What brought Romania into a sovereign debt crisis in 1981?

From Cornel Ban

The economic failure of the Romanian national-Stalinist developmental state had both structural and contingent causes. Most importantly, the 1979 oil shock undermined an increasingly energy-intensive economy, driving the regime to take on a lot more foreign debt, even as interest rates skyrocketed. Thus, the continuing expansion of steel, petrochemicals, and engineering during the 1970s translated into high levels of energy consumption and increasing vulnerability to exogenous supply shocks. However, the analysis below does not support the argument that the Ceausescu regime “borrowed the rope to hang itself,” as Kotkin put it (2010: 28-30), a view embraced by former regime insiders in Romania. Unlike other socialist states, Ceausescu built the bulk of the debt not at the low interest rates of the 1973-1979 period, but at the high interest rates of 1979-1981, in an effort to save large oil processing capacity it built in the late 1970s. This material constraint was important enough to trigger a reconsideration of Romania’s development path during the 1980s. Ultimately, however, it was the regime’s economic ideas about continuing industrialization in an airtight sovereign policy space that led it to to opt not for further liberalization and scaling down of oil-guzzling industries, but a decisive shift: from an economy based on internal demand and modernization contingent on East-West technological and financial flows, to an economy based on forced austerity in the area of consumer demand, isolation from international finance and technology, and an export strategy shackled by import substitution imperatives.

The first oil shock (1973) did not affect Romania as much as it affected other developing countries because the country was able to supply a large share of its energy needs from local oil fields and managed to strike machinery-for-oil barter deals with Iran, Iraq and Libya (Linden 1986). The post-1973 stagflation led to decreasing demand in the European Community, thus reducing the share of Romanian exports to developed states; some of the losses, however, were offset by growing demand in other developing states, particularly those rich in oil (Lawson 1983; Linden 1986).

Conversely, the second oil shock of 1979 and the debt crisis triggered by monetary policy changes in the developed capitalist core put an end to the buffering effect that these factors had had on the Romanian economy. The main reason for this vulnerability was that the unprecedented expansion of oil-guzzling industries and the reckless investment in oil refineries and the manufacturing of oil processing equipment during the second half of the decade dramatically tripled Romania’s demand for oil, from 5 million tons in 1975 to 16 million tons in 1980 (Murgescu 2010: 392). According to a former trade official, while refineries could count on 10 million tons of domestic oil, their capacity had been expanded to processing 33 million tons. These refineries and refinery equipment factories employed tens of thousands of workers and while their shutdown was not unfathomable, given the proven capacity of the state to reallocate labor, Ceausescu thought this option was oustide the boundary of the economically apporpriate. The 1979 oil crisis also coincided with a peak in Romania’s oil production (Ivanus 2004). Consequently, although Romania had maintained a low level of the debt-service ratio by the standards of both newly industrializing and East European countries, in 1978 it began to increase its foreign debt to pay for the imports required by a threefold increase in oil demand. In this way the regime drove the country into sovereign debt not by “buying” the consent of citizens through extensive consumption, as Kotkin and Gross suggest, but through its rigid ideological commitment to economic ideas that saw massive chemical industry expansion as the “second wave” of socialist industrialization. The commitment to basic needs were there, but it was not paid with debt. As explained by a former planner,

During the 1960s and early 1970s there was nothing particularly odd about developing industrial branches that turned crude oil into plastics, synthetic fibers, refined oil and so on. But after the first oil shock Western industrialists stopped to reconsider further development in these areas. For Ceausescu, by contrast, these industries were part of the increasing industrial complexity required by “multilaterally developed socialism” and it was based on this image of industrialization that he decided to expand these industries in the mid to late 1970s.

The predicament was deepened by two geopolitical shocks. The first was the Iranian revolution, which disrupted Ceausescu’s oil deals with the Shah. Iran was Romania’s main supplier of oil and an alternative had to be found quickly. Unfortunately for the regime, shortly after Iraq replaced Iran in this function, Saddam Hussein’s war with Iran meant deceasing oil sales to Romania (Murgescu 2010: 393). The combined effect of these shocks resulted in increasing dependence on Soviet oil, a situation that challenged one of Ceausescu’s core foreign policy priorities: autonomy from the Soviet Union. Faced with the prospect of sacrificing its prided autonomy from Moscow, the regime preferred to look for alternative solutions.

As much as the oil shock weighed down on Ceausescu’s preferred economic strategies, it was revolutionary changes in the world of finance that eventually bred the conditions for the loss of regime legitimacy. The first financial shift concerned interest rates. In 1979 private international capital became considerably more costly following the United States’ sudden move to increase interest rates at a time when monetarist ideas were gaining traction throughout the West (Eichengreen 1992; Blyth 2002; Stein 2011).
This Western policy shift led to a dramatic rise in the interest rates on sovereign debt, pushing many developing country governments into default (Balassa 1985; Easterly 2001). The era of cheap development finance was over.

According to World Bank data, between 1976 and 1981 Romania’s foreign debt went from 0.5 billion dollars (or 3 perent of GDP) to 10.4 billion dollars (or 28 percent of GDP and 30 percent of exports). In 1981 interest rate payments reached 3 billion dollars, up from barely 8 million six years before. Over the period 1980-1982 the country had to pay 6 billion dollars to foreign creditors, and by 1982 Romania needed 80 percent of its hard currency exports to finance foreign debt. The regime first turned to the IMF for assistance, as it did in the late 1970s, when the IMF disbursed resources to cover flood and earthquake related export shortfalls. In early 1981 the IMF’s Executive Board approved a 1.3 billion loan (300 percent of the Romanian quota) but the creditors’ fear of contagion from the crisis in Poland led them to withdraw deposits from Romania and cancel inter-bank credit lines. The situation was complicated by Western banks’ allegations that Romanian banks were abusing banking practices, including the kitting of checks. Requests for rolling over maturing loans were denied, leading to the accumulation of $1 billion in arrears by the end of the year. The country was effectively evicted from international credit markets and was therefore in non-compliance with the stand-by agreement with the IMF.

With central bank reserves at a paltry 400 million, a dramatic policy shift was needed to deal with the debt crisis.