The proximity of the eurozone and its risks

In the midst of Brexit, about which I [i] wrote on June 22, 2016 [ii] and where nothing unexpected has happened since the then-forecast, and in the midst of domestically important political topics, the approaching expected actions for Bulgaria's entry into the "eurozone waiting room" and membership in the zone itself were completely forgotten. If we exclude the statements of Commissioner Valdis Dombrovskis and Prime Minister Boyko Borissov that entry into the "waiting room" could take place in July this year, the last significant event dedicated to the topic was at the end of January - the conference of the newspaper Capital "Bulgaria's Path to the Eurozone."

This is strange because the topic should be relevant due to the upcoming European Parliament elections, the change in ECB policy and the emergence of new views on its role in the Union economy, and the possible facilitation of the accession process to the zone.

The experience

The latter is easy to explain: the concerns and uncertainties surrounding Brexit somehow naturally translate into a desire among Eurogroup politicians to show off their greatness. There are real grounds for this.

They boil down to the general improvement of the main macro-indicators of economic progress of the zone for the entire twenty-year period and in particular of the new member states that adopted the euro – from price stability, through growth in employment and trade, the fall in interest rates, to 54% growth in GDP and the growth of trust in the people of the zone. These indicators, although with certain (and inevitable) optimistic comments, were summarized by the ECB on the occasion of the anniversary in a special report from December last year. The expected benefits for Bulgaria are well described and analyzed by Dimitar Chobanov, Georgi Ganev, in a special report by the IME and by the majority of experts on the country's economy.

For unknown reasons, the view that the EU currency usually results in a shock increase in prices and in a “loss of sovereignty” of national central banks has also gained some popularity in our country. As for prices, the aforementioned reports, statistics and theory prove that these fears are exaggerated even for countries with a previous relatively high inflation and significant, implicit or hidden budget deficits. Such have not been observed in Bulgaria since 1997. It is very likely that with the strengthening of competition (if it is not hindered) in our country amid the adoption of the euro, prices will decrease.

The loss of “sovereignty” by the central banks of smaller European economies, when they are successful, is a familiar situation from their inception to now. This is first. Second, when they were independent, the countries (they and their governments) usually went bankrupt. This is true primarily for Bulgaria, but not only. And in such situations, even the technical management of these banks has passed into the hands of foreign organizations. For the period after World War II, Bulgaria seems to be a European record holder in this unpleasant respect.

On the other hand, the euro is a form of denationalization of money, although it was not carried out according to Friedrich von Hayek's 1976 recipe, i.e. not by demonopolizing money and its supply. The denationalization of money was carried out by transferring this monopoly to the ECB.

In Bulgaria, it is almost unanimously assumed that membership in the eurozone will also contribute to more effective banking and financial supervision. The hope is that cases like CorpBank will not be repeated. Perhaps it is justified. But the CorpBank case is far from being a failure of supervision alone. It is rather an example of political intervention and an illustration of how the political distribution of economic privileges works in our country.

One of the indicators of economic development after the adoption of the euro is the government debt. On this occasion, it is assumed that there are no risks for Bulgaria. Because the effect of increasing government debts is not observed in the Baltic countries, and there the central banks relied on currency boards. But such an effect is obvious in countries such as Slovakia (with about 15% of GDP) and Slovenia (almost a fourfold increase). Of course, the devil is in the details. To a large extent, the behavior of government debts in these countries is also a consequence of the recession of 2009-2010. In addition, with the adoption of the euro in them, except in Estonia, the appetite for financing government projects is also increasing. For example, in Lithuania, the construction of a nuclear power plant is being considered, although the consultative referendum on this occasion was held in 2012, three years before the country entered the eurozone.

The Bulgarian debate

Bulgaria can indeed maintain its fiscal discipline and repeat the example of the Baltic countries. Colleague Georgi Ganev is convinced that 22 years of operation of the currency board in Bulgaria is sufficient reason to preserve its disciplinary function towards the fiscal.

But the experience here is more peculiar. The requirement for the country to also join the zone’s banking union, although somewhat offensive from a political point of view, is explained by the fact that its members do not fully understand the same case with Corpbank. The ECB, however, has a more realistic view: the plan for entering the “waiting room” requires Bulgaria to improve the management of state-owned enterprises and make the banks’ non-performing loans tradable on the secondary market.

On the first occasion, nothing is simply being done in our country. On the contrary, from the political discussion of the sale of CEZ to this day, calls for the expansion of state bureaucracy in the economy cover new and new areas. It is obvious that the public is being prepared for state participation in the otherwise unfeasible and unfounded project to build the Belene NPP. The propaganda for “blocking state quotas” is reminiscent of the vision of state participation in the economy imposed in 1995 and 1996, but the result of this imposition is not remembered, and the mood seems to be common to all major political parties. The problem is important because, on the one hand, state assets were the real economic temptation that created Corpbank and because, on the other hand, there are real attempts to seize private business – starting with the Belvedere case and ending with the Dunarit case. In the field of energy, there is a distribution of privileges, a desire to unreasonably limit coal-fired thermal power plants in order to "make room" for the Belene NPP, and a political will to push through other unprofitable projects.

The share of non-performing loans fell from 16% of banks' loan portfolios in mid-2015 to around 6% at the end of 2018. In this area, there was a visible improvement in the regulation of enforcement after the 2017 amendments to the Civil Procedure Code. However, a new bill by the Ombudsman to amend the Civil Procedure Code was recently submitted to the legislative assembly, which, intentionally or not, increases the risk of a negative turn in the trend of reducing non-performing loans and seems to be approved by the political parties in parliament for the time being.

These two problems are the main risks before Bulgaria is accepted into the "waiting room". The fact that they are not being discussed is worrying. In February-March of this year, somewhat pre-election, other findings of the EC and the ECB on Bulgaria's economic imbalances were discussed. Attention was drawn to the demographic problems (which began in 1975) and to the outpacing growth of incomes over productivity, which the EC points out does not hinder competitiveness for the time being and which is to some extent a consequence of the regulation of the minimum wage and the labor market.

Developments in the area

The Bulgarian government either hopes that the aforementioned "Brexit effect" will dull the ECB's attention to the fact that they are not taking measures against the risks it has foreseen, or it believes that it will cover up the situation with some other report on the draft law on the Civil Procedure Code and banking statistics.

Meanwhile, reforms are brewing in the eurozone itself that do not portend a significant improvement in its governance. Quite the opposite. If I were the Minister of Finance or the Governor of the BNB, I would refrain from rushing into the “euro waiting room” (which is part of a country’s EU membership treaty) at least until it is clear whether these reforms will materialize. The point is the following.

In December last year, the ECB published a report on its plans for 2019 and beyond. In January this year, in Riga, on the occasion of the fifth anniversary of the adoption of the euro in Latvia, the bank's Vice President Luis de Guindos (former Finance Minister of Spain) outlined these commitments once again.

In particular, Mr. de Guindos says the following:

• "However, the end of net asset purchases does not mean that monetary policy is over."
• Significant room for adjustment will continue to be provided by our key interest rate guidance and our policy of reinvesting the significant stock of assets acquired.
• …Further efforts are needed to strengthen resilience, increase productivity growth and maintain economic convergence within the euro area.
• The introduction of structural economic reforms, the building of buffers and the completion of the single market are of key importance.” [iii]

These are intentions that are, to put it mildly, non-trivial for central banking and involve measures that go far beyond the ECB’s mandate to maintain price stability. Bank and government financing operations are envisaged, as well as other active monetary policy measures. [iv]

It is not at all clear to me how such intentions would be consistent with the provision of Article 123.1 of the Treaty on the Functioning of the EU, which states: “The granting of overdrafts or other types of credit facilities by the European Central Bank or the central banks of the Member States, hereinafter referred to as “national central banks”, to the benefit of Union institutions, bodies, offices or agencies, central governments, regional, local or other public authorities, other bodies governed by public law or public undertakings of the Member States, as well as the purchase directly from them of debt instruments by the European Central Bank or by national central banks, shall be prohibited.” Indeed, Article 125.2 allows for such intervention, where “the Council [of the EU], on a proposal from the Commission and after consulting the European Parliament, may, if necessary, specify the definitions for the application of the prohibitions laid down in Articles 123 and 124…”.

The chapter "Monetary Policy" and the European System of Central Banks should not allow decisions based on expediency. At least not extreme ones, i.e. it seems unlikely that the ECB will submit to the EU Council in the same way that the BNB submitted to the Council of Ministers of Bulgaria during the period May 1995 - March 1997. But the very direction of this thinking worries me, not least because I am often familiar with the populist tendencies of quite a few members of the Council and of many members of the European Parliament. They will be no less so in the new parliament. It seems to me more and more often that, in addition to business cycles, a phenomenon that I would call "a long wave of pure political risks" is at work in history.

These risks are created by politicians who, over the course of 65-70 years, for their own reasons and with the approval of voters, have destroyed the achievements of economic freedom and market coordination. The result is usually some monumental economic disaster.

It is strange that these ideas have not attracted the attention of politicians or the otherwise ever-vigilant economic experts and analysts in Bulgaria. If implemented – I still hope that reason can prevail – the new ECB will nullify not only all the real advantages of the eurozone so far, but also the achievements of the currency board system in Bulgaria.

[i] The author is a lecturer at Sofia University, Chairman of the Management Board of IME and Manager of KS2 Ltd. The article in a shorter version was first published in Manager magazine, issue 245 of March this year: https://spisanie.manager.bg/broi-245/ikonomika/blizostta-na-evrozonata-i-riskovete-ot-neya

[ii] See: Krasen Stanchev. Brexit: The Big Picture: https://www.manager.bg/%D0%BA%D0%BE%D0%BC%D0%B5%D0%BD%D1%82%D0%B0%D1%80%D0%B8/brexit-big-picture?page=0%2C2

[iii] Fostering resilience and convergence in Economic and Monetary Union, Keynote speech by Luis de Guindos, Vice-President of the ECB, at the conference “Five Years with the Euro”, Latvia, 7 January 2019: https://www.ecb.europa.eu/press/key/date/2019/html/ecb.sp190107.en.html.

[iv] See a detailed review in: Gordon Kerr, Cavin O'Driscoll, and Enrico Colombatto, Consequences of Future ECB Policies for Banking, IREF, 27 February 2019: https://en.irefeurope.org/Publications/IREF-Newsletter/article/The-Consequences-of-Future-ECB-Policies-for-Banking, and also by the same authors. The EU To Push For EMU Deepening After May Elections (ibid., 9 January 2019) - https://en.irefeurope.org/Publications/IREF-Newsletter/article/The-EU-To-Push-For-EMU-Deepening-After-May-Elections.

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