July 1 was the day Bulgaria celebrated 10 years since the beginning of the most successful reform that has been undertaken in the field of economic policy since the transformation of the Bulgarian economy. The introduction of the currency board put an end to the uncontrollable increase in the money supply and was a significant premise for the stabilisation of the Bulgarian lev and the increasing confidence in it.
A high and stable economic growth is determined by the existence of individual liberty and personal responsibility. The different elements are connected with voluntary exchange, the protection of property rights and the rule of the law, low taxes, free movement of capital and people, and last but not least - stable money. The reforms which were conducted during the past 10 years and which have contributed to an increase in economic freedom, have improved the conditions for individual initiative and accelerated development. The biggest advance has been realised in the sphere of money due to the implementation of the currency board.
The currency board was introduced in Bulgaria after a severe financial crisis, which started in the beginning of the 1990s and reached its peak in 1996 and first months of 1997. The results were disastrous – significantly lower real income, pensions as low as $2 per month, and some wages only $3 per month. People used the lev to a lesser and lesser degree. It was substituted with the US dollar and the German mark not only for savings, but also for everyday payments in shops. In some cases even natural exchange was implemented meaning that the lev did not perform its functions as money. Other negative peculiarities of this period were the real decrease in investment, capital pouring out of the country, the chronic budget deficit, and enormous public debt. The overall expenses of the economy during the crisis were equivalent to 40 per cent of the GDP for that period, classifying the crisis as one of the most sizeable in Central and Eastern Europe.
During the period 1991-1997 the Bulgarian National Bank (BNB) implemented a discretionary monetary policy, meaning a policy without clear principles. The quantitative goals set-down were not publicly known, or if the goals had become known, they were not achieved. Besides BNB was strongly dependent on the government and took into consideration its policy toward the budget deficit and the financing of unprofitable state enterprises. Additionally, at the time of the peak of the crisis, the creditor of last resort was not only the BNB but one of the state owned banks, DSK, which undertook a great deal of the refinancing of the commercial banks.
The existence of a currency board presumes the complete termination of such practices because it requires the maintenance of firm financial discipline in the private and public sectors. The ability for BNB to be a creditor of last resort was limited only to cases of liquidity risk for the whole banking system. The central bank was forbidden from lending money to the government (with the exception of credits from the International Monetary Fund, which have to go through BNB before they are available to the government, but this does not pose a violation of the essence of the currency board).
The Bulgarian lev was pegged to the euro and the BNB was required to maintain a minimum of 100 per cent coverage of the monetary base (including the fiscal reserve account at the Issue Department which functions as a currency board) with assets denominated in euro. The full coverage of the monetary base and the requirement for BNB to exchange leva for euro upon demand ensured the convertibility of the local currency and increased its stability. In this sense the monetary emission was entirely subject to the market demand and BNB could not increase the money supply at its own discretion.
Since 1997 the Bulgarian government, being deprived of the ability to issue money and therefore finance expenditures, has been forced to keep the budget balanced, and in the past three years significant budget surpluses have been realised. As a result the inflation pressure is going down, and its negative consequences are under control. The Bulgarian lev stands stable relative to the goods and services that can be bought with it, and relative to other currencies as well. It functions as a measure of prices and allows comparison between them. Besides, the stable lev results in higher credibility in the economy, reducing the expenses of hedging against sharp changes in price levels. Therefore resources are allocated more efficiently, investment is increased, capital is accumulated, and the economic growth is enhanced.
Of course, the currency board has its opponents who claim that it has caused the emergence of a current account deficit. They argue in favour of depreciation of the lev or a complete removal of the board. The consequences of such a decision would be strongly negative for the economy as a whole and would mean a reduction of real incomes because the prices of raw materials and technology would not be reduced as they are imported and paid for in foreign currency. In the long-run, due to higher inflation, the real return from investment would be lower which would result in an outflow of foreign investment and a lower real growth of productivity.
Therefore, applying such measures is not only undesirable but also detrimental.
As well as the introduction of the currency board there were other reforms such as privatisation, the liberalisation of trade and the movement of capital. The improvements resulted from more a prudent policy and give grounds to conclude that the expansion of individual freedom is the proper way. The policy of the ruling parties should be built on this if their goal is higher economic growth and standard of living.
A very important element of this policy is the maintenance of the currency board and the exchange rate toward the euro until its introduction as legal tender. This will guarantee the preservation of the stability in the economy that has already been achieved and will continue its positive development. Any change in the monetary regime is absolutely ungrounded, would result in destabilisation and the redistribution of income in favour of small groups of society at the expense of everybody else. This is the reason why reasonable and responsible politicians should firmly support the currency board.
