9 Years Currency Board Arrangement

9 years have passed since the introduction of the currency board arrangement in the country, which is a good reason for an assessment of this period and the preceding one. Of course, it should be taken into account that the positive development is a result not only from the CBA but also from the rest of the reforms toward higher economic freedom. These are liberalization of internal and external trade, capital account liberalization, privatization and de-monopolization. Interactions between these factors have had a positive impact on the levels of income, production and employment in the country and have been creating more business opportunities for persons.

The purport of CBA introduction is to provide stability of money that is relative constancy of its purchasing power. Money is a measure of goods’ and services’ prices enabling people to compare them easier. Sound money reduces the uncertainty concerning the future dynamics of prices and makes easier decision taking about consumption and investment thus helping for efficient resource allocation.

In contemporary situation, money supply is controlled almost entirely by the central bank in the country. It directly influences the monetary base as well as the multiplier to a large extent through the commercial bank regulations. However, the demand for money that is independent from the central bank is determined by the individual preferences. The central bank has to make frequent assessments and to conform its monetary policy to them as the misbalance between the demand for and the supply of money could have negative consequences for the economy.

More common is the case when the supply of money exceeds the demand resulting in inflation. Hence, money loses its value in terms of goods and services and does not fulfill its function as a yardstick. In practice, excessive money supply means that the central bank purposely or not shortens this yardstick. The effects on prices are not even. Changes in some of them are bigger thus altering the individual structure of consumption in terms of different quantities of goods and services bought and cause a change in opportunities for certain societal groups on account of the other. Therefore the result from the inflation is income redistribution induced by the central bank policy.

The mean for stabilization the internal and external value of the Bulgarian lev was the currency board. Applying it reduced the ability of the Bulgarian National Bank to influence the money supply as it is carried out according to a certain rule. Banknotes’ and coins’ emission might be realized solely if it is covered by reserve currency i.e. only when there is a demand for central bank money. The exchange rate is strongly fixed to the euro, which is a stable global currency, and 100 per cent coverage of monetary base by assets denominated in reserve currency is necessary to be maintained.

The CBA poses a financial discipline by limiting the lender of last resort function for commercial banks and prohibiting central bank to grant credit for the government in any kind. Banking system should be healthy and labor market should be flexible in order to provide faster accommodation of the economy to shocks for the successful operation of that monetary regime.

The Bulgarian type belongs to the second generation or so-called quasi-currency boards. It contains some features typical for the traditional central bank like the minimum reserve requirement that is a genuine monetary policy tool. The presence of this tool logically led to its utilization aimed at reducing the growth rate of credits although the ambiguous effects.

What are the consequences of the currency board functioning? During the period between 1998 and 2005 the annual average rate of inflation has been 7.2% while it had been 210.1% between 1991 and 1997. The average inflation tax rate measuring the inflation tax on holding cash balances has been 6.7% since 1997 and it had been 57.7% in 1991-1997. Hence, the CBA, which actually imports monetary policy of the European Central Bank, has achieved its target of increasing Bulgarian lev’s stability. It should be noted that the existing differential between rates of inflation is a result from the convergence of price and income levels in the country and the Euro zone.

The annual average real growth rate of gross domestic product (GDP) has also been significantly different before and after 1997. During the first period it is –4.7% while after 1997 it is 4.5% meaning that the Bulgarian economy has succeeded to prevail the 1996-7 crisis. Apart from this, the income per capita is already higher than at the outset of the democratic changes in the country.

The positive development in terms of investment is also clear. The average growth rate before 1997 had been –8.8% and 18.5% thereafter leading to substantial rise in the share of investment measured by gross fixed capital formation to the GDP – from 11 per cent in 1997 to 23.8 per cent in 2005 which is a prerequisite for higher economic growth in the next years.

Foreign direct investment (FDI) has also increased in absolute and relative terms. Their average level before the introduction of the CBA had been USD 135.3 mill. or 1.7 per cent of GDP while it has been USD 1,469.2 mill. or 7.9 per cent of GDP afterwards. Capital account liberalization and market-oriented reforms improved business environment and increased confidence in Bulgarian economy thus attracting foreign investors. The slow down during the last year could be explained by the virtually stopped privatization. The Bulgarian National Bank, which is in charge for the balance of payments composition did not account any privatization receipts in 2005 by foreign residents while the non-privatization investment actually rose.

The imposed strict discipline contributed for the change in public finance. Chronic budget deficits typical for the period before the CBA introduction have been substituted for more prudent fiscal policies of usual surpluses. The budget balance had been on average –6.3% of GDP before 1997 and reached 0.6% of GDP since then. However, switching to the opposite extreme of too large surpluses like 3.2% of GDP in 2005 would not be considered as a positive development for the economy meaning that the government takes away more money from taxpayers than needed for financing its low efficient expenditures.

As a result of bettered fiscal policies the government debt to GDP ratio has considerably lowered. Before 1997, debt is 168% of GDP and 62% after then reaching 32% in 2005.

Of course, the selected indicators do not exhaust the effects of implemented reforms but they are sufficient to draw a good picture of the change in the country after 1997. The currency board has proven itself as one of the most successful reforms through fulfillment of its purpose and on the ground of this its maintenance as a monetary regime until adoption of the euro as a legal tender lacks alternative. Hence, creation and adherence to the rules combined with limiting the discretionary power of the government is an adequate tool for solving problems in the economy.

 

Table: Selected economic indicators

Indicator

1991-1997

1998-2005

Inflation (%)

210.1

7.2

Inflation Tax Rate (%)

57.7

6.7

Real GDP growth (%)

-4.7

4.5

Investment growth (%)

-8.8

18.5

Budget deficit (% of GDP)

-6.3

0.6

Government debt (% of GDP)

168

61.8

Foreign direct investment (USD mill.)

135.3

1469.2

Foreign direct investment (% of GDP)

1.7

7.9

Source: National Statistical Institute, Bulgarian National Bank, Ministry of Finance and author’s calculations


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