The secrets of the Polish Memorandum
The memorandum which western commercial bankers have agreed to present to Poland is extraordinary in that it would give the bankers an IMF role in directing the Polish economy.
By Sarah Martin
A banker sat in a Paris cafe, stirring the remains of an espresso round and round in his cup. The topic for discussion over lunch had been Poland, but he had lapsed into silence. Abruptly he spoke. “You know, we bankers are going to lose our money on Poland."
Few of his fellow bankers were willing to admit that. Commercial bankers from 12 countries had gathered in Paris in late June to try and agree on an orderly restructuring of Poland's 1981 debt. The two-day meeting resulted in an extraordinary document which, as Euromoney went to press, still had to be approved by all the national banking groups and Poland itself before it could come into effect. It is unprecedented in the role it would assign to commercial bankers in monitoring the rebuilding of the Polish economy.
The Polish financial crisis is the biggest shock yet to hit the Euromarket. The country is not a member of the IMF and its debts are larger by far than those of any country that has had to reschedule.
Poland's commercial bank creditors have found it difficult to agree on a common approach largely because they are keenly aware that any agreement will set a precedent, not only for the restructuring Poland itself will need over the next few years, but also for other countries. Even if western bankers do not believe they will get their money back, they must at least be seen to be taking a firm stand. That consideration has been on balance most important to the US banks, which, throughout the tortuous series of negotiations over the last six months, have taken a consistently harder line than have banks from other countries. The US banks have described their approach as ''more commercial than handholding,'' as one put it. The European banks have been more influenced by political considerations. But the political implications of the role which commercial bankers have proposed to undertake are inescapable, since Poland is a member of the Soviet bloc.
The Paris meeting followed weeks of arduous and often frustrating discussions among Poland's commercial bank creditors. Committees were formed and re-formed, named and re-named; committee chairmen came and went. There was a "mad rush" among the bankers, according to one of them, to join the initial steering committee set up in March after Bank Handlowy formally requested a commercial rescheduling. The banker explained that no-one wanted to be left off the steering committee, for fear of losing influence on a settlement. ''In terms of the egos involved, I've never seen anything like it in all my years of banking." In order to reassure those left out that they would still have a say in any final decisions, the name of the group was changed to the more innocuous "multinational task force" or MTF.
The conclusion of an agreement rescheduling Poland's 1981 debt to its official western creditors, on April 27, cleared the way for bankers to reach their own agreement. Although the government pact was only a framework, within which bilateral agreements were to be worked out between Poland and each of its government creditors, it did set specific terms for each country to follow. Poland would be allowed to defer payment of 90% of maturities – both interest and principal – falling due during the last eight months of 1981 over eight years. Virtually no conditions were set, except for a requirement that the governments be kept informed as to the plans Poland would undertake to achieve a balance of payments surplus. Western governments were clearly anxious to give Poland economic breathing-space in order to restore some measure of stability.
Looming above these considerations was the possibility of a Soviet invasion, which western governments feared would be heightened if they took a hard line. Pressure was on the banks to follow suit, especially on the European banks. This accounts, in part, for their eagerness for a settlement. Besides, until an agreement was in place, there was always the danger of Poland reaching separate deals with its creditors. There was also the possibility that an individual creditor might call a default, thus activating cross-default clauses. This would have hit the balance sheets of some of the lending banks, besides throwing Poland's financial affairs further into chaos. Already more than one small US institution has had its portfolio bought out by a bigger bank in order to prevent just such a situation.
The tougher stance of some American banks struck many of the Europeans as obstructive. There were differences within the American camp as well. Before long, press reports were exacerbating tensions further. Several European bankers later complained that they were better informed about the Americans' point of view from reading the newspapers than from discussions with the Americans.
By the time the task force met on May 20 in Frankfurt, however, its members were able to establish enough common ground to draw up proposals to reschedule over a period of seven and a half years 95% of Poland's commercial bank debt falling due between March 26 and December 31 of 1981, or about $2.5 billion. Unlike the arrangement with western governments, the commercial bank arrangement would have obliged Poland to pay interest, at a spread of 1¾% over Libor. (Poland owed commercial banks approximately $3.1 billion – not including short-term debt – during 1981, but managed to repay between $700 and $800 million during the first quarter.)
At the time of the Frankfurt meeting the US banks were being officially represented by Bank of America. Accounts differ as to what extent the American bankers at that meeting went along with the proposals. Many European banks were under the impression they had been approved. However, the proposals were "totally and absolutely rejected" at a meeting of the US coordinating committee in New York some weeks later, according to one banker. Observers spoke of an "orchestrated rejection" by four or five New York banks, whose representatives voted Bank of America out of the chair. They voted in Frederick Schwartz, senior vice-president at Bankers Trust, described as a "toughie" by another banker. The meeting, according to one who attended, was "not very pleasant." At the end of it, the banks reached a unanimous decision to support an extension rather than a rescheduling, until Poland provided more about the plan to put the economy on its feet.
Behind the unanimity were some doubts. Certain Americans felt that their compatriots, having already rejected the extension idea a few months earlier, were nullifying all the efforts since then to reach an agreement. The big New York banks which carried the day, however, believed strongly that "Europe was running just a bit too fast" in the words of one banker. Another observed: “There was a sense that the Americans didn't like being pressured by the Europeans on this.''
Later, an American banker defended the move. “It’s just ludicrous to say that we were stalling. No rescheduling has ever been done in such a short time. A rescheduling as big as Poland’s takes a great deal of time and money that no-one’s going to be compensated for."
A meeting of European banks was then held in London, in such secrecy that, as Euromoney went to press, those concerned were still denying that it ever took place.
"Myopic," "shallow," "ruthless and obstructive,” “very negative,'' were a few of the words many bankers ere muttering privately about the American decision. Even the weather was inauspiciously cold five days later, when the task force delegates met at the Banque Nationale de Paris on the Boulevard des Italiens. Behind the gilded 19th-century facade, the BNP offices are sleek and airy, complete with a garden on an upper floor for entertainment. But the task force had more serious matters in hand. It met in one of the air-conditioned conference rooms below ground level. The talks went on for nearly 12 hours on the first day, breaking up only briefly for a cold buffet lunch. Talks resumed on the morning of June 25 and lasted until midday, though most of the serious negotiating was done on the first day. The US team, led by Rick Schwartz, was described as “very aggressive.”
Despite the apparent logjam created by the American banks’ decision to go for an extension rather than a rescheduling, the banks eventually compromised. They feared that a division in the western banking community might be a useful tool for elements within Poland or the Soviet bloc wishing to discredit them. It was also clear that most countries were anxious for a quick settlement. One participant observed: "If there had been total disagreement the meeting would have broken up after the first few hours.” Another described it as "the most constructive meeting so far.”
The memorandum the task force produced was in two parts: a lead-in agreement and a restructuring agreement to come into effect once the conditions in the lead-in section are satisfied. Until now, the details of the memorandum have been kept confidential on the grounds that they are too sensitive for publication. Here they are.
The details of the secret put before Poland
As a condition of the lead-in agreement, Poland will be asked to retain a technical adviser, acceptable to the western banks, to act as assistant to the Polish authorities. If accepted, this step will mark a sharp departure in the relationship between Poland and western commercial banks. This is the closest the banks have yet come to assuming an IMF-type role.
Poland will be required to provide any economic and other information the banks request not later than November 1, and a Polish representative who can confirm the accuracy of the economic information.
In addition the task force made it clear that it wanted to know the extent of Poland's debt obligations to all other countries, apart from those represented on the task force. The bankers want to know the exact extent of Soviet loans to Poland. The condition was carefully worded, so that the Soviet Union was never mentioned. It delicately suggested that Poland could supply such information indirectly: by inserting the amounts owed, but omitting the names of the creditors.
Western banks have already been presented with data from Poland that projected an improvement in its trade balance with the west, but seemed to imply a corresponding deterioration of its balance of trade with East bloc countries. "If they are asking western banks to accept this, then where is the proof?" observed one economist.
Another significant condition is that Poland develop as soon as possible, or by September 1, a consultative economic group, under the full responsibility of the Deputy Prime Minister for Economic Affairs, which would monitor and provide economic information on a continuous basis. Once the rescheduling section of the agreement comes into effect, Poland would be required to provide quarterly progress reports which would be discussed at semi-annual meetings of a group made up of western representatives and members of the consultative Polish group.
On paper it looks as if an impressive compromise was achieved, with the Americans getting the conditionality they wanted and the Europeans a firm agreement to restructure before the end of the year, largely on the terms agreed in Frankfurt. In reality Poland may have a very hard time fulfilling the conditions required, with its economy on the brink of total collapse and its government's tenuous grip on power slipping. Bankers were hoping that, after the Polish Party Congress in mid-July, it would become more clear who was in control of the government, if anyone. Western economists believe it may be easier to assess prospects for the Polish economy now than it was a few months ago.
The task force has set tight deadlines for the fulfilment of its conditions – deadlines which reflect the pressures on the banks themselves. The bankers are counting on Poland's desire to see an agreement in place as soon as possible. A European banker said: "Poland is lucky to have an agreement at all." An American banker commented: "The western banks are holding the card and the card is a big one." But Poland has at least one card – the banks' need to protect their own balance sheets. Once an agreement is in effect, and the Poles are paying interest on the rescheduled loans, the danger of a write-off recedes. French and German banks, for example, were particularly concerned about the possibility of having to make loan-loss provisions out of reserves if a rescheduling agreement didn't come into effect by the end of the year. There would then be the problem of their tax authorities agreeing to accept the loan-loss provisions as a write-off. If they didn't the banks would be in the worst of all possible situations – a drop in reserves to cover the bad debts, a resulting drop in profits and no assurance that they could write off the loss against tax. One banker observed: “It will be easy to cave in under pressure, and move into stage two of the agreement even if what the Poles provide is unsatisfactory. The political impact of these conditions will depend on how toughly they are enforced.”
He noted that a similar arrangement for economic consultations between Poland and the western banks, in connection with Poland's $325 million syndicated loan of August 1980, produced very little. "It was pretty wishy-washy," the banker remarked. Another banker denied this, insisting that the liaison meetings were still regularly taking place.
What happens if Poland doesn't meet the conditions to the satisfaction of the banks? This has been left unclear. Many bankers doubt Poland's ability to fulfil the conditions of the lead-in agreement completely, but most of those who spoke to Euromoney felt that it was worthwhile to inject some conditionality into the rescheduling. As one put it: "If you don't ask you don't get; if you do ask you might not get but you will at least have tried to get." Or be seen to have tried, he might more aptly put it.
Scepticism runs deep about Poland's ability to provide reliable information. As one American banker admitted privately: "Poland is not in a position to come up with reliable data, because the assumptions it would be founded on are simply changing from day to day. They will disappear the day after the plan is written."
Bankers have good reason to be doubtful. The Polish Ministry of Finance submitted a document to western banks in May, containing projections about its trade balance and balance of payments. This document, said to have been barely proofread, apparently contained a highly imaginative mix of "pure propaganda and wild economic projections,'' in the words of one economist who read it. Several western bank economists were so upset by it they took a special trip to Poland to see for themselves, with little result. Moreover, when the Polish Parliament saw the document they indignantly repudiated it, because of its assumptions of massive layoffs and stiff price increases.
The episode taught western bankers that, if they were to insist on consultation with the Poles, they had better consult with those who could deliver. Hence the stipulation in the lead-in agreement that the Polish body charged with providing economic information be under the full responsibility of the Deputy Prime Minister in charge of Economic Affairs, rather than the Ministry of Finance or the Bank Handlowy. In other words, the banks want to deal with a senior political figure rather than a group of technocrats.
The banks appear to have learned this lesson a bit late, however. Richard Portes, Professor of Economics at London University, wrote in a recent paper that the data provided to western bankers in spring 1980, showing how Poland would achieve near balance on its convertible-currency trade account in 1980, were "clearly absurd". Bankers had requested the data as a condition for organizing a large syndicated loan. Poland's projection was, Portes wrote, "a further attempt to alleviate the external balance at the cost of aggravating the internal imbalance.'' Nevertheless, the loan was signed in August 1980 though the syndicate, led mainly by US banks, was unable to attract participation for more than $325 million, instead of the $500 to 550 million originally envisaged. Even this was achieved only after the participation of Moscow Narodny ($25 million), Bank Polska ($25 million) and Eurobank ($20.5 million). The Paris agreement did not say whether project-linked loans, for example the two copper project loans coordinated and co-led by Chase Manhattan for $525 million, would be included. The loans, arranged in 1975 and 1978, were for the state-owned Kombinat Gorniczo Hutniczy Miedzi w Lubinie, rather than for the government itself. Repayment was tied, Chase insisted, to the proceeds from the copper sales. The issue has not been a major one in slowing progress toward an agreement, but it has aroused fears among other bankers that one syndicate would be singled out for special treatment if the loan was excluded from the restructuring. Chase insisted that the project was profitable and that the syndicate had done everything possible at the time it was arranged to obtain secure guarantees. As Euromoney went to press, Chase was awaiting legal opinion on the question of the security guarantees. One observer commented: "It's debatable, to say the least, whether the copper loans are secured or not."
The west urged loans on Poland to export machinery
Even if the copper loans are finally included in a comprehensive rescheduling, the precedent set should be equally disturbing to all international banks involved in project finance. One banker commented: "It makes you think – why waste the time devising sophisticated guarantees? Why not just send a country a cheque every year and say – see you at the rescheduling?"
Some European bankers still believe strongly that the Americans have been naive and unrealistic in setting the conditions in the lead-in agreement. A French banker observed: "Can you imagine that the Soviets will allow an international expert to roam freely in Poland to look at the performance of the economy? Besides, the Poles would find it humiliating." Another commented: "It's not possible for an East European country to produce a mutually satisfactory definition of an economic programme."
One European remarked: ''The US banks in general see the Polish problem as no different from that of Bolivia and Nicaragua, and those in turn as no different from International Harvester or Massey-Ferguson.'' Americans concede that this is more or less accurate. One said after the Paris meeting: “Restructuring of sovereign risk shouldn't be that much different, just because we're dealing with a centrally planned economy.”
Economists and bankers agree that the purpose of the proposed agreement is constructive – that commercial bankers want Poland's economy back on its feet just as badly as did its western government creditors. But some question whether it's wise that the very institutions whose massive lending encouraged and legitimized Poland's ill-advised investment programme in the mid 1970s should now be held capable of rescuing Poland from economic collapse. Others take the view that, since the western banks were partly responsible for the mess, they should do as much as they can to help clean it up.
Portes wrote: "The west itself was not merely a passive observer, but actively encouraged Poland to take its credits and plant and equipment exports. The major commercial banks took the initiative with Poland, while, among governments, the French pursued an especially aggressive export-credit policy. The financing urged upon Poland did not facilitate adjustment to foreign-sector problems but rather generated them; the machinery exports it sold created employment in the west, but much now sits at least partly unemployed in Poland."
When lending to Poland was commercially attractive, most bankers shrugged off the danger signals, confident they could depend on the Soviet "umbrella" to protect Poland from default. One of the least convincing arguments though most often heard was: "Poland has never missed a payment yet." The "umbrella theory'' was referred to as confidently and casually as if bankers had a written commitment from the Soviet Union promising to bail Poland out. In practice, the Soviet umbrella is providing only partial cover.
How the overdue FRN was paid with Russian money
The Soviet Union subsidizes the Poles through preferential trade terms. It has also provided hard currency loans, over the past year, of at least $1.5 billion. Insiders have suggested that Poland has had an open credit line of as much as $5 billion since February 1980. There was evidence for this in mid-July, when Poland's deputy foreign minister, Marian Dobrosielski, was reported to have said that Poland had received $4.5 billion in aid from the Soviet Union since last summer, though not all in hard currency. The Paris memorandum demonstrates clearly how anxious are western bankers to know the exact extent of Soviet aid to Poland. One of the difficulties inherent in any rescheduling agreement it that it must be lenient enough not to strangle Poland's economic recovery, and yet tough enough to give the Soviet bloc the message that western banks were not going to bail out Poland alone. The Soviet Union, for its part, is signalling to the west. Analysts have suggested that the Soviet Union let Poland know in the first quarter of 1981 that there would be no more hard currency available until the fourth quarter of 1981, a message apparently intended to spur on western bankers. But insiders are certain that there has been money available to Poland to draw on to cover its interest payments and short-term debt. One bank economist said: "There is no doubt about the Soviet Union's ability to provide short-term assistance, but they are naturally reluctant to enter into a long-term open-ended commitment."
One expert spoke of Poland's "big checking account'' with the Soviet Union. When the $30 million floating rate note was due in mid-June, bankers feared that a non-bank holder of the note might spark off a default if it weren’t paid. It was paid. According to several sources, the money came from the Soviet Union through Eurobank, the Soviet bank in Paris. The Soviet Union was known to have than $8.5 billion on deposit with BIS banks at the end of 1980.
The French banks who managed that issue, Banque Nationale de Paris and Crédit Commercial de France, accepted payment, a fact that set off a heated debate at the Paris meeting. Bankers were upset at what appeared to be preferential treatment. The French banks argued that that was better than running the risk of a private investor, who hadn't received his money, calling Poland into default. The Paris memorandum differentiates between corporate and private investors holding Polish floating rate notes and other marketable securities (corporate investors, including banks, are covered by the agreement) but the issue has not yet been settled. Poland’s outstanding à forfait (non-recourse) paper was also meant to be included in the agreement, but bankers have yet to find out how much is outstanding. "The Poles certainly don't know how much there is,'' commented an expert.
The deadline for termination of the lead-in agreement was to be December 10 or when the conditions it laid down are satisfied, whichever date is earlier. Poland was meeting the task force in Zurich on 22 and 23, at the headquarters of Union Bank of Switzerland. By that time, the task force hoped to have the memorandum approved by each national committee. The Paris memorandum retained the terms put forward at Frankfurt: an interest rate of 1¾% over Libor or over the actual cost of funding, with a stiff penalty of 2¾% for late payments. The restructured debt is proposed to be repaid in seven equal semi-annual instalments with a four-year grace period, starting the day after the rescheduling part of the agreement comes into effect, or no later than December 10, 1985. The same interest terms are to be applicable during the period of the lead-in agreement once it is signed by Poland. The memorandum also contained a statement requiring covenants to insure equal treatment for all signatories to the agreement, and prohibiting preferential treatment to other creditors. The banks also wanted Poland to agree to supply them with the texts of the bilateral agreements between Poland and its western government creditors in the context of the April 27 rescheduling agreement.
It's unclear to what extent Poland has been led to believe it can expect additional funds from western banks if it satisfies the conditions laid down in the lead-in agreement. It certainly needs them. It's estimated to require between $12 and $15 billion between now and the end of 1985. There is some ev1dence that bankers would be prepared to extend new money, perhaps to help finance a specific area of exports, but it's very difficult to imagine, for example, that they would provide any straight balance of payments loans. According to one banker who attended the Paris meeting, the topic of new finance "wasn't even raised.”
On paper, then, bankers have assigned themselves the kind of political role in shaping Poland's economy that they have always shunned. It is ironic that they are doing so under pressure from US bankers, who believe they have taken a commercial approach rather than a political one. In the case of Poland, the two cannot be separated. Whether they can succeed in having an impact on economic decision-making in Poland is dubious, and they are aware of that. From a commercial point of view, there can be no winners in the Polish situation.