A Pegged Future?

Economic News

22 Jul 2010
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A statement by the leader of Bulgaria's main opposition party last week that he intended to maintain the currency board that pegs the lev to the euro at least until joining the EU in 2007, sparked a sharp reaction from the government and the IMF. Both called on the Bulgarian Socialist Party (BSP) to clarify its stance on this all-important issue.

The statement has had an impact because current thinking by the government and the Fund has been to maintain the peg until 2009. With opinion polls placing the BSP in a position to become the largest party in parliament after elections set for later this year, the opposition party's apparent break with this date was treated with alarm by the financial and business community.

Bulgaria's currency board arrangement (CBA) was introduced as a key element of the macroeconomic stabilisation programme back in April 1997. A law on the Bulgarian National Bank (BNB) gave this institution the task of determining the rate at which the lev was fixed to the peg currency, which was at the time the Deutsche mark (DM). On January 1, 1999, the fixed exchange rate to the mark was converted to a euro base at the official exchange rate of the time. The choice of the euro as peg currency was designed to reinforce the political objective of EU accession and, eventually, to facilitate Bulgaria's integration into the eurozone.

According to the rules of the CBA, the BNB is obliged to buy and sell any amount of foreign or domestic currency at the fixed exchange rate, and the size of the domestic money supply is dependent on the central bank's stock of foreign exchange reserves and the demand for domestic currency.

Few question the obvious advantages of having the currency board. As Professor Steve H. Hanke, the father of Bulgaria's CBA, told OBG recently, "A fixed exchange rate has resulted in stability. And while stability might not be everything, everything is nothing without stability."

Yet the CBA has also limited the government's ability to use adjustments of domestic interest or exchange rates to stimulate the economy. Instead, economic adjustment can be achieved only through wage and price adjustments. Until recently, however, there had been a consensus among Bulgarian politicians that the currency board should be kept until 2009, when the country is expected to enter the eurozone.

At a press conference on Wednesday, Finance Minister Milen Velchev argued that even hints of possible tinkering with the currency board could trigger economic shocks. Velchev expressed hopes the statement by BSP leader Sergey Stanishev was a result of some confusion and misunderstanding in the executive body of the party, rather than a real intention.

However, during a briefing on December 15, attended by OBG, Reuters and the EIU, Stanishev had stressed that the CBA would remain in place until at least 2007 and any further changes after that date would be carried out following consultations with the IMF and the EU.

"You should not expect the socialist party to create risks in macroeconomic stability," Stanishev said, "because we understand that it is of paramount importance to economic development."

He then added, "We will follow the practices of other East European countries which have recently joined the EU and had currency board arrangements, such as Lithuania and Latvia."

Meanwhile, according to Velchev, the IMF's position is already clear. While in Washington on January 19, Velchev told by a number of experts, including those from the IMF, that Bulgaria will need the currency board until 2010 or later, when it will be able to introduce the euro.

Appearing to back away from the earlier statement, BSP deputy leader Rumen Ovcharov then told journalists this week that all executives of the party were supporting the currency board until the adoption of the euro.

However, this still did not manage to dampen some concerns that a potential left-wing government could retain the currency board, but with some adjustment to the acting exchange rate peg in favour of exporters.

In the past, the BSP has criticised the government and the central bank for being too hasty in adopting a euro strategy, which relies on maintaining the currency board until the euro adoption and rules out any adjustments to the currently applied rate against the euro.

Commenting on Stanishev's comments, Deputy Minister of Finance Lyubomir Datsov told the local media this week that the termination of the currency board arrangement would spark inflationary pressures, leading to a 13% inflation rate or even hyperinflation.
He also said that the Council of Ministers and the BNB were working together to propose a strategy for terminating the currency board, envisaging that this would happen with the introduction of the euro in 2009.

Datsov also recalled that Bulgaria had made a commitment during EU negotiations to keep the monetary board and the EU would be unlikely to budge on this issue.
During his visit to Brussels last week, Velchev reiterated Bulgaria's hope to join the eurozone in 2009. At a meeting with EU budget commissioner Dalia Grybauskaite on January 17, he said, "Our objective would be to join the eurozone as soon as possible, which means just more than two years after our joining the EU, which is scheduled for January 2007."

While in Brussels, Velchev also told journalists that he is to ask for a debate on the future of the currency board upon his return. Meanwhile, the socialists are set to meet the IMF resident representative, James Roaf, to clarify their position on the future of the fixed exchange rate. For the time being, at least, the future looks to be pegged until 2007 and perhaps beyond.

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