The sub-prime mortgage situation that plunged the international financial markets to an enduring crisis and caused global investment heavyweights to write-offs billions of euro focused public attention on the issue. Crisis harbingers were given due time as well. In Bulgaria, experts started speculating about whether Bulgaria was facing another fiscal stability shake-out.
Concern as to the soundness of Bulgarian macroeconomic fundamentals was also fuelled by two concurrent events, both showing international institutions’ growing distrust of the Bulgarian market. Recently, credit rating agency Fitch downgraded two of Bulgaria’s sovereign credit rating outlooks from stable to negative and the European Central Bank (ECB) hinted that autumn was the earliest Bulgaria could hope to join the Exchange Rate Mechanism II (ERM II). Bulgaria’s Finance Ministry had been talking about it possibly happening in spring.
To say these events kick-started the talk about the financial market is an exaggeration. Speculations on the risks to Bulgaria’s fiscal stability have been going on for months. The main concerns being the unchecked growth in consumer loans, the small liquidity of the capital markets and the soaring current account deficit.
Lately, discussions have taken on a new dimension as inflation exceeded all expectations for the first time in 10 years. Experts saw the waiver of import duties on goods from the European Union after Bulgaria joined the EU and the concurrent growing consumer spending as catalysts for price growth. The growth was also attributed to seasonal and external factors. Whatever the reason, inflation reached double digits in 2007 and naturally re-kindled long-forgotten memories of the 1996/97 grain crisis and large-scale currency devaluation.
In the 1990-1997 period cumulative inflation reached 210 per cent and by the end of the period 3000 leva was worth less than $1.
The situation then necessitated the introduction of the currency board. Strict fiscal discipline also mended the main failings of the fiscal system with a new state budget and public debt management strategy; the pegging of the lev to, consecutively, the German mark and the euro. External financial and expert aid helped rein in the situation. The crippled macroeconomic fundamentals were restored to normalcy. Inflation was kept in the single digits, the state budget kept generating surpluses and public debt dropped to below 30 per cent of GDP.
Since then talks on inflation have subsided – until now. Inflation often triggers concerns about currency devaluation and considerations as to whether the exchange rate should prompt currency adjustments. To take things further, economists raised the issue whether the current exchange rate of the lev to the euro corresponded to its purchasing parity and whether, given all the inflation, the lev was not overvalued.
Re-assurances that the currency is stable is all the more important now that Bulgaria is to shortly file a request with the ECB to join the ERM II, the waiting room for EU member states in the Eurozone. Especially in view of the fact that the ECB is overly strict on EU hopefuls in their abidance to the five Maastricht musts (inflation below three per cent of GDP, an annual public budget deficit of three per cent of GDP, public debt below 60 per cent of GDP, a fixed exchange rate to the euro and no de-valuation thereafter, and long-term interest rates of 6.4 per cent).
Given that recently inflation has overshot its expectations and the soaring current account deficit, speaking about currency re-valuation seems to make sense. Yet economists warned against over-stretching this concern.
Analysts have not drawn a parallel between 1997 and now. No signs from the mid-1990s were in place. Had there been lev devaluation concerns, for example, Bulgarians would have stood in long lines outside exchange offices to convert Bulgarian leva to Western currencies. This was the case 10 years ago.
The press office of the Bulgarian National Bank (BNB) said that the lev-to-euro exchange rate would remain at 1.95583 and would remain such at least until Bulgaria joined the ERM II. The present exchange rate could also not be subject to re-valuation because it has been entered into the BNB act.
Other economists even believed that talk on the currency re-valuation was unfounded. In an interview with the Bulgarian edition of Business Week, the programme director of the Centre for Liberal Strategies Roumen Avramov subscribed to this point of view and said the exchange rate would remain unchanged both on entry to the ERM II and on the Eurozone threshold.
He said a potential re-valuation of the lev would immediately lead to the re-valuation of all prices and would hit bank balances and savings.
“When an economy has adjusted all its price parities and relative prices to an exchange rate, ongoing for 10 years now, then one might argue that this is the real and objective exchange rate of the currency,” Avramov said.
A requirement for a country under a currency board is the full coverage of money in circulation with a foreign currency. For Bulgaria, this currency is the euro. At present, Bulgaria has 7.6 billion leva in notes and coins in circulation whereas the foreign currency reserves at the BNB are roughly 23 billion leva.
On re-valuation of the lev, the main victims would be the population. The main beneficiaries would be the ones with savings in euro and the companies exporting goods.
Economists staved off the main factor to fuel currency re-valuation speculations. They recalled the inability to match the ECB requirement for low inflation and that Bulgaria was playing catch-up with the remainder of the European economies. Fast economic growth cannot go with a slow-paced inflation rate. With local prices being at 35-40 per cent the EU average levels, the process of converging prices in Bulgaria with the rest of the EU would lead to an increase in prices and, respectively, a consumer price index that surpassed ECB recommended targets. It was hardly coincidental that a number of countries in the SEE region have called for a differentiated approach with regard to the less developed economies because of the faster economic development they are experiencing.
For a Bulgaria, whose memories of currency tribulations are still fresh, whose present is intertwined with the currency board and whose future is pinned to the Eurozone, any plans about reforms to the national currency policy-making is unlikely be done unilaterally or be based on local economic developments alone.
In view of these facts, Bulgaria is hardly likely to re-valuate its currency any time soon.
