Bulgaria and the Euro

The reports of the European Commission and the European Central Bank on the convergence of the various countries were published recently.  They aim at presenting the current state of the economies and their preparedness to accept the Euro as a legal tender. The conclusions from these reports are that Bulgaria is not yet ready to meet the criteria and as a result the formal membership to the Euro zone will not take place soon.

The factors on which this process depends are several. In the first place are the so called Maastricht criteria, which cover the public finances (budget balance and public debt) the rate of inflation, the interest rates and the exchange rate. Bulgaria meets the budget criteria, since in the last few years a budget surplus[1] is maintained. This allows for accumulation of fiscal reserves, which are used to buy back the external public debt.   This is the reason the level of the Government and the Government guaranteed dept during 2007 to be 18.2% of the gross domestic product[2], which is one of the lowest among the countries of the European Union (EU). Only the Baltic countries, Romania and Luxemburg have a lower ration dept/GDP[3].

The next criteria, which Bulgaria meets is the interest rates – the profitability of the 10-year Government bonds. The average value over the period under review is 4.7%, while the referent is 6.5%. This criterion is related to the stability of public finances, which are the main factor for the perception of risk and respectively profitability of the bonds issued by the Bulgarian Government. Until the middle of 2006 the spread between the Government bonds of the countries in the Euro Zone was falling, which reflects the trust of the investors in the macroeconomic perspectives of the country. After that the external misbalances and the crises of the international financial markets contributed to the increase of the spread, but this does not impede meeting the criteria.

Inflation represents a problem to Bulgaria at present, the average rate for the period (April 2007 – March 2008 reached 9.4% measured by the harmonized index of consumer prices. This value is way above the referent 3.2%. Something more – during April 2008 the rate of price increases continued growing and reached 13.4%. This caused the discontent in some groups of society, which attempt to get some benefits by asking for various concessions.

The government's policy in this case aims at achieving a budget surplus. The logic is that taking more money from the economy than the government spending will reduce the disposable income and as a result the demand, which will reduce the inflation rate. The effects on the supply are not synonymous. Such policy is limiting the opportunities for investments and to create greater production capacity.

In addition the Bulgarian National Bank increased the minimum reserve requirements to 12% in September 2007, which aims to reduce the rate of increase of the internal credit and as a result – the money supply to the economy. However, the effect on the credits is stronger due to the rise of the base interest rate of the European Central Bank, which is expected to continue during 2008 due to the higher than anticipated inflation in the Euro zone.

Over all, it is expected that meeting the criteria of inflation will continue to be a problem over the next few years, which to a very large extend is a result of the insufficient competition in some sectors of the Bulgarian market, which allows for faster growth of prices and monopolistic profits.

The last criterion which also has not been met is the stability of the exchange rate against the Euro. The reason for that is formal. This could not take place until Bulgaria is accepted in the so called Exchange Rate Mechanism 2. After the date of entering it is necessary to keep the stability of the exchange rate within the range of +/-15% to the central parity. Maintaining the currency board will guarantee that but the procedure require that a membership to CEM2 is approved.

In addition to the above mentioned criteria there is another formal obstacle to joining the Euro zone. According to the EC the Law about the Bulgarian National Bank is not totally compatible to the European legislation, although the last modifications and amendments were made in the middle of 2007, when Bulgaria was already a member of EU. The problem areas are related to the emissions of banknotes and coins, the smooth functioning of the payment systems, the approval by ECB before the participations of representatives of the BNB in international financial institutions, audit by independent outside auditors, institutional and personal independence and a ban on financing the budget. All of these areas require changes in the Law for the Bulgarian National Bank, which must take place very quickly.

As a whole the reports of the EC and ECB are nor surprising with respect to the formal criteria.  The deficiencies in the Law about BNB must be corrected in order to prevent their use as an argument against the country. Meeting the criterion on inflation remains the main challenge, but the immediate task must be undertaking measures towards the entry of Bulgaria in CEM2. Up until now there was no success in this area, which further delays the acceptance of the Euro as the means of payment in the country and deprives the Bulgarian economy from the benefits from that.

 


[1] Denmark, Finland and Sweden have higher budget surplus/gross domestic product ratio.

[2] Referent value is 60% public dept to GDP.

[3] Data from Euro stat.


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