$Unique_ID{COW04138} $Pretitle{299} $Title{Yugoslavia Chapter 3E. Banking and Inflation} $Subtitle{} $Author{Darrel R. Eglin} $Affiliation{HQ, Department of the Army} $Subject{percent banks foreign exports exchange 1970s imports bank payments economic} $Date{1982} $Log{Beach at Dubrovnik*0413801.scf } Country: Yugoslavia Book: Yugoslavia, A Country Study Author: Darrel R. Eglin Affiliation: HQ, Department of the Army Date: 1982 Chapter 3E. Banking and Inflation In the 1970s the banking system was restructured in response to deficiencies that emerged in the 1960s. Reforms in the 1960s had been partly based on the belief that government had intervened excessively in the allocation of resources, and that such decisions were best left to those most affected-the workers. By the mid-1960s the federal role in investment financing was greatly reduced. Self-financing by enterprises proved limited, however. Banks played an increasing role, channeling household savings to finance enterprise investments. By 1970 bank financing of total fixed investments approached one-half, and it was about 48 percent in 1980. The reforms in the 1960s did not produce the desired results. Regional barriers restrained mobility of capital. For political reasons duplications of factories and facilities continued to be built in each republic. Excess demand for credit forced banks to ration it. By the early 1970s Yugoslavs saw the banks as exercising too great an influence although some economists argued the opposite point-that banks were too liberal in granting credit and not rigorous enough in evaluating projects, thus contributing to inflation and questionable investments. All during the 1970s measures were introduced affecting the financial structure. Laws in 1976 and 1977 specifically dealt with the banking system and credit operations. The National Banks of Yugoslavia along with eight national banks in the republics and autonomous provinces constituted the country's central bank (commonly called the National Bank). It had most of the normal central bank functions, such as currency issue, extension of credit to banks and governments, and regulation of credit, other banks, and foreign exchange transactions. It had available various tools, such as reserve requirements, rediscount facilities, and purchase and sales on the foreign exchange market. The central bank had little control over interest rates, however. For major decisions-those affecting republic or province-a consensus among the nine banks was required. Banks were the predominant financial institutions (accounting for about 65 percent of total financial assets in the mid-1970s), although there were investment loan funds, insurance firms, and savings institutions including the Post Office Savings Bank, which provided easy access through many branches for most of the population. A 1977 law formalized a reorganization of banks that had begun in the early 1970s. Three different categories of banks were established called internal banks, basic banks, and associated banks. In mid-1979 there were 160 basic banks and nine associated banks. The number of internal banks was unknown. In addition the Yugoslav Bank for International Cooperation was created in the late 1970s to provide a variety of services in foreign trade, including insurance and export credits for commodities and overseas construction contracts. Internal banks are the financial counterpart of BOALs. One or more BOALs, enterprises, communities of interest, or other self-management organizations in the social sector (but not governments) may establish an internal bank to meet the banking needs of its founders. An internal bank keeps accounts and makes payments for its founders but may not extend credit. Internal banks maintain deposits in basic banks to effect transactions beyond the circle of founders, but deposits are not kept with the central bank and regulations are minimal. Internal banks were established to handle the greatly increased transactions and accounts resulting from the division of enterprises into BOALs so that BOALs would not have to turn to larger banks for services and credit. Internal banks are the financial decentralization that corresponds to BOALs on the production side. Basic and associated banks perform the usual banking services, including financing trade and investments. Basic banks are formed by BOALs, internal banks, enterprises, communities of interest, and other social legal organizations (except governments). The founders have equal voice in management of basic banks regardless of the amount of funds contributed, and they usually have unlimited liability for the bank's obligations. Basic banks can unite to form an associated bank to handle such large transactions as major investments and foreign borrowing. In several instances, branches of the former commercial banks became basic banks that joined to become an associated bank using the same name it had as a commercial bank. The former branches operated with considerable autonomy in their locality as basic banks. Although a few banks operated throughout the country, many remained regional or smaller in their operations. Banks were not formed to make a profit but to perform services, primarily for the members who retained favored access over non-members. By pooling resources of self-management associations, banks in theory could provide liquidity and investments to those in need without an autonomous intermediary. In fact, however, banks have been more important in channeling household savings to investments by self-management organizations. Since the mid-1960s banks have for the most part set interest rates. They have been low and usually negative in an inflationary situation, particularly in the 1970s when founders were the main borrowers as well as in control of management. Interest rates neither reflected the cost of money nor played much of a role in investment decisions. Banks did not carry out settlement of transactions; a separate nonfinancial, service agency maintained accounts for banks, making the necessary entries for payments. The trend toward decentralization since the 1960s largely stripped the federal government of fiscal policy and dismantled other means of controlling aggregate demand. Monetary policy remained the basic tool. Several economists believed that the central bank had sufficient means to exert greater control over expansion of the money supply than were actually used. Part of the problem lay in the contradictory responsibilities assigned to the central bank-namely monetary stability and supplying the credit needs of the economy and government. Credit needs usually took precedence except when the highest Yugoslav leaders agreed that stabilization was a priority goal. The result was increasing inflation from 1965 onward. Many factors affect the growth and control of inflation besides monetary policy. The Yugoslav price system has undergone various degrees of liberalization since the complete control exercised in the late 1940s, but it has never been wholly free of intervention by various levels of government, and considerable influence remained in 1980. Since the 1965 reforms an effort has been made to keep domestic prices close to world market prices, but some lagged more than others. In the 1970s the principle was established that when government intervention kept prices too low, that body was responsible for compensating the producing units. This was one of several measures enacted in the 1970s to force greater discipline in the economy and reduce the demand for credit. In 1975 a law concerning payments between enterprises was introduced to control the growth of interenterprise credit that was outside of the banking system. Inefficient producers or those with cash flow problems often resorted to nonpayment of obligations to banks and suppliers, which had a snowball effect, particularly in times of credit contraction. Three times between 1971 and 1974 the large indebtedness of enterprises had to be converted into long-term credits or written off. Enterprises also failed to pay suppliers, thus extracting a form of credit. By late 1975 this interenterprise debt had reached 60 percent of the social sector GMP. This huge indebtedness was settled in various ways, including sanctions against enterprises that were unable to meet their obligations. Three hundred enterprises were undergoing liquidation in 1976, but because the system largely precluded lay-off of workers, most of the failing enterprises were probably merged with more efficient producers. Since 1976 buyers have been required to settle obligations in fifteen days or provide the seller with a bill of exchange guaranteed by a bank; the bills of exchange can be discounted. The change did not rule out growth of interenterprise indebtedness, but it forced such credits into banking channels where they became subject to a degree of control. [See Beach at Dubrovnik: Beach at Dubrovnik. Courtesy WORLD BANK PHOTO (Hilda Bijur)] A 1976 law stipulated the method by which enterprises computed income. The most important feature was that goods had to be sold and legal payment received to enter income computation. The intent was to stop the practice of including in the calculation of income the production of goods that were unmarketable or that had been sold to an enterprise that would not pay. In the same year, annual revaluation of fixed assets on which the legal depreciation rate applied became mandatory; previously, fixed assets had been revalued every five years. This measure was to ensure a higher savings rate by enterprises to increase the funds at their disposal. A stabilization program in 1976 cut the increase of the cost of living from 25 percent in 1975 to 11.6 percent in 1976, but more expansionary policies in the next few years saw the inflation rate rise again. The cost-of-living index rose 15 percent in 1977, fell to 14 percent in 1978, and reached 20.4 percent in 1979. In 1980 the index rose 30 percent, compared to a planned increase of 17 percent. Retail prices increased 39 percent when measured from December 1979 to December 1980. Domestic factors accounted for most of the inflation after 1975, but rising international prices, particularly for crude oil, also became important after 1978. By 1981 increasing inflation indicated that the many reforms had not effectively dampened excessive demand. Yugoslav officials and economists noted many different problems with little agreement that one was more important. The problems included overly regionalistic approaches, underused industrial capacity, excessive investment, failure to complete projects on time, wage increases above that of productivity, failure to comply with social compacts on wage and price increases, and too great a share of investment going into nonproductive activities. In 1980 the federal government was more active, providing firm guidelines that were incorporated into social compacts to limit the increase of wages and salaries; the effect was to reduce real earnings in the social sector by 7 to 8 percent. In 1981 the federal government, in agreement with republics, imposed a 7 percent ceiling on price increases for goods and 5 percent for services during the year as a temporary palliative to slow the rise of prices. By 1981 there was wide agreement that inflation had to be controlled and that the 1981-85 plan would have to sacrifice some economic growth to achieve price stability. Foreign Trade and Balance of Payments Since World War II foreign trade has been important to the economy, primarily because of the need for imports. In the early years, most manufactured goods, including equipment for industrialization, had to be imported. As the domestic industrial base expanded, the import dependency shifted toward raw and semi-finished materials. In 1979 the ratio of imports to GDP was 21 percent, about the same as in 1965. Exports expanded and diversified along with the rest of the economy, but there was not a close relationship between economic growth and exports. For most of Yugoslavia's industry, exports were a minor part of activities, and rapid economic growth tended to diminish efforts to export. The ratio of exports to GDP generally declined, from 16 percent in 1965 to 10 percent in 1979. Balance of payments difficulties have been a recurrent problem, causing frequent policy shifts and a growing foreign indebtedness. Until the early 1960s, Yugoslavia retained many of the features of the communist foreign trade system first established in the late 1940s. One feature was the separation of domestic prices from those in other countries through a variety of buffers. An implicit system of multiple exchange rates provided one of the buffers and also incentives for exports. Between 1954 and 1965, exports increased by an average of 11.7 percent a year, a rate higher than that of the economy as a whole. By 1965 foreign trade was liberalized; many of the interventions were abolished or reduced. The goal was alignment of domestic prices with international prices, integration of the country into the world economy, and eventually convertibility for the dinar. These goals still guided policy in the early 1980s. In the late 1970s several laws altered the administrative structure for foreign trade. Communities of Interest for Foreign Economic Relations (CIFERs) were formed at the federal, republic, and province levels to bring together the earners and users of foreign exchange to plan and guide foreign economic activities. Among other duties, CIFERs are responsible for drafting regional and national balance of payments plans, allocating and regulating foreign borrowing rights, administering the export incentive program, and allocating and monitoring the use of foreign exchange. The changes were gradually effected during 1978, and before the CIFERs were fully staffed and functioning they were given the task of allocating foreign exchange during a period of shortage that apparently exceeded their capabilities. Under the Yugoslav system the BOALs earning foreign exchange had rights to it. This included subsidiary suppliers down the line, who contributed to some degree to the export of goods and services. Retention rights were to be spelled out in self-management agreements between suppliers. Those that did not need or had excess foreign exchange would sell it to their regional CIFER to be purchased by an importer in need of exchange for an approved commodity. In a period of foreign exchange shortage, complaints have been voiced by suppliers of an unfair division. Complaints have also been voiced that suppliers were profiting from sales of unneeded foreign exchange, in effect introducing a variety of implicit foreign exchange rates. The system also tended to regionalize the balance of payments although there was some pooling of foreign exchange for needs of the federal government and regions that lacked sufficient foreign exchange earning power for necessary and planned imports. Although foreign trade was liberalized after the mid-1960s, commercial policy was an important adjunct of economic development policy. During the 1970s exports were encouraged through subsidized credit and general and selective incentives, including retention rights to foreign exchange. Data were unavailable on changes introduced by CIFERs for export promotion. Imports were restricted in a number of ways, including some quotas and the necessity to procure a certification that domestic suppliers were not available. In 1979 the average, effective tariff rate on imports was about 22 percent, but this fell in 1980 when an import surcharge was abolished. Customs duties tended to be higher for finished goods than for raw and semi-finished materials, although after 1976 more protection was given to raw materials to encourage production while duties on machinery and equipment were lowered somewhat. Foreign exchange shortages have imposed cuts in imports, such as in 1976 and 1980. Although the value of imports rose from US $14 billion in 1979 to US $15.1 billion in 1980, the volume decreased by more than 10 percent. A rise of over 70 percent in imported oil and gas prices was an important factor, adding US $1.2 billion to the import bill even though the volume was 5 to 6 percent less. In 1980 oil and gas imports cost US $3.1 billion, about one-fifth of total imports (see table 24, Appendix). Imports of raw and semifinished materials (including oil and gas) amounted to 62 percent of total imports, compared with 31 percent for finished manufactures (primarily machinery) and 7 percent for food and agricultural commodities. The reduced volume of imports created problems throughout the economy and particularly in industry. The country's exports were diversified for its stage of development. In 1980 finished manufactured articles accounted for 45 percent of total exports. Other important categories were: semifinished materials, 22 percent; chemicals, 11 percent; agricultural materials, 11 percent; and raw materials, 7 percent. The total value of exports amounted to almost US $9 billion, a 32 percent nominal increase over 1979 resulting from the balance of payments pressures and successful efforts to increase exports (see table 25, Appendix). Although exports increased sharply in 1980, their expansion has been substantially lower than imports since 1965 and a major factor contributing to the country's balance of payments constraints. Economists attributed the sluggish growth to several causes. Perhaps most important was the nature of exports for most Yugoslav enterprises, which focused primarily on production for the home market and only secondarily devoted attention to the potential export market. In addition official policy that encouraged additional processing for the greater value-added restricted growth of exports of raw materials, partly minerals and metals, to Western Europe. During the 1970s Yugoslavia had some success increasing exports of heavy electrical equipment, transport equipment, wood products such as furniture, and selected items of clothing and footwear to Western Europe but less success in other products compared with other developing countries. Specific policies adopted by the EEC may have restrained Yugoslav exports to these countries as the Yugoslavs claimed, but it would not explain the inability to increase exports to the rest of Western Europe. Yugoslavia had more success expanding exports to Eastern Europe, particularly after the mid-1970s, and to developing countries over a wide range of manufactured goods. Most of Yugoslavia's foreign trade is with industrialized countries. Those in the Organisation for Economic Co-operation and Development (OECD), which included nearly all of the major noncommunist industrial powers, accounted for 53 percent of imports and 37 percent of exports in 1980. The bulk of that trade was with EEC countries (see table 26, Appendix). Trade with the United States only amounted to US $1 billion of imports and US $400 million of exports. In the 1970s trade with communist countries, primarily the Soviet Union and Eastern Europe, grew substantially, and in several years after 1974 these countries were the largest market for Yugoslav exports. Trade with developing countries remained relatively minor in spite of the rise in value of oil imports. The slow growth of exports has caused a worsening balance of payments situation for the country. Several times during the 1970s (in 1972, 1975-76, and 1979-81) balance of payments constraints forced a slowdown in domestic activities. Once the immediate situation eased, however, officials returned to the expansionary policies of the past. The 1976-80 five-year plan attempted structural adjustments to reduce permanently the import dependency and to expand exports, but it was far less successful than planned. By mid-1979 Yugoslavia again faced a very difficult situation in its international payments, one that could persist for several years. Although the trade balance was critical to the long-term balance of payments, services also played an important role. In fact after 1977 the inflow of service payments (but not on a net basis) exceeded the value of exports. The most important inflow was remittances from workers abroad, reaching over US $4 billion in 1980. In spite of a declining number of workers in foreign countries, remittances continued to rise during the 1970s, but officials anticipated a drop in the 1980s. Tourism and transportation services were also important foreign exchange earners. Yugoslav contractors have won an increasing number of overseas construction contracts that added to the inflow of payments. The outflow of service payments was also growing, particularly personal remittances. Interest on the country's foreign debt increased from US $820 million in 1979 to nearly US $1.3 billion in 1980. Net service receipts in 1980 amounted to 62 percent of the trade deficit (see table 27, Appendix). In most years of the 1970s and every year since 1976 the current balance of goods and services was in deficit. The size of the deficit was increasing, amounting to US $1 billion in 1975 and US $3.7 billion in 1979. The Yugoslavs have received long-term credits for development as well as other international assistance from governments and institutions. The World Bank (see Glossary) has been a major lender, financing a variety of projects in the economy. Increasingly in the late 1970s, however, the country has had to resort to commercial borrowing at world interest rates. Gross medium- and long-term capital flows averaged US $2.6 billion between 1976 and 1979; they rose to perhaps US $3.6 billion in 1980. Short-term borrowing was erratic but increased by nearly US $300 million in 1980. The country's external medium- and long-term debt exceeded US $13 billion, and the short-term debt was about US $650 million at the end of 1980. Debt servicing (interest and principal) amounted to over US $3.2 billion in 1980, about 20 percent of exchange earnings from exports of goods and services. The situation was precarious; at the beginning of 1981 official foreign exchange reserves were sufficient to pay for only about one month of imports of goods and services. The 1981-85 Plan The outlines of the 1981-85 five-year plan available in mid-1981 reflected the seriousness of the internal and external economic situation. Officials were forced to break with traditional thinking and scale down the pace of development in order to make adjustments in the economy. Some of the target annual growth rates (in real terms) over the five years included: social product, 4.5 percent; agriculture, 4.5 percent; industry, 5 percent; fixed investments, 1.5 percent; imports, 1 percent; and exports, 8 percent. By reducing domestic demand and shifting resources to exports, the plan expected to bring the rate of inflation and the deficit in the balance of payments to manageable proportions by 1985. Although targets have been substantially reduced compared with earlier plans, the 1981-85 plan was ambitious in several respects under present conditions. Holding imports to a 1 percent increase a year (in real terms), if successful, will require delicate management so as not to disrupt industrial production and not to starve it of necessary equipment for technical advances. Expanding exports by 8 percent a year could prove difficult if economic conditions in OECD countries stagnate because the world situation has a pronounced impact on Yugoslavia's foreign sales. Moreover a complicated policy mix will be required to encourage enterprises to think permanently in terms of foreign markets. Reducing demand by cutting government consumption in half and fixed investments even more will require a degree of discipline hard to achieve in the country's decentralized management structure. The plan also called for a 40 percent reduction in personal consumption and nearly a 50 percent reduction in real disposable income, as well as substantially lower fringe benefits for social sector employees. The changes in workers' organizations during the 1970s were intended to introduce them to the trade-offs necessary for economic growth. The Yugoslavs were proud of and worked to make their system of workers' self-management effective, not hesitating to criticize their own creations and make frequent changes. In 1981 efforts were still ongoing to staff and make effective the changes introduced during the 1970s. The plan period to 1985 could well be a severe test of the dedication to self-management and building a unified nation. A united effort and skillful economic management will be required to bring the country's economic problems under control. The 1981-85 plan requires belt tightening by nearly everybody. Major miscalculations or lack of cooperation by self-management organizations would likely impinge on real incomes and consumption. If such should happen, the reaction of the population, or at least parts of it, is open to question, for the rapid economic expansion and rising standards of living over the past three decades has presented such a problem only for brief periods. * * * Widespread interest in Yugoslavia's economic system has produced numerous books and articles. A basic study is Yugoslavia, Self-Management Socialism and the Challenges of Development, written by Martin Schrenk and a team from the World Bank. Other recent books include John H. Moore's Growth With Self- Management: Yugoslav Industrialization, 1952-1975; Ellen Turkish Comisso's Workers' Control under Plan and Market: Implications of Yugoslav Self- Management; Jaroslav Vanek's The Labor-Managed Economy; and Branko Horvat's The Yugoslav Economic System: The First Labor Managed Economy in the Making. Briefer studies include Laura D'Andrea Tyson's The Yugoslav Economic System and Its Performance in the 1970s and OECD's annual surveys Yugoslavia. The Yugoslav government publishes statistical data annually in Statistical Pocket-Book of Yugoslavia (in English) and in the more comprehensive Statisticki Godisnjak Jugoslavije, which in a separate volume provides an English translation for the tables. (For further information see Bibliography.)