and effectiveness of monetary policy. We conclude that the international institutions must put the full weight of their authority and credibility behind such a package in order to break through the obstacles to successful restructuring.
Keywords: debt; bankruptcy; recapitalization; eastern europe
JEL Codes: E44; G33
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| failure of enterprise debtors to meet their scheduled payments (G33) | suspension of the price mechanism and the normal exit process in a market economy (E64) |
| suspension of the price mechanism and the normal exit process in a market economy (E64) | inefficiencies in resource allocation (D61) |
| disproportionate share of bank credit going to refinancing incumbents (G21) | negative impact on economic restructuring (F69) |
| lack of enforcement of debt contracts (G33) | increased systemic risk and uncertainty about the liquidation value of enterprises (G33) |
| credible sequencing of recapitalization of banks and enterprises (O16) | effectively address these issues (I24) |