EKIP– Expert Club for Economics and Politics A Different Opinion
Author: Steve Hanke
Earlier this year, we witnessed a dramatic slowdown in Bulgaria’s headlong rush to abandon the lev and adopt the euro. Prime Minister Boyko Borisov sensed that Bulgarian society was not in agreement with being brought into the European Monetary Mechanism ERM-II. The year 1997 was both the worst and the best for Bulgaria. It started badly. In February, hyperinflation peaked at an astronomical level of 242% per month. Then things improved. On July 1, a currency board was adopted, and the Bulgarian National Bank, specifically its issuance department, began operating under the rules of the currency board. According to these rules, the Bulgarian lev was to be fully backed by reserves in the German mark, today euro reserves, and to trade at a fixed rate to the German currency. With this decision, the lev became a clone of the German mark, and with this the good news followed.
The results of the currency board were immediate and dramatic. The annual inflation rate fell to 13% by mid-1998. Interest rates also fell, with the BNB's key interest rate falling to 5.3% in October 1998 from 200% in early 1997. That was not all. Demand for the currency board-remodeled lev skyrocketed. The BNB's foreign reserves also soared. Eventually, the only way to get levs was to sell marks at the fixed rate. The BNB's foreign exchange reserves skyrocketed to $2.5 billion by the end of 1997 from $864 million at the end of 1996. In addition to these immediate positive results, the currency board allowed Bulgaria to withstand all external financial crises after 1997. Including the collapse of the Russian ruble in 1998 and the global financial crisis in 2008.
Discipline and resilience
The currency board also allowed Bulgaria to withstand the bankruptcy of the Corporate Commercial Bank in 2014. The KTB disaster was not caused by the currency board system, but by the failure of regulators at the Bulgarian National Bank, who failed to adequately regulate and monitor what was happening in the private bank. Unlike most cases, where banking crises go hand in hand with currency crises, the KTB crisis did not threaten Bulgaria’s currency. Thanks to the currency board system, the country did not suffer a typical banking-currency crisis. The crisis was limited to the banking sector. Thus, Bulgaria’s currency board limited the damage caused by the collapse of KTB.
It is also important to note that Bulgaria's currency board imposes fiscal discipline on politicians and fiscal institutions in Bulgaria. The government cannot borrow from the currency board. Subsequently, since the introduction of the currency board in 1997, fiscal deficits have been controlled very strictly and the level of public debt in Bulgaria relative to GDP has fallen significantly. It was 96.2% in 1997 and has fallen to 18.6% according to the most recent data. Bulgaria's fiscal discipline and the decline in its debt make it an excellent performer in the European Union in terms of fiscal indicators.
The geopolitical aspects of Bulgaria’s currency board should also be noted. Former President Petar Stoyanov told me, while I was his chief economic advisor, that Bulgaria would have had much greater difficulty joining NATO in 2004 and the EU in 2007 without the security and stability that the currency board creates. Perhaps this is why over 50% of Bulgarians support the currency board and the leva, while only about 25% support adopting the euro.
Bulgarian society is sensible enough to realize that you shouldn’t try to “fix” something that isn’t broken. But with the onset of the coronavirus pandemic and while the Bulgarian population’s gaze was elsewhere, Prime Minister Boyko Borissov changed course. He wrongly claimed that Bulgaria was missing out on European financing because it was not part of the eurozone. And then, in a desperate attempt to recapitalize First Investment Bank, a requirement for Bulgaria’s accession to ERM-II, the Bulgarian Development Bank, a state-owned bank, bought BNB shares at twice the market price. Time will tell how the European Commission will assess this dubious maneuver and whether the Bulgarian government made the right decision.
