Financial-Market Reform in the Czech Republic, 1991-1994: The Revival of Repression?

Abstract

In 1991 the Czech and Slovak Federal Republic embarked on the rapid liberalization of its financial markets under tight monetary policy. This involved the creation of a functioning capital market through a program of mass privatization, along with the establishment of a universal banking system. In these respects, the Czech Republic is considered one of the most successful examples of post-socialist reform. But evidence from the former CSFR and the Czech Republic between 1991 and 1994 also shows that some of the main institutions created to oversee industrial-financial reform have been converted into instruments of indirect, selective credit-allocation, due largely to the leverage of economically non-viable firms and their large-bank creditors, together with the unwillingness of reformers to re-organize fundamentally the economic bureaucracy. How can we explain the formation of these institutions by which reforming governments intervene in financial markets, even in the relatively successful case of the Czech Republic? In a system of financial repression, governmental authorities maintain substantial control over the allocation of credit, which is often granted at below-market interest rates to favored enterprises. This paper suggests that financial repression has political sources. In the economies of the former East Bloc, privatizing firms whose subsidies have been cut off want cheap credit. Old state banks whose portfolios are tied up in bad loans want substantial debt relief. The executive bureaucracies, finally, need to acquire the expertise and information in order to replace centralized command structures with broad financial regulation. So it is in the Czech Republic that reformers, fearing that bankruptcies of the largest firms will send unemployment figures soaring and strengthen the hand of the opposition, are led to design institutional structures which allocate credit to vital industries, which swap bank debt for equity in these firms, and which generally enable some governmental discretion in corporate finance.