Itching to Pull the Plug on Poland

By John Greenwald.

Declaring default would be the ultimate financial weapon

The uneasy stalemate over Poland's struggle to repay even part of the $28 billion it owes Western banks passed another milestone last week, when Warsaw virtually completed interest payments on its 1981 debt, thereby paving the way for rescheduling last year's unpaid $2.4 billion in principal. Crisis-weary bankers gave a sigh of relief, and then started thinking about collecting the $10.4 billion in debt-service payments that Poland must make this year.

Other voices, however, are beginning to demand what to many bankers is unthinkable: declare Poland in default. That would probably trigger a worldwide rush to seize Polish assets located outside the country. It could also push the international banking system toward chaos.

Advocates of default insist that Poland's creditors have an unparalleled opportunity to pressure the Soviet Union by squeezing its troubled satellite. Says Felix Rohatyn, a partner in the investment-banking firm of Lazard Freres: "For the first time in 25 years, the Western governments have a truly credible weapon in their armory, and that's control of the capital markets. The Russians can get technology elsewhere, and lots of people will provide them with grain. But nobody else can make the capital available." A default declaration might force the financially pressed Soviet Union to increase its aid to Poland and the other satellites, Rohatyn argues, and could drive the Soviets into liberalizing the Polish regime and making other political concessions in exchange for resumed Western lending.

Defense Secretary Caspar Weinberger also favors default. In addition, the AFL-CIO executive council last week called for a declaration of default during a meeting in Bal Harbour, Fla.

Bankers, however, deeply fear the consequences of such a move. Says Rimmer de Vries, a senior vice president of Morgan Guaranty Trust Co. and a member of TIME's Board of Economists: "This is a very urgent issue that needs to be handled very carefully." Not a single member of the board was willing to recommend a default during a discussion of the topic at this month's meeting. Lawrence Brainard, a senior international economist with Bankers Trust Co. in New York City, warns that default would set off "an unholy scramble" to grab the few Polish assets in the West. Unlike Iran, which had an estimated $12 billion in gold and bank deposits that was frozen by the U.S. Government in 1979, Poland has relatively little to offset its huge debt. Any effort to attach its ships or jetliners that happen to be in the West would create a nightmarish financial and legal snarl that would take years to untangle.

Moreover, bankers warn, calling the loans would dry up the trickle of payments that the Poles are actually making. Says a leading U.S. moneyman: "Poland is not paying anything more than nickels and dimes right now. But with default, we don't even get that."

Washington, meanwhile, is taking a wait-and-see attitude. The Reagan Administration last month kept the Poles out of default by paying $71 million in gram-export loans that Warsaw owed to U.S. banks. That sum, however, is dwarfed by the $1.7 billion that American banks have loaned Poland, and the $ 1.9 billion of total direct Government lending. Administration officials believe that the best Western position is to continue holding out the threat of default without actually using it. Said the President at his press conference last week: "Default will make Poland more dependent on the Soviet Union."

U.S. allies applaud a policy of restraint. Said West German Minister of Economics Count Otto Lambsdorff in New York last week: "I feel it has been a wise and helpful decision not to officially declare a Polish default."

Academic experts warn that one of the first consequences of such action would be to reduce the little leverage that the West has on Warsaw and Moscow. Says Edward Hewett of the Brookings Institution: "A default would prompt the loss of what influence we have." The move would also hurt the reputation of Western bankers. Adds a European banking authority: "A Western declaration of default would make the Soviets chuckle. The Russians would be able to discredit the West, particularly in the Third World, where such action would be regarded as callous capitalism."

Whether Warsaw is defaulted or continues to pay only interest on its debt, the Polish situation has already had a major impact on Western lending to Eastern Europe. The Communist bloc as a whole owes the West some $70 billion. Aside from extending credit for the Soviet natural gas pipeline, Western lenders have virtually stopped making new loans. That will set back plans to modernize agriculture and other obsolete economic sectors. Said a European banker who refused to lend more money to East Germany: "I told them that I was sorry and hoped to do business with them again, but that until the mess in Poland is straightened out I cannot increase my bank's exposure in Eastern Europe."

The Soviet Union has publicly taken a hands-off attitude toward the debts of its satellites. Records of the Bank for International Settlements in Basel, however, show increases in Soviet borrowings and steep drops in its foreign currency reserves. Says a highly placed international financier: "Part of this activity is clearly being used to bail out Poland." Bankers in New York City also say that the Soviets are helping the Poles pay their debt-servicing charges.

The Soviet Union is hardly in a position to take over all of Poland's problems. Its own economy is weak because of repeated bad harvests, and it has been forced into a cash squeeze to buy grain. Moscow has sold gold heavily on world markets to raise money during the past six months. Even without the risky step of declaring Poland in default, Western banks and governments can still exercise great financial influence over the Communist world. --By John Greenwald. Reported by Richard Homik/Warsaw and Bruce van Voorst/New York

With reporting by Richard Homik, BRUCE VAN VOORST

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