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CURRENCY BOARD IN BULGARIA AND
STRATEGY TOWARDS EMU
KALIN HRISTOV
BULGARIAN NATIONAL BANK
EU AND EURO AREA MEMBERSHIP


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For new member states there is no opt-out
clause for adoption of the single currency
The questions are “when” and “how”
Strategy for development of the Bulgarian
National Bank 2004-2009
Agreement between the Council of
Ministers and the Bulgarian National
Bank for the adoption of euro in Bulgaria
STRATEGY TOWARDS EURO AREA
MEMBERSHIP




Bulgaria will apply for joining ERM II
immediately after the date of EU
membership
We intend to enter ERM II at current
exchange rate – 1.95583 BGN for 1 Euro
Bulgarian authorities unilaterally commit
to keep currency board until Euro area
membership
Council of Ministers commits to follow
balanced budget policy and to honour
SGP principles
IS THIS STRATEGY FEASIBLE?


Experience from the founding and almost
founding members of the Euro area –
corner cases - Austria versus Greece
Experience from the new member states “Fast track” versus “On a slow boat to …
Euro area”
MONETARY INTEGRATION - THAN


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Austrian versus Greece (Hochreiter and
Tavlas, 2004)
November 1981 Austria fixed its exchange
rate to deutsche mark at 7.03 ATS per
DEM. In 1995 Austria entered EU and
ERM. In 1999 became a member of Euro
area.
January 1981 Greece became a member
of the EU. In March 1998 Greece entered
ERM and in 2001 became a member of
Euro area.
MONETARY INTEGRATION – THAN
ERM II ISSUES

The timing of entry

The choice of the central rate

The width of the exchange rate band

The length of stay in the mechanism
MONETARY INTEGRATION - NOW
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What do the new member states bring to
EU? How different they are and what are
implications for monetary integration.
New member states strategies towards
ERM II and the adoption of the euro
Lessons for Bulgaria
WHAT DO NEW MEMBER STATES
BRING TO EU?

Lower income and price level than the
euro area countries

Low capital bases

Large capital inflows

Rising real exchange rates

Low bank intermediation

Large general government deficits (except
Estonia, Latvia, Lithuania, Slovenia)
NEW MEMBER STATES STRATEGIES
TOWARDS ERM II AND THE EURO
•
Within new member states we have two
groups of countries
–
–
First group (Estonia, Lithuania, Slovenia,
Latvia, Malta and Cyprus) - targeting euro
adoption in 2007-2008. Small open economies,
fixed exchange rates, good fiscal stance and
low public debt (except Malta and Cyprus).
Second group (Poland, Hungary, Czech Rep.
and Slovak Rep.) - targeting euro adoption in
2010 or later.
FRAMEWORK FOR DECISION ON THE
TIMING OF THE EURO ADOPTION



Do long-term benefits outweigh the longterm costs
What policy and institutional changes are
required
How long will take to put needed policies
in place in order to fulfil Maastricht
criteria
DO LONG-TERM BENEFITS
OUTWEIGH THE LONG TERM COSTS

Benefits
Gains from trade (Frankel and Rose, 2002; Micco
et.al.,2003; Faruqee, 2004; Baldwin, 2005)
Elimination of exchange rate risk should lower
real interest rate
Elimination of exchange rate volatility should
increase FDI
Euro adoption will reduce transaction costs
Joining the Euro area would secure a clear
framework for macroeconomic discipline

Costs
Lack of independent monetary policy
Exchange rate as a shock absorber
TRADE GAINS: AN EXAMPLE
0.45
0.40
0.35
0.30
0.25
%
0.20
0.15
0.10
0.05
0.00
1998
1999
2000
Share of BG export in EU-15 import
2001
2002
2003
Share of BG GDP in EU-15 GDP
2004
WHAT POLICY AND INSTITUTIONAL
CHANGES ARE REQUIRED

Policy changes
No need to change exchange rate policy – “problem of
double regime shift”
Current fiscal policy is consistent with euro adoption –
fiscal balance or surplus ensure room for
manoeuvre of the policy makers. Harmonization of
indirect taxes has to be consistent with fulfilment
of the inflation criteria

Institutional changes
Central bank independence, legislative requirements
for integration into the Eurosystem
BNB capacity to participate in formulation and
implementation of single monetary policy
Euro changeover
HOW LONG WILL TAKE TO FULFIL
MAASTRICHT CRITERIA –FISCAL POSITION
2
1
% of GDP
0
-1
-2
-3
-4
1999
Euroarea
2000
Bulgaria
2001
2002
2003
2004
2005f
Maasticht convergence criteria & SGP criteria
HOW LONG WILL TAKE TO FULFIL
MAASTRICHT CRITERIA – PUBLIC DEBT
90
80
70
% of GDP
60
50
40
30
20
10
0
1999
2000
Euroarea
2001
Bulgaria
2002
2003
2004
2005f
Maasticht convergence criteria
HOW LONG WILL TAKE TO FULFIL
MAASTRICHT CRITERIA – INTEREST RATES
9
9
8
8
7
7
6
6
5
5
%
%
4
4
3
3
2
2
1
1
0
0
1999
2000
Eurozone (average)
2001
Bulgaria
2002
2003
2004
Derived Maasticht convergence criteria
HOW LONG WILL TAKE TO FULFIL
MAASTRICHT CRITERIA – INFLATION
12
10
8
% 6
4
2
0
1999
2000
Euroarea
2001
Bulgaria
2002
2003
2004
Aug-05
Derived Maasticht criteria
WHY INFLATION CRITERIA IS THE
MOST DIFFICULT TO FULFIL
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
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


No independent monetary policy
No absolute control of inflation
No complete inflation convergence – for
example USA inflation among states
Balassa-Samuelson effect
Reaction to supply shocks
Different exchange rate pass-through
Microstructure of good markets – pricing
power
Consumer preferences
Measurement problems
Definition of inflation criteria
RELATIVE PRICE LEVEL AND REAL GDP
EU25=100, 2004
140
Relative price levels (final consumption of private households)
DK
FI
IR
SW
120
DE
BE
EU 25
100
FR
AT
NL
UK
IT
CY
PT
80
ES
GR
SI
MT
EE
HU
60
LT
LV
BG
40
PL
CZ
SK
RO
20
20
40
60
80
Relative GDP at PPPs
100
120
140
RELATIVE PRICE LEVEL AND REAL GDP
EU25=100, 2004
log relative price levels (final consumption by private households)
0.20
DK
IR
FI
0.10
DE
EU 25
0.00
CY
PT
-0.10
MT
EE
-0.20
LV
LT
CR
IT
SW
FR
BE
UK
AT
NL
ES
SI
CZ
HU
-0.30
PL
BG
SK
-0.40
Y=0.6839X - 0.024
Adj. R2=0.85
RO
-0.50
-0.60
-0.60
-0.50
-0.40
-0.30
-0.20
log relative GDP at PPS
-0.10
0.00
0.10
0.20
Estonia
Romania
Bulgaria
Slovakia
Slovenia
Latvia
Italy
Luxemburg
Poland
Austria
Spain
Czech Rep.
Belgium
Sweden
Netherlands
Greece
Lithiania
Hungary
Germany
Portugal
France
Finland
Cyprus
Denmark
Ireland
Malta
UK
Brent
REACTION TO SUPPLY SHOCK: AN
EXAMPLE
120
100
80
% 60
40
20
0
DEFINITION OF INFLATION CRITERIA
• “Average rate of inflation, observed over a
period of one year before the examination,
that does not exceed by more than 1½
percentage points that of, at most, the three
best performing member states in terms of
price stability”
• In 2004 ECB’s Convergence Report average of three lowest non-negative
inflation rates plus 1.5 percentage points
• Currently means criterion is 2.4 percent
(August 2005)
• Is there room for convergence?
Derived Maastricht criteria 1
European Union
Euro area
Derived Maastricht criteria
Jul-05
Apr-05
Jan-05
Oct-04
Jul-04
Apr-04
Jan-04
Oct-03
Jul-03
Apr-03
Jan-03
Oct-02
Jul-02
Apr-02
Jan-02
Oct-01
Jul-01
Apr-01
Jan-01
Oct-00
Jul-00
Apr-00
Jan-00
Oct-99
Jul-99
Apr-99
Jan-99
Oct-98
Jul-98
Apr-98
Jan-98
Oct-97
Jul-97
Apr-97
Jan-97
Oct-96
Jul-96
Apr-96
Jan-96
DEFINITION OF INFLATION CRITERIA
4.0
4.0
3.5
3.5
3.0
3.0
2.5
2.5
% 2.0
2.0 %
1.5
1.5
1.0
1.0
0.5
0.5
0.0
0.0
Bulgaria
Latvia
Lithuania
Slovenia
Estonia
Jul-05
Apr-05
Jan-05
Oct-04
Jul-04
Apr-04
Jan-04
Oct-03
Jul-03
Apr-03
Jan-03
Oct-02
Jul-02
Apr-02
Jan-02
Oct-01
Jul-01
Apr-01
Jan-01
Oct-00
Jul-00
Apr-00
Jan-00
Oct-99
Jul-99
Apr-99
Jan-99
Oct-98
Jul-98
Apr-98
Jan-98
Oct-97
Jul-97
Apr-97
Jan-97
Oct-96
Jul-96
Apr-96
Jan-96
DERIVED INFLATION CRITERIA AND
EURO ADOPTION CANDIDATES
14
14
12
12
10
10
8
8
% 6
6 %
4
4
2
2
0
0
-2
-2
Derived Maastricht criteria
EU Min
EU Max
EU
Jul-05
Apr-05
Jan-05
Oct-04
Apr-04
Jul-04
Jan-04
Oct-03
Jul-03
Apr-03
Oct-02
Jan-03
Jul-02
Apr-02
Jan-02
Jul-01
Oct-01
Apr-01
Jan-01
Oct-00
Apr-00
Jul-00
Jan-00
Oct-99
Jul-99
Jan-99
Apr-99
Oct-98
Jul-98
Apr-98
Jan-98
Jul-97
Oct-97
Apr-97
Jan-97
Oct-96
Apr-96
Jul-96
Jan-96
INFLATION CONVERGENCE IN EU
10
10
9
9
8
8
7
7
6
6
5
5
% 4
4 %
3
3
2
2
1
1
0
0
-1
-1
-2
-2
Euro area Max.
Euro area Min.
Euro area
Jul-05
Apr-05
Jan-05
Oct-04
Jul-04
Apr-04
Jan-04
Oct-03
Jul-03
Apr-03
Jan-03
Oct-02
Jul-02
Apr-02
Jan-02
Oct-01
Jul-01
Apr-01
Jan-01
Oct-00
Jul-00
Apr-00
Jan-00
Oct-99
Jul-99
Apr-99
Jan-99
Oct-98
Jul-98
Apr-98
Jan-98
Oct-97
Jul-97
Apr-97
Jan-97
Oct-96
Jul-96
Apr-96
Jan-96
INFLATION CONVERGENCE IN EURO
AREA
10
10
9
9
8
8
7
7
6
6
5
5
% 4
4
3
3
2
2
1
1
0
0
-1
-1
-2
-2
%
VULNERABILITIES ON THR ROAD
TO EURO
• Capital account volatility
– Underlying differences in capital-labor ratios will
remain large – return over investment should
remain high or even rise
– Convergence play during the run-up to euro
– Success carries its own risks – improve
confidence and reduced risk premia
• Large current account deficits
– Financial market integration and goods market
integration lead, in the poorer countries, to both
a decrease in saving and an increase in
investment (Blanchard and Giavazzi, 2002)
VULNERABILITIES ON THR ROAD
TO EURO
• Risks for lending booms
– Inflation is somewhat above euro area implying
low real interest rates
– In the past households were liquidityconstrained
– Expectations of fast income convergence after
EU accession
• Terminal date risk
• Risk from policy inconsistency
15
15
10
10
5
5
0
0
-5
-5
-10
-10
-15
-15
-20
-20
1991
1992
1993
Total for the economy
1994
1995
1996
Corporate sector
1997
1998
1999
2000
2001
General government
2002
2003
Households
% of GDP
% of GDP
SAVING INVESTMENT BALANCE
CURRENT ACCOUNT AND FOREIGN
DIRECT INVESTMENTS
15
15
10.5
8.1
% of GDP
6.4
8.0
5.9
10
5.9
5
5
0
0
-5
-5.0
-5
-5.3
-5.6
-7.2
-10
% of GDP
10
10.9
-7.5
-9.3
-10.0
-15
-10
-15
1999
2000
2001
2002
Foreign direct investments
2003
2004
2005f
Current account
CREDIT TO THE PRIVATE SECTOR
Percent of GDP, 2004
120
120
100
100
80
80
60
60
Average for NMS (exl. Malta and Cyprus)
40
40
20
20
0
0
Romania
Poland
Lithuania Slovak rep. Czech Rep. Bulgaria
Slovenia
Hungary
Latvia
Croatia
Estonia
% of GDP
% of GDP
Average for Euro area
BANK INTERMEDIATION AND GDP
1995-2004
120
100
Credit/GDP
80
1996
60
1995
40
2004
2003
2002
20
1997-2001
0
0
20
40
60
GDP per capita
80
100
120
BANK INTERMEDIATION AND GDP
1998-2004
15
2004
10
2003
2002
Credit/GDP
5
1999
2001
1998
0
2000
-5
-10
-15
-4
-3
-2
-1
0
GDP per capita
1
2
3
4
Thank you very much indeed