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CURRENCY BOARD IN BULGARIA AND STRATEGY TOWARDS EMU. KALIN HRISTOV BULGARIAN NATIONAL BANK. EU AND EURO AREA MEMBERSHIP. For new member states there is no opt-out clause for adoption of the single currency The questions are “when” and “how”
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CURRENCY BOARD IN BULGARIA AND STRATEGY TOWARDS EMU KALIN HRISTOV BULGARIAN NATIONAL BANK
EU AND EURO AREA MEMBERSHIP • For new member states there is no opt-out clause for adoption of the single currency • The questions are “when” and “how” • Strategy for development of the Bulgarian National Bank 2004-2009 • Agreement between the Council of Ministers and the Bulgarian National Bank for the adoption of euro in Bulgaria
STRATEGY TOWARDS EURO AREA MEMBERSHIP • Bulgaria will apply for joining ERM II immediately after the date of EU membership • We intend to enter ERM II at current exchange rate – 1.95583 BGN for 1 Euro • Bulgarian authorities unilaterally commit to keep currency board until Euro area membership • Council of Ministers commits to follow balanced budget policy and to honour SGP principles
IS THIS STRATEGY FEASIBLE? • Experience from the founding and almost founding members of the Euro area – corner cases - Austria versus Greece • Experience from the new member states - “Fast track” versus “On a slow boat to … Euro area”
MONETARY INTEGRATION - THAN • Austrian versus Greece (Hochreiter and Tavlas, 2004) • November 1981 Austria fixed its exchange rate to deutsche mark at 7.03 ATS per DEM. In 1995 Austria entered EU and ERM. In 1999 became a member of Euro area. • January 1981 Greece became a member of the EU. In March 1998 Greece entered ERM and in 2001 became a member of Euro area.
MONETARY INTEGRATION – THANERM II ISSUES • The timing of entry • The choice of the central rate • The width of the exchange rate band • The length of stay in the mechanism
MONETARY INTEGRATION - NOW • What do the new member states bring to EU? How different they are and what are implications for monetary integration. • New member states strategies towards ERM II and the adoption of the euro • Lessons for Bulgaria
WHAT DO NEW MEMBER STATES BRING TO EU? • Lower income and price level than the euro area countries • Low capital bases • Large capital inflows • Rising real exchange rates • Low bank intermediation • Large general government deficits (except Estonia, Latvia, Lithuania, Slovenia)
NEW MEMBER STATES STRATEGIES TOWARDS ERM II AND THE EURO • Within new member states we have two groups of countries • First group (Estonia, Lithuania, Slovenia, Latvia, Malta and Cyprus) - targeting euro adoption in 2007-2008. Small open economies, fixed exchange rates, good fiscal stance and low public debt (except Malta and Cyprus). • Second group (Poland, Hungary, Czech Rep. and Slovak Rep.) - targeting euro adoption in 2010 or later.
FRAMEWORK FOR DECISION ON THE TIMING OF THE EURO ADOPTION • Do long-term benefits outweigh the long-term costs • What policy and institutional changes are required • How long will take to put needed policies in place in order to fulfil Maastricht criteria
DO LONG-TERM BENEFITS OUTWEIGH THE LONG TERM COSTS • Benefits Gains from trade (Frankel and Rose, 2002; Micco et.al.,2003; Faruqee, 2004; Baldwin, 2005) Elimination of exchange rate risk should lower real interest rate Elimination of exchange rate volatility should increase FDI Euro adoption will reduce transaction costs Joining the Euro area would secure a clear framework for macroeconomic discipline • Costs Lack of independent monetary policy Exchange rate as a shock absorber
WHAT POLICY AND INSTITUTIONAL CHANGES ARE REQUIRED • Policy changes No need to change exchange rate policy – “problem of double regime shift” Current fiscal policy is consistent with euro adoption – fiscal balance or surplus ensure room for manoeuvre of the policy makers. Harmonization of indirect taxes has to be consistent with fulfilment of the inflation criteria • Institutional changes Central bank independence, legislative requirements for integration into the Eurosystem BNB capacity to participate in formulation and implementation of single monetary policy Euro changeover
HOW LONG WILL TAKE TO FULFIL MAASTRICHT CRITERIA –FISCAL POSITION
HOW LONG WILL TAKE TO FULFIL MAASTRICHT CRITERIA – PUBLIC DEBT
HOW LONG WILL TAKE TO FULFIL MAASTRICHT CRITERIA – INTEREST RATES
HOW LONG WILL TAKE TO FULFIL MAASTRICHT CRITERIA – INFLATION
WHY INFLATION CRITERIA IS THE MOST DIFFICULT TO FULFIL • No independent monetary policy • No absolute control of inflation • No complete inflation convergence – for example USA inflation among states • Balassa-Samuelson effect • Reaction to supply shocks • Different exchange rate pass-through • Microstructure of good markets – pricing power • Consumer preferences • Measurement problems • Definition of inflation criteria
DEFINITION OF INFLATION CRITERIA • “Average rate of inflation, observed over a period of one year before the examination, that does not exceed by more than 1½ percentage points that of, at most, the three best performing member states in terms of price stability” • In 2004 ECB’s Convergence Report - average of three lowest non-negative inflation rates plus 1.5 percentage points • Currently means criterion is 2.4 percent (August 2005) • Is there room for convergence?
VULNERABILITIES ON THR ROAD TO EURO • Capital account volatility • Underlying differences in capital-labor ratios will remain large – return over investment should remain high or even rise • Convergence play during the run-up to euro • Success carries its own risks – improve confidence and reduced risk premia • Large current account deficits • Financial market integration and goods market integration lead, in the poorer countries, to both a decrease in saving and an increase in investment (Blanchard and Giavazzi, 2002)
VULNERABILITIES ON THR ROAD TO EURO • Risks for lending booms • Inflation is somewhat above euro area implying low real interest rates • In the past households were liquidity-constrained • Expectations of fast income convergence after EU accession • Terminal date risk • Risk from policy inconsistency
