Bulgaria: Challenges of convergence to EMU Nikolay Nenovsky University of National and World Economy Bulgarian National Bank

Bulgaria: Challenges of convergence to EMU

Nikolay NenovskyUniversity of National and World EconomyBulgarian National Bank

Sofia, UNWE - KIA, 3/05/2007

Topics to discus

What is convergence and why convergence is necessary?

Relationships: convergence, economic cycle and monetary regime

Two historical remarks on convergence Some theory of convergence Bulgaria: some facts of convergence Bulgaria: some problems of convergence


Why convergence is necessary?

Convergence: process according to which the differences between countries' main characteristics become smaller and eventually disappear with the time …

Why convergence? Readiness to adopt common monetary policy (ECB) and

common currency (Euro) Synchronization of economic cycle, catch-up EU Similar transmission channels of Monetary policy Similar reaction to EU shocks Appropriate mechanisms of shocks absorption

(openness, flexible markets, free movement of goods, K, L, budget transfers etc.)


Convergence of economic cycle

BG

EU

i ?i ↑

i ↓

BG

EU

GDPGDP

Bad synchronizationGood synchronization


Some theory and empirics of convergence

Maastricht criteria (static) (ST: inflation, public deficit, exchange rate;LT: public debt, long term interest rate)

Econometric measuring (dynamic) of convergence: convergence (the variable of the poorer country advance faster that of richer country and catch-up with them) convergence (means dispersion between the variables in the rich and the poor countries decreases with time)Conditional convergence: local (versus absolute)

absolute local

A

B

A

B

GDP GDP

t t


Convergence and monetary regime

Economic approach: from real economy convergence to the adoption of common currency(ex: big countries, low inflation countries, Germany)

Monetarist approach: from common currency to real convergence (ex: small countries, inflation-prone economies, South

Europe, Bulgaria)

Actually: compromise (since Delors)


The basic ideas of the Monetarist approach

Common currency: strong stimulus for real convergence

Stimulate real convergence via trade integration (endogenous currency area)

Transaction cost reduction, Exchange rate risk elimination, low interest rates, high investment etc.

Low probability of twin crisis Help to build hard budget constraints, “culture of

discipline” and higher credibility External monetary anchor for small open economy


The monetarist approach in Bulgaria: the Currency board

Institutional solution after the crisis (1997) Exchange rate fixed by low (since 1997) Full coverage of monetary base (imitation of the

gold standard, automatic mechanism etc.) Limited monetary policy tools (RR) and limited

LLR High transparency, credibility and discipline Quasi Euro area – import ECB monetary policy


Remembering: the balance sheet of Bulgarian Central Bank

ASSETS LIABILITIES

Cash Currency in circulation

Monetary gold Bank deposits (R = RR+RE)

Foreign securities Government deposits and accounts

(Fiscal reserve)

Banking Department deposit

(Net value of Currency board)

Total 8.6 b euro

ASSETS LIABILITIES

Non monetary gold and other precious metals

Borrowings from IMF

Investment in securities Liabilities to other international financial institutions

Loans and advances to banks Capital

Claims on government Reserves

Bulgarian’s IMF quota and holdings in other international financial institutions

Retained profit

Deposit with Issue Department

Issue departmentCurrency board

Banking department


Historical remark on convergence (1)Industrialization: economic growth in Europe (%, annual) Gold standard is the best period for growth

Western South Oriental Europe Europe Europe

GDP

1820–1870 1.7 1.0 0.6

1870–1913 2.1 1.5 2.4

Population

1820–1870 0.7 0.3 0.9

1870–1913 0.7 0.4 1.3

GDP per capita

1820–1870 1.0 0.6 0.7

1870–1913 1.3 1.1 1.0

[1870–1910] 1.2 0.9 1.4

Source: A. Maddison (1995), Good D., T. Ma (1999)


Historical remark on convergence (2) GDP level in Europe 1913 – 2003 (%, annual), UK = 100Source: Landes, D. (2000), OECD (2005)

0 25 50 75 100 125

Grande-Bretagne

Belgique

France

Suisse

Danemark

Allemangne

Pays-Bas

Suède

Norvège

Autriche

Irlande

Italie

Espagne

Finlande

Hongrie

Grèce

Portugal

Bulgarie

Russie

PIB (2003)

PIB (1913)


Some facts on convergence – real growth

0

1

2

3

4

5

6

7

2000 2001 2002 2003 2004 2005 2006 2007(f)

2008(f)

per

cen

t

EU-25 Bulgaria


Some facts on convergence – Long term interest rates

3

4

5

6

7

8

9

2002 2003 2004 2005 2006

per

cen

t

Reference Value

Bulgaria


Some facts on convergence – price level

35

36

37

38

39

40

41

42

43

2000 2001 2002 2003 2004* 2005

Comparative price levels of final consumption by private households including indirect taxes (EU-25 = 100)


Some facts on convergence – inflation

0

5

10

15

20

per

cen

t

Bulgaria Bulgaria (underline inflation)* Reference Value


Some facts on convergence – monetary aggregate

0%

5%

10%

15%

20%

25%

30%

2001 2002 2003 2004 2005 2006

%

M3 (growth rates) - Euro area M3 (growth rates) - Bulgaria


Some facts on convergence – credit growth

0%

10%

20%

30%

40%

50%

60%

2001 2002 2003 2004 2005 2006

%

Claims on non-government sector (growth rates) - Euro area

Claims on non-government sector (growth rates) - Bulgaria


Some facts on convergence – public finance

0.00%

20.00%

40.00%

60.00%

80.00%

2000 2001 2002 2003 2004 2005 2006e 2007e

Decreasing levels of public debt (22.8% of GDP as end-2006)

Budget surplices in last years (3.3% of GDP as end-2006)

-4

-3

-2

-1

0

1

2

3

4

2000 2001 2002 2003 2004 2005 2006e 2007e

%

ЕС-25 Bulgaria Reference value


Some facts of convergence – productivity

GDP in Purchasing Power Standards (PPS) per person employed relative to EU-25 (EU-25 = 100)

• Some preliminary conclusions from the different studies (including econometrical) on Bulgaria:

High nominal convergence (Currency board)Low real convergence

28

29

30

31

32

33

34

35

36

37

2000 2001 2002 2003 2004f 2005f 2006f 2007f 2008f


Labor productivity per person employed

GDP in Purchasing Power Standards (PPS) per person employed relative to EU-25 (EU-25 = 100)

28

29

30

31

32

33

34

35

36

37

2000 2001 2002 2003 2004f 2005f 2006f 2007f 2008f

Source: Eurostat


Some problems of convergence

Convergence and development – enemies or friends? Does poor countries (catch-up countries) need the same cycle

and the same institutions like in the rich countries?

Who drives the convergence? Market driven convergence State driven convergence

The challenge of institutional convergence? Where are the limits of European and National Institutional

building? Institutional competition

When and how to adopt the euro?


Strategies of Euro adoption

Bulgaria was committed to join 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 respect SGP principles

For new member states there is no opt-out clause for adoption of the single currency, the questions are “when” and “how”

Now - decisions to take: the date of entry, the choice of the central rate, the width of the exchange rate band, the length of stay in the mechanism etc – from our point of view is clear.


Strategies of Euro adoption – the standard procedure

COMECOM EU

ERM II

ERM II

ERM II EMU

EMU

EMU

1989

01/200706/2007 06/2009

06/2007

transition

+/- 15%Min 2 year no devaluation

Maastricht criteriaEx rate is of common interest

(all kinds of preliminary Euroization are almost impossible)

Scenario 1

Scenario 2

Scenario 3


Strategies of Euro adoption:

Currency board versus inflation targeting

Inflation targeting needs Central bank credibility Need for good knowledge of the transmission mechanism

and good macroeconomic model Need for well defined loss function (output gap) and

reaction function (Taylor rule for example) Need for good inflation forecasts (EE never hit the target) Need for very good macro econometric model Need for developed financial markets None of these conditions exists in Bulgaria, Romania or

Eastern Europe in general


Instead of Conclusion: possible sources of Bulgarian influence in EU and EMU decision making

Helen Wallace (2003) methodology 7 sources of influence: Political weight (non) Economic weight (non) Political practice (yes) ? Social and economic practice (yes) ? Persuasive ideas (yes) ? Compelling demands (yes) ? Credibility and consistency (yes) – Currency board, fiscal discipline

Bulgaria should take the example of the Benelux countries Currency board, fiscal discipline Policy entrepreneur Persuasive ideas Pace-setting role

Documents

Bulgaria: Challenges of convergence to EMU Nikolay Nenovsky University of National and World Economy Bulgarian National Bank