Download Speech of Mr. Ivan Iskrov, Governor of the BNB, delivered during the

Speech of Mr. Ivan Iskrov, Governor of the BNB, delivered during the
official visit at the Deutsche Bundesbank, 20 December 2006
BULGARIAN ECONOMY ON THE ROAD TO
EUROPEAN UNION AND ECONOMIC AND MONETARY UNION
Dear Mr. President of Deutsche Bundesbank,
Ladies and Gentlemen,
First of all, please let me express my most sincere thanks to President Weber for this invitation
and for the opportunity to speak today, a few days before Bulgaria joins the family of the European
Union. Today I would like to talk about the condition of the Bulgarian economy, the development of
the financial sector, and Bulgaria’s economic prospects. I know very well that my audience today is
very special. Bundesbank is the central bank that has been and will be fundamental to the
philosophy of price and macroeconomic stability consistently followed both in Germany and in
United Europe.
The strong historical connection between Germany and Bulgaria
Today’s meeting is extremely important to me also because of the fact that between Germany and
Bulgaria, and between our banks, there have always been very strong ties based on mutual respect
and good cooperation. The relations of Bulgaria and the Bulgarian National Bank with Germany and
the German banking system were established as early as 1879, immediately after the liberation of
Bulgaria and the foundation of the BNB.
In the period from 1879 to 1944 the BNB and the Bulgarian banking system went on
strengthening their relations with Germany. The BNB signed the first two agreements on the
extension of foreign loans with Deutsche Bank and Dresdner Bank in 1889 and 1893. In the early
20th century the first subsidiaries and branches of German banks were set up in Bulgaria, and they
continued their operations until 1949. In the late 19th century and the early 20th century the BNB
and Reichsbank had a very close cooperation. The end of the Second World War, the establishment
of a pro-Soviet socialist regime in Bulgaria, and the existence of the Iron Curtain in Europe
considerably constrained the economic ties between Bulgaria and Germany. The dramatic political
changes in Europe after 1989, the removal of the Berlin Wall, and the subsequent EU enlargement
were favourable conditions and made possible the strengthening of the good economic relations
between Germany and Bulgaria.
The productive interaction between the economies of Germany and Bulgaria was continued and
was given new incentives by the start of the economic reforms in the early 1990s. From the very
beginning of the transition Germany became the biggest trading partner of our country, reaching, in
2005, a 12.1% share of Bulgaria’s foreign trade. Over the last few years, German investments have
been increasing and we expect that this process would carry on and even speed up after Bulgaria
becomes a full-fledged member of the EU.
Current macroeconomic policy framework
In order to understand the way that the Bulgarian economy has developed since 1989 one should
know the starting conditions of the Bulgarian transition. I will not go into details on the
characteristics of the transition from a centrally-planned to a market economy. However, I would
like to point out an important fact which largely distinguishes Bulgaria from the other Central
European countries. This is the fact that the Bulgarian society could not, as quickly as the other
Central European countries, reach a consensus and set its priorities. Therefore, we did not carry out
prompt and effective market reforms. For various reasons (mostly the lack of political will and
consensus) the restructuring was delayed and we paid a high price for this – a long period of
stagnation and macroeconomic instability. In the mid 1990s our country fell into a profound
political, economic and financial crisis which eroded the savings of the population and undermined
the confidence in public institutions. But crises, as we know from both the Bulgarian and the
German economic history, bring a new impetus which triggers large-scale economic reforms. The
most important thing about Bulgaria’s economic policy after 1997 is the drastic change in the
philosophy that underlies the macroeconomic governance of the country. The new culture of
stability, predictability and lasting sustainability is the foundation of the economic reforms in
Bulgaria. This has been the driving force behind the high economic growth, foreign investors’
confidence, and the increasing prosperity in our society.
In order to overcome deep economic and political crisis, in mid 1997, Bulgaria adopted a
monetary policy based on currency board arrangements. The Bulgarian Lev was pegged to the
Deutsche Mark (and from 1 January 1999 to the Euro) and the BNB was banned to lend to the
government and commercial banks in whatever form. There was a period of painful adjustment of
economic agents – a process that is well-known to and even ongoing in some of the Euro area
countries. Today, 10 years later, the currency board symbolizes stability, predictability and
sustainability of Bulgaria’s economic policy.
At the time when the currency board was introduced the US Dollar was the foreign currency that
dominated our foreign trade. The population and the companies definitely preferred the dollar for
their savings. The choice of the Deutsche Mark (the Euro respectively) as the reserve currency
stemmed from the political consensus for EU accession.
A country with a currency board in place is viewed as mechanically importing the monetary
policy and confidence of the country, or area, to whose currency it has pegged its national monetary
unit. This, of course, is true but only to some extent. Confidence can be credited, but only for a
while. Ultimately, confidence must be built by a consistent and prudent policy. Therefore, giving up
an autonomous monetary policy would require a fiscal policy oriented towards supporting the fixedexchange-rate regime and carrying out structural reforms that would enhance the flexibility and
competitiveness of the economy. The fiscal policy systematically conducted since1997, based on a
balanced budget or a budget surplus reduced the government debt to levels much lower than the
criterion of the European Union. This significantly improved Bulgaria’s credit rating, decreased the
sovereign spread and the cost of credit, and provided better investment opportunities.
The sound macroeconomic policy and the structural policies aimed at privatization of state-owned
enterprises and liberalization of markets inevitably brought about significant changes in the real
economy. Since 1997 our economy has been growing at relatively high rates – 5% on average. The
growth sped up in the last two years due to the microeconomic reforms and the forthcoming
accession of the county to the European Union.
The macroeconomic stability, privatization, and liberalization of the economy, and the high
degree of predictability of the policy pursued, provided far better incentives for investing in
Bulgaria. Between 1999 and 2005 the amount of FDIs on an average annual basis was 8.5 % of
GDP. Only about one third of these investments came from privatization deals. These massive
inflows of capital largely accelerated over the last 3 years as a result of the favourable international
situation and Bulgaria’s approaching membership in the EU. As an outcome, investments began to
increase faster and their share in the GDP structure went up to 33% over the first three quarters of
2006 – the highest level since the start of the economic reforms.
The high levels of investments certainly increased labour productivity and, along with a moderate
increase in wages and unit labour costs, helped our exports to remain competitive and the country to
keep on attracting direct investments. At the same time the more intense economic activities were
accompanied by stable growth rates of employment and a parallel decrease in unemployment. The
higher disposable household income generated by the increased employment and wages was the
initial spur to a stable growth rate of consumption in the economy. Subsequently, this effect was
reinforced by the rapid development of the banking sector and the improved access of households to
lending. The easier access to the credit market, coupled with decreasing interest rates due to
Bulgaria’s better credit rating and the global excess liquidity over the last 3 years, led to reduced
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household savings and increased consumption. The lower levels of savings by households and
companies resulting from the increased consumption and investment inevitably gave rise to a deficit
on the BoP current account.
Challenges facing the policy-makers
As a result the current account deficit increased, reaching levels of more than 5% from the GDP
in 2003 and 2004, and increased even further to 11.3% at the end of 2005. It is expected to reach
13.9% of the GDP in 2006. Current account deficits have a high level of inertia, which presupposes
that the shrinking of the external imbalance of the country will be a gradual process. In addition, the
economy of Bulgaria is in its initial stage of convergence, suggesting an accelerated investment
growth and inflow of capital for a longer period of time.
As I have already mentioned, during the last few years the country received a substantial inflow of
capital and the banking system was the natural intermediary in its effective distribution. This does
not come as a surprise, having in mind the successful privatization and restructuring of the banking
sector in Bulgaria. At present, 99.7% of the banking sector is private, and nearly 85% of the banks
in the country are owned by foreign investors – most of them from Euro area member states. Due to
the strong competition and good investment opportunities the growth of the private sector lending
reached levels as high as 48.6% at the end of 2004. Only for a few years the ratio between the
banking credit to the GDP increased from 12.1% in 1999 to 46.0% at the end of September 2006.
To minimize inherent risks from the beginning of 2004, the BNB started a process of gradual
implementation of measures (mainly supervisory and administrative) which aimed at diminishing
the growth rates of banking credits, down to stable levels, which do not jeopardise the stability of
the economy. The data indicate a slower growth of banking credit - 23.4% as of September 2006.
We do not envisage a considerable and fast credit growth in 2007. The debt burden accumulated
during the last few years, as well as the monetary policy tightening in the Euro area will curb credit
to a great extent.
The Prospects of the Bulgarian Economy
By signing the Accession Treaty with the EU, Bulgaria has committed itself to join the Euro area
and to adopt the single currency. The current EU legislation does not give member states the right of
an opt-out clause for their membership in the EMU. This means that the decision which our country
will need to make is not whether to join the EMU and to introduce the single currency, but how it is
going to be done and in what time period.
Regarding the introduction of the single currency, Bulgaria and in particular the BNB, have
always had a consistent, long-term policy. This policy is determined by the existing currency board
arrangements and their broad national and political support. Having in mind the governing
principles of the state policy and the requirements of the acquis communautaire in 2004 the
government and the BNB signed an agreement, aiming at the only logical decision - to introduce the
Euro in Bulgaria in the shortest possible time horizon, conditional on fulfilment of the Maastricht
criteria. The document outlines the following basic principles of EMU membership:
 Joining the Exchange Rate Mechanism II (ERM II) as soon as possible after Bulgaria’s official
accession to the EU.
 Keeping the currency board until Bulgaria joins the Euro area, with the current exchange rate of
the Bulgarian Lev to the Euro - 1.95583 for Euro.
 A unilateral commitment of the Bulgarian government and the BNB to maintain a zero
fluctuation of the exchange rate from the fixed level.
 Meeting the minimum period set in the EU legislation for participation in the ERM II and
taking in time all the necessary steps of the procedure for membership in the Euro zone.
The time horizon for meeting the Maastricht criteria is determined by the state of fiscal
preparedness and inflation convergence. Very often nominal and real convergence processes are
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wrongly perceived as two mutually exclusive goals. We believe that the competent combination of
fiscal, structural and regulatory policies that would encourage competition on a microeconomic
level can bring about a quicker real convergence while simultaneously achieving the nominal
criteria.
The aspiration for Euro area membership has dimensions that go far beyond the domestic
economic and political aspects. From an economic perspective the adoption of the single currency is
in itself the ultimate stage of the European economic integration. All national governments in their
pursuit of multiple political and economic goals are often faced with contradictory objectives.
Sometimes populist and short-term goals seem to supersede the main long-term ones. Therefore, the
states that manage to follow a sound macroeconomic policy favouring Euro adoption set a positive
example to those member states whose policy deviates from stability and long-term sustainability
objectives. The political will in itself is not sufficient, but extremely necessary precondition for
Euro adoption. I highly appreciate the fact that Germany has laid down in its programme for EU
presidency next year that it will support the member states in their aspiration for Euro area
membership. Moreover, each country will obtain a prompt and detailed assessment regarding ERM
II membership and Euro adoption. I believe that this is the only prudent approach that guarantees
equal treatment to all member states. All member states – both present and prospective – are
responsible for the sustainability of the EMU. This sustainability favours their own interests.
Bulgaria is now ready to contribute to this global aim. In the past 5 years we have fulfilled all
Maastricht criteria, except for the one on inflation. We envisage to maintain this consistency in the
years to come. Our efforts will be directed at curbing inflation to the compliant level. Today
Bulgaria already meets 4 out of 5 Maastricht criteria and we believe that our strategy for ERM II
participation as soon as possible we be fully supported by the German presidency. Our state of
preparedness could be assessed by the fact that even though no preconditions for ERM II entry are
required, Bulgaria has committed to proving its capacity by sustainably meeting 4 out of 5
Maastricht criteria. This provides us with the confidence that we will be a full- fledged member of
the EMU at the beginning of next decade.
Following the current policy of balanced budget, with a surplus if possible, will enable us to
continue meeting the Maastricht criteria in terms of budget deficit, government debt and long-term
interest rates, and will also make the macroeconomic policy more responsive and flexible. It is well
known that under a currency board arrangements, the fiscal policy is the only tool available for a
relatively quick response to adverse developments in the economy of the country. Furthermore, in
order for us to have this flexibility with the growing current account deficit and rapidly increasing
private debt, in periods like this when the economy is growing at rates close to or a little above the
long-term growth rates, the budget needs to compensate by generating a sufficient surplus.
The tough fiscal policy is needed also because it will help us comply with the inflation criterion.
Operating under a currency board arrangements, the central bank has no direct control of inflation
rates in the country. Given the current trend of price levels in the new member-states converging to
the levels in the old member-states (a result of the well-known Balassa-Samuelson effect), this
criterion is a challenge not just for the countries with a currency board in place, but also for all
countries with price levels lower than the average in the EU.
In the particular case of Bulgaria where a fixed exchange rate regime is in place together with a
very conservative fiscal policy, reserves should be looked for in promoting the competition and
improving the business environment so that the economy would have greater flexibility to respond
to both external and internal challenges. In 2006, we expect an average inflation rate of 7.2 %. The
main factors driving inflation at the present moment are the increase of excise duties on alcoholic
beverages and tobacco. In 2007, we foresee the declining trend from the second half of 2006 to
continue and our forecast is that inflation will be approximately 3.7%.
Finally, I would like to express my highest appreciation of and gratitude for the steady and
consistent support given by Germany and the people of Germany for the reforms in Bulgaria and
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especially for our accession to the EU. This support is very well known in the Bulgarian society. We
do hope that this friendship and assistance will continue during Bulgaria’s accession to the Euro
zone and afterwards.
Thank you for your attention.
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