Bulgaria in ERM2 and the Banking Union of the EU

An emerging investment destination enters the club of most developed European economies

July the 10, 2020, Bulgaria and Croatia got integrated into the EU exchange rate mechanism commonly known as the Eurozone ‘waiting room’. The formal membership lists both these rising economies on a par with Denmark. Their three national currencies can fluctuate at a minimum compared to the Euro applied by 17 other EU member states. Politically, the membership of Croatia and Bulgaria in the Eurozone seems secured, whereas Denmark will be always welcome to the club at its own discretion. Bulgaria’s membership takes along two more details worth notice. The first one translates into Bulgaria’s integration in the ERM2 and the EU Banking Union. The second one infers keeping the currency by the country’s integration in the Eurozone, and the ultimate dismissal of the national currency.

The Banking Union

The Banking Union membership is a corner stone in the shift from the national monetary policy toward a membership in a supranational monetary system as is the European Central Bank. It is traditionally the central bank to regulate the commercial banks, and its monetary policy goes widely through the commercial banks operations. Bulgarian National Bank which is the central bank in the country has been thus far licensing and supervising the private commercial banks, in addition, it has been performing some monetary policy, however limited, in the way of fine-tuning the requirements concerning mandatory reserves, capital adequacy, and local liquidity (regulating exposures in foreign assets). The Banking Union membership will essentially make those functions shift to the supranational European regulator, discharging the local financial system from the risk, however small, of local political intervention in bank affairs. Banks on their part will enjoy enhanced investor trust following their membership having been formalized in the common European financial system.

The Currency Board

The currency board was introduced in Bulgaria way back in 1997, ever since supported by a wide political consensus in the country. The currency board is kind of a super conservative monetary policy having the emission of local currency limited by the reserve assets in the central bank. At the outset, reserve currency of the Bulgarian lev used to be the German mark at an exchange rate of 1:1; subsequently, it has been substituted by the Euro equivalently at the same exchange rate at which the mark got substituted by the Euro in Germany 1.95583. Ever since the exchange rate of the Bulgarian lev has kept unchanged and secured by the currency board mechanism. There are two major supplements to the said mechanism, and the model run in Bulgaria. First, the central bank cannot finance the government, which in turn guarantees fiscal stability and public debt management sustainability. Second, the central bank cannot finance commercial banks making use of repo deals that are traditional for a monetary policy. That results in conservative and stable commercial banks which for the 23-year period have suffered a single crisis of (almost) systematic nature, and it got promptly held in check.

Against this institutional background, the ERM2 and the European Banking Union membership of Bulgaria can be defined a step toward better predictability, less risk and more economic freedom.

Predictability and stability

As at the moment of the EMR2 membership, the budget metrics of Bulgaria rank amid the best in the EU, substantially outperforming some of the Euro area member states. Moreover, the balanced budget policy and the continuous debt reduction is a long-term path followed by already six governments with a diverse governmental support. Almost invariably, the budget balance has kept striking on the positive, or tending to zero for all those years. The debt had been keeping on the down, placing the revenue from privatization (which happened in late1990s) into repaying first and foremost the public debt, and subsequently having the budget excesses coming along to the help. Presently, the public debt of Bulgaria is about 20% of GDP, having none but Estonia an outperforming indicator in the EU. Two other countries in the ERM2, namely Croatia and Denmark, have their debt to GDP ratio respectively 73% and 33%.

Fiscal stability translates into predictability of tax policy and business environment as a whole. Commercial banks in the country play on a government securities market; their role, however, is not critical to the public budget. Thus there is almost no political pressure on monetary affairs in the country. The ERM2 and the Banking Union membership reaffirm that position of the country, and it enters the club with a long-year tradition of stable money and public finances. The currency board itself secures the exchange rate keeping unchanged as it has been for 23 years now, to the accession of the country in the Eurozone. Needless to say, the local currency rate will keep out of fluctuation (even within the set margins of plus/minus 15% in the ERM2), and will keep fixed to the Euro.

Economic freedom

The monetary policy is a pull-up of macroeconomic tools which governments traditionally argue as an adjustment of the business cycles; to all practical purposes, however, the discretionary monetary policy is a source of risk and unpredictability for the business climate. Europe’s dismissal of national monetary policies is a step to a freer economy. This holds essentially true to small open economies which are strongly integrated in the global value chains. This argument is only too applicable to economies such as Bulgaria which we are still defining as emerging. As an indicator, monetary stability is critical to the level of economic freedom of a country. And though of equal importance with the other aspects of state intervention in business affairs on the economic freedom indices, it is worth mentioning that for the recent two decades Bulgaria has proved two of the highest indices in this sphere. Reportedly by the Index of Economic Freedom (Heritage Foundation & Wall Street Journal), Bulgaria ranks fourth worldwide in the ‘monetary freedom’ index (the aggregate index of the country ranking 36th among 180 countries classified under the mostly free group) having the index 85.7 of 100. As reported by the Economic Freedom Index (Fraser Institute) Bulgaria ranks 38th among 162 economies in terms of stable money (the aggregate indicator ranking the country 44th) with an indicator of 9.43 out of 10.

All such achievements favoring the business climate have become a fact even prior to the ERM2 membership of Bulgaria which in turn promises to eliminate the political risk of change of the exchange rate and local inflation policy. This is here to stand till the country’s accession in the Eurozone which will be performed at the current rate of the lev to the Euro, and in keeping the currency board working by that time to secure stable money and stable public finances.

This author of this publication is Georgi Stoeff, Co-founder of Industry Watch and strategic consultant of the public-private partnership Trakia Economic Zone.

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