Bulgaria and the Euro

Link to Bulgaria and Euro Adoption - Costs, Benefits and Risks (Bulgarian version)

Background and current situation

• Currency board (hard peg) since 1999
• Consequences: benefits of no exchange rate risk, but also costs due to the lack of independent monetary policy
• Nominal criteria for ERMII Membership have been fulfillled. However shared concerns by the fact that the country still has real GDP per capita at only around 50 % of EU average. (see end of page of relative speed of convergence of Eastern European countries and GDP growth rates)
• Business cycle convergence has however increased
• New criteria for ERMII Membership, as of 2018: Comprehensive Asset Quality Review of the banking system and a close cooperation with the SSM to identify possible risks and imbalances in the financial system

• Benefits
• Lower interest rates for firms and households,
• Reductions in bank transaction costs and elimination of currency conversion fees for firms and households
• Enhanced control and supervision of the financial system and improved confidence in the financial sector in the country through membership in the Single Supervisory Mechanism (SSM)
• Possibly, the increase in confidence in the country can lead to improvement of credit ratings, but this depends on many other economic policy outcomes
• If timing is set up properly, additional financial resources provided around new EU Budget instruments (Reform Delivery Tool, Convergence Facility) for new euro member states can be used
• Possible reputation effects; participation in the decision of the Governing Council of the ECB

• Costs
• Significant entry costs, mainly the payment to the ESM, which amounts between 1% and 2% of GDP (0.52 to 1.04 bn Euro)
• With a debt to GDP ratio of 18%, improbable that Bulgaria would ever need the ESM - but would be jointly liable for any problems and any possible future ESM programs
• Elimination of currency exchange fees for firms and households
• Entering the Euro is a final decision, whereas the current currency board arrangement
• Some minor logistic costs of introduction (between 0.30% and 0.70% of GDP, one-off costs

• Risks
• High (mis)perception of inflation (as was also observed in other Eastern European Euro adopting member states, although actual inflation was moderate) - can lead to negative attitude towards the euro
  • European Commission [2009]: "We find that aggregate inflation rates were largely unaffected by the introduction of the euro. For some product groups, however, we observe significant price increases during the period of the euro cash changeover"
  • If inflation effects are more pronounced for some types of consumer goods bought by low income households, they might be in danger of being affected negatively
• Requires a comprehensive plan for the transition period (National Changeover Plan)
  • Including a wide and efficient information campaign
  • Including strong monitoring of prices so that the costs of the changeover to the new currency are not transferred into higher prices for households
  • Including a dual pricing period
• Unclear whether there is democratic support for Euro adoption at the current moment - latest Eurobarometer survey puts support for EMU Membership at 51%
• There has been also an ongoing discussion regarding fears of what has been deemed a "Greek scenario". Different people mean different things by this. In what regards fiscal sustainability, Bulgaria has the third lowest debt-to-GDP ratio in the European Union, so its fiscal policy trajectory seems to be too conservative, rather than too lax. Euro adoption would not change that, as budgetary decisions will further be in the hands of the government and will be influenced by their decisions and priorities. In what regards capital flows and credit expansion in the Bulgarian economy, long-term interest rates are at their historical lows anyways. Both the government and the business could take more debt now, if they wanted to. Euro adoption does not change these circumstances considerably.

Current structure of the European Monetary Union

• Discussions in Bulgaria recently have also focused on the future of the Euro area architecture and its sustainability - one of the most crucial debates on economic policy topics between economists and institutions of recent years. It is not clear, whether the architecture of the Euro area itself and its incomplete nature should be central to the decision of Bulgaria to join ERMII and the Euro area - as the uncertainty around the future path of developments is so large and depends on many economic and political economy factors, that are hard to be estimates and taken into account.
  • Since the Global Financial Crisis, the European Monetary Union architecture has been developed further, with a number of important institutions and mechanisms built-in to enhance its sustainability and resistance to shocks. For a review see: [Constancio 2018]
  • On the one hand, in its first decade, the Euro area has contributed to the real convergence of its member states. According to a survey by the [Bertelsmann Stiftung 2019] European citizens have e.g. profited by more than 1000 euros on average per person from the Single Market.
  • On the other hand, the second decade, in the aftermath of the global financial crisis, has been marked by dangerous fragmentation and has raised questions on the risks of long-term divergence and structural polarization between the core and the periphery.
  • The dangers to the currency union in Europe go back to the work by Robert Mundell [1961] on optimal currency area. Different reasons have been discussed for why the Euro area may not fulfill the criteria to be an optimal currency area, how business cycles in the Euro area might diverge instead of converge and the possible effects of specialization. Krugman [1996], Alesina, Barro & Tenreyro [2002] Stiglitz [2016] Mody [2018] [Graebner, Heimberger, Kapeller and Schuetz 2019].
  • The number of critical assessments and difficulties faced during the Euro area debt crisis, has led to numerous policy proposals in recent years on how to improve the European Monetary Union and make it more resistant to different shocks. [Benassy-Quere et. al 2018] [International Monetary Fund 2018]
  • A summary of the debate on the future of the Euro area and the European Monetary Union from the past years, as well as a summary of different policy proposals to address future macroeconomic shocks, can be found here and here: [Pekanov 2019] Twitter thread