Download Speech by Tsvetan Manchev, Ph. D., Deputy Governor of the

Speech by Tsvetan Manchev, Ph. D., Deputy Governor of the Bulgarian
National Bank, at the Congress on Central and Eastern Europe, Frankfurt,
17 November 2005
BULGARIA AND THE BULGARIAN BANKING TOWARDS THE EMU
Ladies and Gentlemen,
It is a great honour for me to address today such a renowned audience at the Congress on Central and
Eastern Europe. First of all, I would like to thank our hosts for their kind invitation and the opportunity
given.
In my speech I will focus on two interrelated issues. First, I will briefly present the current economic
development, the condition of the banking system, and the business opportunities arising from the
macroeconomic and financial stability in Bulgaria during the accession period. Second, I will describe
the key points of the national strategy for joining the EMU and the introduction of the Euro. Finally, I
will outline the major challenges for Bulgaria on its way to membership in the Eurozone without
derogation, as well as, the progress in the adoption of the acquis communitaire in the field of banking
so as to ensure the compliance of the Bulgarian financial legislation with European laws.
1. Stable and catching up economy
Eight years after the introduction of the currency board arrangement in Bulgaria, we can point out
several important outcomes, among them:

Macroeconomic and financial stability accompanies by a sustainable economic growth at a
relatively high rate - about 6% for 2005, which is considered close to the potential GDP. The growth
rate for the last 8 years - 4.5% on average – contributes to the gradual improvement in living
standards;

A relatively low and stable one-digit inflation for years coupled with an intensifying
convergence of all interest rates on the prevailing Euro area rates, and the shrinkage in the margin
between lending and deposit interest rates;

The tough fiscal stance since the introduction of the currency board arrangement ensured fiscal
stability and sustainability through a tight control of non-interest expenditures and the continuing
process of budget consolidation. The consolidated fiscal program at the end of 2005 is expected to
achieve a surplus of at least 1.5% to GDP.

In 2001 the public debt decreased considerably from over 80% to GDP to the acceptable levels
of less than 30% to GDP in September 2005, due also to clear debt management strategies and the
aggressive exploration of market opportunities. In our pursuing the goal of the EU and the Eurozone
accession, the share of the USD-denominated debt gradually declined in favour of the shares in Euro
and in Bulgarian Levs;

After the successful privatisation of state-owned banks, the banking system is now exclusively
owned and controlled by private and foreign investors. From the end of 2003 the share of banking
assets owned by foreign banks exceeded 80%. Now more than 98% of commercial banks’ total
assets are privately-owned. The system is dominated by three banks (Bulbank from the Unicredit
Group, UBB from the National Bank of Greece Group and DSK Bank from the OTP Group), whose
combined shares of total assets reached 35.3% in September 2005. Further restructuring is underway
via mergers and acquisitions, which will surely decrease the number of licensed banks (from 34
currently);

Although still highly dominated by the banking sector, domestic financial markets have
overcome their past isolation from the international financial markets, and long-term interest rates
gradually decreased following the increased inflow of FDIs and the repeated upgrading of the
country's credit rating.

The increasing competition in the financial sector is visible and associated with improvements
in several directions - notably a greater customer satisfaction, better corporate governance and risk
management, as well as less asymmetry in information;

In an environment of almost full capital liberalisation the current account deficit is well backed
by FDIs, which further decreases the unemployment and increases the flexibility of the labour
market.
As regards the economic criteria for accession, the 2005 Monitoring Report of the European
Commission comes to the conclusion that Bulgaria is a functioning market economy and the
continuation of the current pace of its reforms should enable us to cope with the competitive pressure
and market forces within the Union.
The long-lasting financial stability and the robust economic growth in Bulgaria have been recognised
by international financial institutions and credit rating agencies. Bulgaria received its first investment
rating from S&P’s in June 2004, closely followed by Fitch in August. Just a few days ago the third
consecutive upgrade by S&P became a fact.
2. The Strategy for the EMU membership and for the Euro adoption
The considerable achievements in the reform process over the last 8 years, already mentioned, are a
good basis for strengthening further the economic conditions and for setting even more ambitious
goals. On April 25, 2005 Bulgaria signed its EU Accession Treaty. The accession to the European
Union in a year and half will be a milestone in the modern Bulgarian history, a reward for our efforts
during the transition. This is another major challenge, a challenge that the entire Bulgarian society is
willing and, I am sure, is ready to face. The Bulgarian economy shows that the country has moved
rapidly towards the Maastricht Criteria on nominal convergence. Bulgaria is already steadily within
three of them – regarding debt, deficit, and interest rates. In addition, the strong political will to adhere
to the currency board rules until Bulgaria’s full EMU membership without derogation would
unconditionally guarantee the compliance with the Maastricht Criterion on exchange rate stability. The
main credits for this go to the balanced combination of a strong fiscal policy and a currency board, as
well as the increased implementation and enforcement of the European laws.
The most important decision that a country joining the EMU with derogation should make is the time
horizon within which it wishes (and is able) to join the euro area and to adopt the euro as its currency.
This decision must be formulated with regard to the country’s starting position vis-а-vis the Maastricht
criteria and its existing institutional framework for implementing the macroeconomic policy which
largely predetermines the social benefits and costs of EMU membership timing. We feel that the
existing institutional framework would reduce the social costs to a minimum if Bulgaria chooses to join
the euro area immediately after the EMU derogation membership.
In line with the above vision, in September 2004 the Governing Council of the Bulgarian National
Bank adopted the Strategy for the Central Bank’s Development until 2009, which presents our position
on joining the euro area. Regarding the changeover to the single currency, the full compliance with the
Maastricht criteria will be responsibility of both the central bank and the government. Being aware of
this, in November 2004 we signed an agreement which defines the policy and the commitments to be
pursued during the changeover to the Euro in the Republic of Bulgaria until 2010. Recently, the new
coalition that came into power after the parliamentary elections in mid-2005 firmly confirmed its
commitment to the above strategy and its willingness to pursue a fiscal and economic policy consistent
with the goals underlying this strategy.
The strategy for Bulgaria‘s EMU membership, outlined in the above mentioned documents, is based
on the following principles:

Accession to the Exchange Rate Mechanism II (ERM II) immediately after Bulgaria’s official
accession to the EU.

Preserving the currency board arrangement until we join the euro area while maintaining the
fixed exchange rate of the lev to the euro at the current level of 1.95583;

Unilateral commitment on the part of the Bulgarian government and the BNB to adhere to the
zero deviation of the exchange rate from the fixed level (i.e. continuing the current policy);

Observing the minimum term set in the EU legislation for joining the ERM II and taking in a
timely manner all necessary steps for the procedure for the euro area membership.
Bulgaria considers the above path as the only relevant strategy to exit the currency board
arrangement. Bulgaria‘s strategy is similar to the path to the single currency followed both by the old
EU member-states (like Austria), and recently by Estonia and Lithuania – the two countries with a
currency board which jointed the EU in 2004. The agreement between the BNB and the government on
the country’s policy towards the EMU membership largely eliminates the uncertainty regarding the
macro-economic policy, thus creating an atmosphere of predictability and easing the setting of goals by
entrepreneurs and households.
We are fully aware of the challenges. It is well known from the theory that under a currency board
arrangement the central bank cannot directly target the inflation. Actually, the criterion whose
performance will be our greatest challenge is inflation. Given the current pace at which the new
member-states’ price level is converging on that of the old member-states (as a result of the so-called
Ballasa-Samuelson effect), this criterion is a challenge not only for the countries having currency
boards, but for all countries whose price level is below the EU average.
The varying of the inflation criterion due to the definition that the inflation rate must not exceed the
three EU lowest average inflation rates plus 1.5% creates uncertainty. In the case of the 25 memberstates (perhaps 27 with Bulgaria and Romania), it is very likely that three countries, the so-called "best
performers", would have inflation rates close to zero due to cyclical and other country-specific reasons.
This means that the inflation criterion will be very strict and will require reaching inflation rates even
lower than the ECB inflation target 2%. Given the highly restrictive inflation criterion and the
uncertainty about its degree, we expect that the ECB and the European Commission would show
greater flexibility in evaluating the performance of this criterion.
I would like once again to stress the need of a prudent fiscal policy in line with the country‘s overall
strategy for successful fulfilment of the Maastricht criteria. As the changes in indirect taxes and
administered prices directly affect the inflation in the country, it is necessary that their catching up
adjustment should be realised before the years to be taken as a basis for assessing the performance of
the Maastricht criteria, i.e. before 2008. From this perspective, the intentions announced by the
government for moving forward in time the harmonisation of some excise duties is a step that will
considerably assist the fulfilment of the inflation criterion as it will abolish the inflationary effect from
the increased taxes in the years when the assessment will be made. The policy of administered prices
for some services should also take into consideration the country’s overall strategy for the adoption of
the single currency.
As a measure of last resort for the fulfilment of the inflation criterion it is possible that some
administrative measures may also be used, such as reducing indirect taxation in the year that will be
taken as the basis for the fulfilment of that criterion (for example Greece applies a similar approach).
Of course, we well understand that the rates of inflation must converge on those of the Euro area and
that such convergence must be placed on a sound basis, and not only as at a single point in time when
the evaluation of the performance of criteria will be made. However, every economy is under a huge
number of internal and external influences, which makes the highly restrictive inflation criterion very
hard to achieve, especially in the absence of an independent monetary policy.
In meeting the challenge of the inflation criterion, we are going to enhance the banking environment.
The recent amendments to the Law on the Bulgarian National Bank brought the Bank's legal
framework very much in line with the acquis of the Economic and Monetary Union, while retaining the
currency board conditions and principles. Significant progress has been made in transposing the
provisions of the EU banking directives into the Bulgarian legislation without any delay whatsoever in
the entry in force of these regulations. To date, the following regulations are in place:

In the banking supervision area Bulgaria has achieved full (compliance with Council Directive
93/6/EEC on the capital adequacy of investment firms and credit institutions;

The newly adopted Law on Funds Transfers, Electronic Payment Instruments and Payment
Systems is in accord with the European legislation on domestic and cross-border transfers and on
transactions by electronic payment instruments;

The legal framework is in place for out-of-court settlement of payment disputes by means of a
Conciliation Committee having the competence to settle disputes between an initiating institution
and a client in relation to the execution of transfers, as well as between the issuers of electronic
payment instruments and their authorised depository as regards the issuance and use of such
instruments.

Directive 94/19/ЕC on deposit-guarantee schemes is fully transposed in the regulation of the
bank deposit insurance. A clear schedule for increasing the guaranteed amount paid to a single
depositor for his deposits with one bank, irrespective of their number and amount, has been
announced, and this amount is to reach EUR 20 000 by December 31 2006 from the present level of
about EUR 12 500.

With the amendments to the Law on the Measures Against Money Laundering, the Rules for the
Application of the Measures Against Money Laundering Law, and the Rules of the Procedure of the
Financial Intelligence Agency, the Bulgarian legislation has been brought in full compliance with the
respective EU directives and the Financial Action Task Force requirements on Money Laundering.
By the date of the EU membership, Bulgaria will have adopted the remaining laws and regulations in
the financial field, namely:

A new regime of liquidation and reorganisation of credit institutions compliant with Directive
2001/24/EC on credit institutions reorganisation;

Full transposition of Directive 2002/47/EC on financial collateral and Directive 2002/87/EC on
financial conglomerates;

A Consumer Credit Law;

Regulations on credit transfers, cross-boarder transfers, as well as, on preventing and combating
crime with credit cards, which will integrate, respectively, the Interbank Convention, the European
Banking Standard on Cross-boarder Transfers, the CREDEURO, and the European Banking
Standard on Electronic Payment Indicator (e-PI) in the national banking arrangements.
Conclusion
In conclusion, I would like to assure you that the BNB will consistently pursue the targets within the
context of our country's EMU integration. The Bank is strongly determined to maintain the progress so
far achieved and will continue these efforts so that at the point of our country's accession to the
European Union it would have reached the required preparedness for the ERM II membership.
The pre-accession challenges facing us would require the strong will of the central bank, the banking
and financial community and the government, and their concerted efforts to reach the strategic goal of
full euro area membership.