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Home , Bulgarian lev, Steve Hanke

ISSN: 2560-1601

Vol. 26, No. 2 (BG)

Febr 2020

Bulgaria economy briefing: CHANGES LEGISLATION TO JOIN ERM2 EXCHANGE RATE MECHANISM Evgeniy Kandilarov

1052 Budapest Petőfi Sándor utca 11.

+36 1 5858 690 Kiadó: Kína-KKE Intézet Nonprofit Kft. [email protected] Szerkesztésért felelős személy: Chen Xin

Kiadásért felelős személy: Huang Ping china-cee.eu 2017/01

BULGARIA CHANGES LEGISLATION TO JOIN ERM2 EXCHANGE RATE MECHANISM

One of the most up-to-date socio-economic topics in Bulgaria in recent weeks directly related to the financial and economic situation and future development of the country is that of the forthcoming eventual accession of Bulgaria to the preliminary ERM II mechanism, the so- called "waiting room for the " as well as joining the so called . The topic has sparked enormous public debate, as well as many fears amongst the ordinary about the stability of the country's financial system, which has plagued thousands of Bulgarians who pay off loans, have small savings or are just on the brink of survival. Bulgaria’s parliament adopted on Thursday (6 February) changes to the country’s law so as to allow its accession to the “waiting room” of the Eurozone. Since 1999, Bulgaria has operated an IMF-led board arrangement that pegs its lev to the at a fixed rate of 1.95583. The ERM2 Exchange Rate Mechanism (known as the “waiting room” to the Eurozone), rules require Bulgaria’s central bank to allow currency fluctuations of up to 15% above or below the central rate. So, Parliament voted to allow the central bank to now operate on that basis. As long as Bulgaria is in ERM2, the central lev-euro rate would be negotiated with the , the Eurozone member states and Denmark, the changes read. The EU’s poorest member state would need to spend at least two years in the mechanism before it is allowed to join the Eurozone. In fact, this obligatory text lifts the last obstacle to Bulgaria’s entry into the euro ‘waiting room’ in end-April. Last month, International Monetary Fund head, Bulgaria’s Kristalina Georgieva, said the country’s accession to the euro “by 2023 is entirely possible”. Contradictory interpretations of the legal amendments had sparked speculation about a possible devaluation of the lev before euro adoption. Bulgarians still have bitter memories of the country’s worst banking and financial crisis in 1996-1997 when 14 banks went bankrupt and inflation soared to 300%. The IMF-led and the fixed rate helped the country control that hyper-inflation and maintain one of the lowest debt ratios in the EU of 19.9% of GDP at end-2019 Meanwhile on January 28, 2020, Bulgaria’s premiere digital news outlet Iconomist.bg, published a note on Professor Steve H. Hanke and his deep

1 engagement within the Bulgarian Banking and Financial Regulation Legislation and the successful implementation of the country’s Currency Board System. In this publication Economist emphasizes: “On January 23rd, MP Menda Stoyanova amended the law governing the work of the . Stoyanova’s amendment would change the rules governing the currency board system in Bulgaria and the exchange rate of the lev to the euro.” In this context Prof. , the father of Bulgaria’s Currency Board and adviser to former President Peter Stoyanov, notes: “Stoyanova’s correction is shocking. Why would you want to repair something that is not broken?” Professor Steve H. Hanke continues to caution the Bulgarian policy makers and is certainly ringing the alarm bells: “In addition to being shocking, Stoyanova’s correction is dangerous; it brings to life memories of Argentina. On April 1st, 1991, Argentina introduced a system called “convertibility”. It wasn’t exactly a currency board, but it had some similar features. Most importantly the convertibility system fixed the peso’s exchange rate into US . Convertibility killed Argentina’s inflation and worked well until early 2001. It was then that Argentina’s economic tsar made changes to the Convertibility Law. These were similar to Stoyanova’s amendment. The results were catastrophic. In less than a year, on December 23rd, 2001, Argentina defaulted on its sovereign debt and political chaos reigned.” In order to reassure Bulgarians, parliament adopted last week a resolution saying that it would only allow euro accession at the current rate of 1.95583 leva. The reminded that this was not the first time that countries with a fixed exchange rate join ERM2 and adopt the euro, and that the Baltics were a good example. Indeed, and had currency boards before joining the euro, and the rate of their was not changed during the ERM2 period. “Participation in ERM2 will maintain the substance of the Bulgarian currency board. As from the moment Bulgaria applies to and participates in ERM2, a (central) rate between the euro and the lev will be fixed under the ERM2 framework. This fixed rate between the lev and the euro could be, and is even likely, to be the same as the current rate of the existing currency board”, said the Commission. However, the fears of Bulgarian citizens remain. First, Bulgaria is neither Estonia nor Lithuania. It is difficult to compare the influence of the Baltic republics with that of the poorest country in the EU. Therefore, we cannot rule out the (successful) pressure for a change in the to the euro unfavorable for Bulgaria. Moreover, participation in ERM II itself allows the exchange rate against the euro to fluctuate within ± 15% of the "central rate" agreed between the ECB and the acceding country. Second, the current decision of Parliament is a political one. It does not have the force of law and can be changed - for example by another majority in the next parliament. It looks like

2 it will be in 2021 unless there is an early vote. We have also seen current MPs radically change their positions - sometimes between two sessions of the Parliament. The good news is that membership in the banking union is a condition for Bulgaria's accession to the so-called waiting room. This means that potential problems in the banking system will be highlighted and, if necessary, the sector will be restored before the country is admitted to the euro are at all. One of the benefits of Eurozone membership is that Bulgaria would receive assistance from the ECB in the face of a liquidity crisis. The poorer countries in the EU are interested in the introduction of the euro because they benefit from redistribution mechanisms. Joining the euro area means access to the euro area common funds - the 700 billion European Stability Mechanism, the single troubled restructuring mechanism, possibly a single deposit guarantee fund, as well as access to liquidity and refinancing from the ECB. This dramatically reduces the risks to both the banking system and the fiscal system, and is a kind of crisis insurance. Accordingly, this means an easier transition of the country and its financial system through periods of crisis. At the same time, however, the ECB will take away 80% of Bulgaria's currency board guarantee. And that is 38-40 billion . Due to tensions and speculation that the currency board was being quietly abolished, Prime Minister Boyko Borisov asked to amend the law with something like a safeguard clause. The Prime Minister insisted that the exchange rate of the lev to the euro, which is theoretically negotiable with the and the ECB, should be adopted only with the ratification of the Bulgarian Parliament. Part of the problem of the discussion is that for almost 23 years (the exchange rate has not actually changed since March 1, 1997), people and companies in Bulgaria perceive the stability of the lev as granted and the predictability of monetary policy as something automatic. The suspicion is, in fact, that politicians are not comfortable with the currency board's restrictions because they cannot print money for "important", in their view, endeavors. That’s why although in April, the government wants Bulgaria to join the so-called waiting room for the euro area most Bulgarians are against the euro. Of course Bulgaria cannot expect that by replacing the lev with the euro this will automatically lead to higher growth for the economy. In order to reach it, additional efforts have to be made by the state.

We should hardly doubt that the most important factors are others than simply joining the Eurozone - dynamic socio-economic development (high rates of economic growth, rising incomes, rapid transition to the so-called "Fourth Industrial Revolution"), overcoming demographic catastrophe, etc.

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Bulgaria will be able to take advantage of European supply chains with the adoption of the euro. However, the state should make good use of these opportunities. With regard to expectations of attracting more direct foreign investment after Bulgaria moves to the single European currency most of the experts are skeptical about this. Additional foreign investments may be attracted, but most probably they will not increase significantly. Attracting foreign investment is a result of many complex factors. For example, corruption, the lack of transparency in business life, and the demographic disaster, which leads in difficulties in finding the skilled workers, are by no means a strong feature of the business environment in Bulgaria. The overall political environment is also an important point. In this sense, raising the country's credit rating as a result of the steps to join the Eurozone is not a sufficient condition for an "invasion" of a flow of foreign investments. On the topic of interest rates and whether they would fall significantly we have to admit that Interest rates in the country have to fall compared to other markets in the , but we must be prudent in terms of this decline. We can say that the interest rates will fall, but this must be on the backdrop of improving the economy and introducing the necessary reforms by the state. Actually, the main expected benefit from joining the Euro may be the lower cost of doing foreign transactions, which can save the country several million euros a year. According to the expert analyses, one of the most significant positive changes for Bulgaria in adopting the euro will come from lower spending on foreign transactions. It is likely that these costs will fall, and this is an important argument for the Bulgarian economy. The introduction of European payment systems can save several million euros. On the issue of the possible effect of the adoption of the single currency on the real estate market in Bulgaria the analyses show that a potential drop in housing prices could be expected. Adopting the euro will lead to more investment in the Bulgarian property sector, but this will not be as much about interest rates as the country perceives as part of the Eurozone. For example, Asia is a big investor in real estate in Eastern Europe, particularly in , but that does not apply to countries like Bulgaria and Romania. The big Asian investors rely heavily on security and reputation when they choose countries to direct their investments. With the introduction of the single currency in the country, these investors will come, and that will be because they will already see Bulgaria as part of the Eurozone. The national organizations representing workers and employees, and employers in Bulgaria express full support for the National Assembly’s decision – that the country should leave the exchange rate mechanism should a Lev-Euro exchange rate be proposed that is different from the exchange rate now in place.

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The employers are insisting that an end be put to speculations and to the fostering of negative and apocalyptic expectations among the public, and for the necessary steps to be taken in fulfillment of the plan for the country’s accession to the Eurozone. Employers object to the attempts to manipulate public opinion and the suggestions of holding a referendum on the introduction of the euro. They say that this runs counter to the EU Accession Treaty. At the same time here we have to ask the question is there any wide public support for the introduction of the euro? A recent survey shows that only 19% of Bulgarians approve of the government's ERM II exchange rate, and at least 54% want a referendum on the abolition of the Bulgarian lev as a national currency. The fears are coming also from the fact that as a rule, the current practice of switching to the euro in all countries without exception shows that changing one's currency with the euro leads to a double jump in retail prices. Despite accusations from supporters of rapid integration in the Eurozone that such "fears" are speculative, no one can guarantee that such a phenomenon will not happen. And if that become a fact Bulgarian people will face an extremely difficult challenge since 1/3 of the people are already below the poverty line.

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