1. The European Union - on the Horizon
1.1 What is the Final Goal?
1.1.1 Definition
Monetary union is the final stage in economic and financial integration
among countries, in the specific case analyzed in the present paper among
the countries participating in the Treaty of Maastricht providing for
the implementation of such a union as the ultimate objective of the convergence
toward a unified Europe. Membership in such a union would require the
adoption of a common currency and its circulation as a single legal tender
(or the final and irrevocable pegging of exchange rates among the currencies
of the participating countries), as well as the conduct of common monetary
(including foreign-exchange) policy.
The Treaty of Maastricht specifies a time-frame for achieving
the final goal in three stages of economic and monetary
convergence:
1) The first stage includes both integration processes having
evolved to a large extent even before the Maastricht Treaty and
processes whose concluding phases coincide with the end of the
first stage of convergence two years after the signing of that
treaty in early 1992. These processes could be summarized as a
gradual liberalization of the movement of goods, labour and
capital within the territory of the European Union (EU);
2) The second stage started on 1 January 1994. In the area of
monetary and foreign-exchange policies it is characterized by the
creation of a new institution to replace the European Monetary
Cooperation Fund (EMCF), established in 1973, which had performed
functions related to the short-term financing of intervention
operations in the early phases of monetary integration. The new
institution was named European Monetary Institute (EMI) and is
managed by a Council consisting of the Governors of the central
banks of the member countries. The EMI is entrusted with the task
to promote cooperation in the area of monetary policy and to
execute the technical preparation of the transition to the third
stage of the European Economic and Monetary Union (EMU);
3) The third stage (known also as a "full EMU") is
to commence with the final and irrevocable pegging of the
currencies of the member countries to a (common) European
currency unit (ECU) and their subsequent withdrawal from
circulation, as these currencies are replaced by the
fully-fledged supranational currency of the EU which from just a
unit of account at present is to become the single legal tender
within the territory of the EMU. Originally (in accordance with
the Treaty of Maastricht), this final stage was envisaged to
begin on 1 January 1997 or - in case this proves to be impossible
- not later than 1 January 1999, even if the participant
countries which fulfil the four membership criteria specified
further down in this paper do not represent absolute majority.
Nowadays it is quite certain that the earliest possible date for
replacing national currencies with the (common) European currency
unit is 1 January 1999. A new institutional framework is relevant
to the third stage of the EMU. The EMI is to grow into a European
Central Bank (ECB) and a European System of Central Banks (ESCB).
Irreversibility of commitments under the Treaty on EMU is
explicitly stated in a Protocol to the Treaty of Maastricht which
has later been ratified by all signatories.
1.1.2 Macroeconomic Criteria for Participation in the
EMU
The Maastrich Treaty sets out four criteria as preconditions
to be satisfied by each country wishing to join the monetary
union. One of them (the third criterion) concerns directly the
stability of currencies, but all four criteria, in essence, have
bearing, although indirectly, to monetary policy. These criteria
are the following:
1) a high degree of price stability, apparent from a rate of
inflation that does not exceed by more than 1.5 percentage points
that of, at most, the three best performing member states in
terms of price stability;
2) sound public finance, expressed in achievement or, at
least, close approximation of two target ratios:
- government budget deficit not exceeding 3% of gross domestic
product (GDP);
- stock of government debt, as at the moment of joining the EMU, not exceeding
60% of GDP;
3) nominal exchange-rate stability, apparent from the
observance of the normal fluctuation margins ("bands")
provided for by the Exchange-Rate Mechanism (ERM) of the European
Monetary System (EMS) for at least two years, without devaluing
against any other member state's currency;
4) durability of economic and monetary convergence being
reflected in the convergence of long-term interest rates, their
level not exceeding by more than 2 percentage points that of, at
most, the three best performing member states in terms of price
stability.
The problem, however, is that, having been formulated in such
a rather conservative variant consistent with price stability as
the primary and ultimate objective of the ESCB, the criteria
enumerated may prove to be difficult for achievement even for the
most "sound", in an economic sense, western economies.
Therefore a relative "relaxation" of these membership
preconditions in the future, which some of the provisions of the
treaty allow for due to possible different interpretation of
their wording, does not appear impossible. For the time being,
however, such a scenario is not envisaged, at least officially.
Despite that some uncertainty remains with regard to the
question how strictly the Maastricht criteria will eventually be
applied by the incumbent EU member states, these criteria should
serve as a long-run strategic goal for macroeconomic policy in
Bulgaria. The principal argument in support of such a conclusion
is of domestic character: prudent macroeconomic policy is
imperative for sustainable growth. Within the context of
integration processes, any refusal to follow such a direction
of development could be interpreted as non-compliance with the
commitments undertaken by Bulgaria through the ratification of
its European Agreement. The possible steps and performance of the
east European most "diligent" reformers could be a
minimum standard in this respect. Bulgaria has already missed one
opportunity to be treated in the same group with the Visegrad
four. The statute of a country lagging behind, always in the
shadow of the front-runners, cannot and should not be satisfying.
1.2 Where are the Countries of Western Europe?
1.2.1 Historical Overview
Monetary integration among west European countries has evolved
only at a later stage of their economic integration. The
foundations of the EMS were laid down in March 1979, more than
two decades after the signing of the Treaty of Rome. Attempts for
coopeartion in the monetary area, however, have started as early
as in the beginning of the 1970s, following the demise of the
Bretton-Woods international monetary system.
In 1979 the European Currency Unit (ЕCU) was introduced, as a
weighted currency basket including the national currencies of the
European countries participating in the system. The
"grid", formed by the "central" rates of all
EMS currencies vis-a-vis the ECU, as well as the
"narrow" (plus-minus 2.25%) and "broad"
(plus-minus 6%) fluctuation bands, also came into being. Thus the
ERM, although the currencies participating in the EMS and its
currency basket (the ECU) were not obliged to join it, turned out
to be, in fact, at the heart of the newly-established system.
Growing convergence of exchange rates, inflation rates and
interest rate levels, as well as of many of the remaining major
macroeconomic indicators, witnessed over the 1980s led to a new
impulse in the evolution of the ideas for monetary integration.
In the Treaty of Maastricht, signed on 7 February 1992, the EMU
attained concrete dimensions and assigned to participating
countries irrevocable obligations.
1.2.2 Current Situation and Prospects
There is a substantial degree of differentiation among the
present EU member states. The 15 countries currently forming the
union are at various phases of the programme for their common
convergence into a future EMU. In the area of monetary policy,
their differences can be reduced mainly to:
- the stability of national currencies and their participation
in the ERM;
- the level of the long-term nominal interest rates and of the rates of
inflation;
- the fiscal and other macroeconomic and structural characteristics of
their economies.
Comparing the actual values of the relevant variables
registered during the recent years with those prescribed by the
Maastricht criteria may serve as a good illustration of still
differing macroeconomic indicators of the EU countries. In 1992,
for instance - the year of signature of the Treaty on EMU -
divergence of inflation rates and long-term interest rates was
considerably larger than that provided for in the Maastricht
Treaty. ERM problems in the late summer and early autumn of 1992,
when the British pound and the Italian lira left the mechanism,
as well as the adoption in August 1993 of extremely broad, from
the viewpoint of historical experience within the EMS,
fluctuation margins for the ERM currencies (plus-minus 15%) may
be regarded as a certain step back, and away from convergence
commitments to an EMU. According to the data for last year, only
three countries - Germany, Luxembourg and Ireland - comply with
all criteria. Most countries experience problems with the
government debt target ratio, although the criterion for a
government budget deficit below 3% of GDP seems more difficult to
meet. Greece, Spain and Italy face the most serious hardships in
satisfying the criteria. This differentiation engenders inside
tensions about the possible unfavourable effects for both groups
of countries: the one that will prove successful in achieving the
Maastricht requirements by the end of 1999, and the other in
which countries will initially have to retain their national
currencies. These and some other unresolved problems will be
discussed by the end of 1995; until then the finance ministers of
the EU member countries have to coordinate a plan for transition
to a single European currency. Such a plan is to be deliberated
at the forthcoming biennial summit to be convened in Madrid.
From the perspective of east European countries in general,
and Bulgaria in particular, processes in countries such as Greece
and Portugal, and Spain as well, which have structural
characteristics of their economies and incomes closer to the
Bulgarian ones, deserve special attention. These three countries,
and most of all Greece, are still far away from the Maastricht
EMU membership criteria. Countries such as the Czech Republic and
the Baltic states, for example, have even performed better than
Greece according to some indicators (exchange-rate stability,
government budget deficit, government debt).
With view to existing differentiation, a variant of the EMU,
which has to be based on the right to membership without
participation in the ERM provided for in the Treaty of Maastricht
and to permit two or more fluctuation zones around each of the
four membership criteria, seems quite possible. According to such
a scenario for the development of integration processes, the
future EMU could consist of at least two groups of countries:
countries that have met the Maastricht criteria themselves (such
as Germany, the Netherlands, Denmark, France, Luxembourg), and
countries that have satisfied possible broader requirements than
those of the Maastricht criteria (the vanguard of reforming east
European economies might be also among this latter group). In
this line of thoughts, two possible approaches to the
establishment of an EMU have gained popularity during the recent
one or two years: the so-called "big bang" approach
according to which all member states will adopt simultaneously
the common legal tender and reject their national currencies, and
the so-called "critical mass" approach according to
which a step-by-step process of an EMU creation through an
initial participation in the union of a "core" group of
countries having fulfilled the Maastricht criteria, to be
gradually joined later by other countries, will be followed.
Despite continued discussions and debates on the pros and cons of
each one of the two alternative approaches to "start"
the EMU, the opinion in favour of the "critical mass"
approach has recently been gaining stronger hold. This means that
the so-called "core Europe", within which the European
currency unit is to be gradually introduced on 1 January 1999,
has already been taking shape. Given such a scenario, financial
institutions in the countries of "core Europe" are
expected to maintain dual book-keeping, in their national
currencies and in the single European unit, over a two-year
transition period. Such a phased approach, however, has its own
problems too. Changes in the government debt criterion will
apparently be required, if political aspirations of France and
Germany to attract into "core Europe" at least Belgium,
or, as a better alternative, Benelux as a whole, are sustained.
No matter the number and complexity of the problems, waiting
for their solutions, among the incumbent EU member states,
re-formulation or relaxation of the criteria provided for in the
Treaty of Maastricht to a degree facilitating the incorporation
of new countries appears unrealistic. Even for a member state
such as Greece, for example, it is now accepted that its
incorporation is not likely to occur together with the second
group of countries that will join the EMU.
1.3 Where are the Countries of Eastern Europe?
1.3.1 Historical Overview
In the recent past the currencies of the former socialist
countries were inconvertible. Due to the state monopoly on
foreign trade and foreign-exchange transactions, state-owned
foreign trade companies (also sometimes called foreign trade
"organizations") in these countries were the only
economic agents granted the right to effect foreign trade
transactions and operate, in connection with their activity, with
foreign exchange and foreign-exchange accounts. Exchange of
currencies took place according to announced official and
commercial exchange rates and in compliance with existing legal
restrictions.
1.3.2 Current Situation and Prospects
Following liberalization of prices, foreign trade and the
exchange-rate regime at the beginning of the ongoing process of
transition to a market economy, different forms of partial
(mainly internal) currency convertibilty were introduced in the
countries of central and eastern Europe. In the majority of them
current account convertibility has - more or less - been
achieved. In many of these countries (including Bulgaria) de
facto capital account convertibility (to a higher or lower
degree) has also resulted from insufficient effectiveness of
exchange controls.
In principle, east European countries have to pass through
processes analogous to those which the countries of western
Europe that aspire to become future participants in the EMU
themselves have to advance through. But these are only few of the
numerous accompanying problems resulting from the uniqueness of
the transition from a planned to a market economy to which the
countries of central and eastern Europe will continually have to
search for solutions in their economic and monetary convergence
to the European west. Along the road to an EMU, eastern Europe
must first arrive there, where western Europe, or the larger part
of it, stands at present, and only after getting there it can
progress further on, in the pursuit of the final goal. This
implies that east European countries have to walk down the road
marked, in the case of western Europe, by the Treaty of Rome and
the Single European Act. Within the context of payments
regulations, this would mean that the countries of the European
east should first achieve full convertibility of their national
currencies through liberalization of their regimes regarding
current and capital account transactions. If the process of
accession into the EMU is not to be indefinitely protracted over
time, these countries must, in parallel with the liberalization
of their current and capital account regulations, accomplish the
transition from the present state of their economic and monetary
systems to the state typical nowadays for the western countries.
2. Bulgaria and the European Union - Main Issues from the Perspective
of the Payments Regime
The long and difficult road which lies in front of the
countries of central and eastern Europe before they join the EMU
is well illustrated by their macroeconomic performance in the
recent years. The overwhelming majority of the countries in this
group nowadays remain still at a rather big distance from
meeting, or at least approximating, the Maastricht membership
criteria. In terms of inflation (which varied between 20 and 120%
on a consumer price index (CPI) annual basis in 1994 in the nine
countries with European agreements) and, as a consequence, in
terms of the level of long-term interest rates, none of the east
European states is, and could not claim over the following two or
three years to be, ready for EMU membership. In terms of the two
remaining criteria, namely exchange-rate stability and
"safe" government indebtedness - only the Czech
Republic, to some extent the Baltic countries, and to a lesser
degree Slovenia approximate and could, in a foreseeable future,
conform with the membership requirements of the Maastricht
Treaty.
Bulgaria with inflation rate of 121.9% (cumulative), nominal
lending-rate levels and nominal depreciation of the Bulgarian lev
of more than 100%, budget deficit of 6.3% of GDP and a high, even
problematic for servicing, government debt was in 1994 in the
rear compared to its east European partners of the former Council
for Mutual Economic Assistance (CMEA) along the road to the
monetary integration of Europe. At the same time, its
macroeconomic performance in the first half of 1995 and
anticipated outcomes for the entire year appear to be more
optimistic. Cumulative inflation for the first six months of 1995
was a little above 15%, nominal interest-rate levels dropped
almost by a half, the exchange rate remained stable, and
government (both domestic and foreign) debt service did not
create serious problems. The tendencies observed suggest that the
hope for Bulgaria to participate in the process of economic and
monetary convergence of Europe on an equal footing with the
remaining central and east European states has not been
completely lost yet. Such a membership in the would-be union, on
equal terms, however can be achieved only if consistent
stabilization fiscal and monetary policies, supported much more
definitely than in the recent five years by structural and
institutional reforms, are conducted.
Three relatively self-contained sets of problems, which need
their solutions if Bulgaria wishes to retain some realistic
chances for a full membership in a future EMU, are now
confronting its economic policy in the areas related to the
foreign-exchange regime, convertibility of the lev and monetary
policy:
• achieving current account convertibility of the
lev;
• liberalizing the regime of capital account transactions;
and
• pegging the exchange rate of the lev to the European currency
unit, with the ensuing effects on the formulation and implementation
of monetary policy in particular, and macroeconomic policy in general.
The above-mentioned three sets of issues are further down
successively considered. We refer to these as "sets of
issues", and not "stages" or "phases",
since work on them can and must advance in parallel, if Bulgaria
wishes to join the EMU within a foreseeable time-frame. They can,
on the other hand, be logically distinguished from one another
quite easily and unambiguously. Parallel progress in the three
mentioned areas is not only imperatively predetermined by the
strategic goal chosen, but is also feasible, as we shall attempt
to prove in the next sections of the paper.
3. Currency Convertibility - Some General Issues
3.1 Definition
By tradition, i.e. by the first 2-3 decades of this century,
the notion of "convertibility" has been used to
designate the unlimited right of a holder of a currency to
exchange it into gold at a predetermined fixed rate. At present,
gold does not play a substantial role in international payments
and, therefore, convertibilty of currencies into gold is not an
up-to-date concept. The term "convertibility" in its
modern context relates to the right of a holder of a national
currency to freely exchange it into each and every other national
currency at the prevailing exchange rate. The
"prevailing" exchange rate may be either pegged, or
floating.
3.1.1 Internal and External Convertibility
From the perspective of the holders of money balances,
difference is made between external and internal
convertibility.
External convertibility denotes the right of
non-resident domestic currency holders to convert it into foreign
currencies. Such restricted convertibility in the form of
external convertibilty is usually applied by countries striving
to stimulate the inflow of foreign capital. Within a more general
context, external convertibilty provides incentives for
non-residents to engage in transactions in countries having
introduced external convertibility of their currencies. External
convertibility of a currency is directly related to private
foreign investment, especially when complemented by the right to
repatriation of profits and of receipts from liquidation of
non-residents' assets in a country.
Internal convertibility, on the other hand, relates to
the right of residents to convert their money balances into
foreign currencies. Although this form of restricted
convertibility also has some implications for the inflow of
foreign investment, it is of greater significance as a
disciplining factor for national macroeconomic policy.
By the right which internal convertibility grants to residents
to arbitrate between the local and foreign currencies, it exposes
domestic macroeconomic policy to foreign competition. This
creates risks for governments, but, at the same time, forces them
to pursue internationally coordinated and competitive policy. In
cases of a fragile equilibrium coordination between government
financial policy and central-bank monetary policy attains greater
importance. The sharp turn in the financial policy of the
government headed by Prof. Berov in 1994 compared to 1993 is the
most recent illustration of the above-mentioned general
conclusion. This turn was imposed by a "flight from the
lev" rather than by any direct pressure of international
financial institutions. It is a differnet matter that the
discontinuation of official foreign financing in 1993 accelerated
the depletion of foreign-exchange reserves and thus catalyzed the
process of "taking confidence away" from the lev, as a
reaction of economic agents to the bleak macroeconomic policy
conducted.
3.1.2 Current and Capital Account Convertibility
With view to the objectives which convertibility is
wished and designed for, a criterion determining the nature of
the transactions requiring convertible currency is applied. The
traditional differentiation is between convertibility on current
account transactions (current account convertibility) and
convertibility on capital account transactions (capital account
convertibility).
Current account convertibility is defined as the right
to convert the local currency into foreign currencies for the
purpose of effecting payments related to imports of goods and
services. The dividing line between current (particularly the
so-called "invisible") and capital transactions is
quite blurred. For all practical purposes, including, and most of
all for, international negotiations, whether a country has or has
not achieved current account convertibility is judged unambiguously
by the fact whether the respective country has accepted or not
Art. VIII status according to the Articles of Agreement of the
International Monetary Fund (IMF). In particular, Art. XXX (d) of
the IMF Articles of Agreement determines the following scope of
the transactions and payments considered to be current:
"Payments for current transactions means payments which
are not for the purpose of transferring capital, and includes,
without limitation:
(1) all payments due in connection with foreign trade, other
current business, including services, and normal short-term
banking and credit facilities;
(2) payments due as interest on loans and as net income from
other investments;
(3) payments of moderate amount for amortization of loans or
for depreciation of direct investments; and
(4) moderate remittances for family living expenses; (Art.
ХХХ, (d))".
Some of these payments transactions, from a purely economic
point of view, bear the nature of capital transactions. Their
inclusion in this category is predetermined by the necessity to
stimulate and facilitate current transactions which, as a rule,
require repayment of short-term bank loans and transfers for
depreciation of direct investments.
Capital account convertibilty relates to the right to
convert the local currency into foreign currencies for the
purposes of capital transactions and transfers. In reality, it is
less frequent than current account convertibility. As a
consequence of the tendencies of capital markets liberalization
and financial sector deregulation on a global scale dominant
since the beginning of the 1980s, capital account convertibilty, de
jure or de facto, has been encompassing an
increasingly larger number of countries. All EMS member states
have abandoned controls on capital transactions, thus ensuring
capital account convertibility for their currencies.
The primary concern for current account (like internal)
convertibility is the competitiveness of the economy and economic
policy, while for capital account (like internal) convertibility
it is the economy's capability to attract foreign investment that
really matters.
3.2 Currency Convertibilty: Preconditions and Implications
3.2.1 Implications of Introducing Current Account
Convertibility
Introducing current account convertibilty, when complemented
by foreign trade liberalization, has the following more important
economic implications:
• Extends the world structure of prices to the reforming country.
In a market economy, world prices ensure the most clear and precise signals
for production and investment decisions and decentralization of this type
of decisions.
• Impalnts competition in local markets. What made western countries
rich was not just the market economy itself, but competitive markets.
No one likes competition, since it is a constraint, yet only the actions
of the others can make each and every producer to perpetually improve
production in order to survive. The external source of such competition
is particularly important for the economies in transition, whose productive
sector was monopolized to a substantial degree in the pursuit of scale
economies.
• Current account convertibilty of the local currency unit provides
access to international markets of goods and services, thus contributing
to the improvement of consumption standards.
• Through the opening of local markets to foreign competition and
the equalization of domestic with international prices, current account
convertibilty leads to a more efficient allocation of resources in those
industries in which the country has a comparative advantage and to a higher
productivity, thus stimulating investment, employment and growth.
The favourable medium- and long-term economic effects of
current account convertibility may be derived only if a certain
minimum of preconditions are met, so that convertibility can be
"sustained", and not abandoned after a short period of
time. Ensuring these preconditions, however, has its own
short-term costs.
3.2.2 Preconditions for Introducing Current Account
Convertibility
There are four most frequently commented preconditions for
introducing and maintaining current account convertibilty:
• Prevailance of an appropriate exchange rate;
• Availability of sufficient foreign-exchange reserves;
• Macroeconomic policy which is consistent with a stable functioning
of the economy;
• Price system which reflects relative efficiency and utility of
products being the principal incentive mechanism.
There is no universal recipe how to determine the level of the
exchange rate which is "appropriate" and of
foreign-exchange reserves which is "sufficient". It can
be stated, as a general rule, that the "appropriate"
exchange rate is that one which equilibrates the demand for and
supply of foreign currency in the absence of exchange
restrictions and within the context of a specific macroeconomic
policy. Under a regime of a floating exchange rate it is usually
easier to combine current account convertibility with external
balance. If, however, fiscal and monetary policies remain
overexpansionary, inflationary pressure would escalate, causing a
prolonged depreciation of the national currency. Such a situation
of instability will harm investment and growth.
"Sufficient" foreign-exchange reserves are needed to
allow the country to (a) absorb domestic or external shocks
without resorting to exchange restrictions until macroeconomic
policy and/or the exchange rate respond to these shocks and (b)
finance temporary or seasonal fluctuations in net
foreign-exchange receipts without experiencing large temporary
fluctuations in the exchange rate. The greater the significance
awarded to exchange-rate stability, the higher the level of
foreign-exchange reserves. No strictly defined method of
"calculating" the sufficiency of foreign-exchange
reserves exists. Practice has, however, shown that, at least in
the past, maintenance of foreign-exchange reserves equivalent to
at least three months of imports has proved to be sufficient for
sustaining convertibility under a regime of a "pegged"
/fixed/ exchange rate. The Republic of Korea adopted Art. VIII
status (in the IMF) in 1988 with reserves equivalent to its
imports over a three-month period; the Kingdom of Thailand
accepted Art. VIII status in 1990 with reserves equal to five
months of imports; Poland virtually liberalized all current
account transactions (without accepting the obligations under
Art. VIII) with foreign-exchange reserves and external credit
lines equivalent to imports of four months and a half. In 1991
Bulgaria did the same with practically no reserves.
In an ideal case, the attainment of macroeconomic
stabilization is a prerequisite for the introduction of current
account convertibility. In a more realistic scenario, however,
what is important is that the macroeconomic policy conducted
right after the introduction of current account convertibility
should be consistent with internal equilibrium, i.e. it should
equilibrate aggregate demand with the available resources and the
growth of aggregate demand with the potential growth of GDP.
Otherwise, inflationary pressure would erode the economy's
competitiveness, leading to current account deficits at a given
exchange rate. Alternatively, macroeconomic instability may give
birth to the depreciation-inflation-depreciation spiral.
Fiscal policy, and in particular the tax system, is of key
importance for current account convertibility. Without a reliable
tax base there is an inevitable recourse to the financing of
government expenditures in an inflationary way, which undermines
confidence that convertibility will eventually be sustained. From
the perspective of monetary policy, money supply growth should
certainly be contained under strict control. The lesser the
budgetary demands for credit, the easier to control the supply of
money; but such a monetary policy also requires the relevant
institutional development of the financial system and of the
central-bank policy instruments.
Well-functioning price system and system of incentives are an
essential precondition, if the impact of convertibility
contributing to a more efficient allocation of resources is to
reach the real economy. In order to extract all positive effects
of convertibility on efficiency, employment and growth, abolition
of foreign trade controls, tariff barriers, domestic trade and
price controls, restrictions on labour market functioning and of
other administrative obstacles is also necessary.
3.2.3 Implications of Introducing Capital Account
Convertibility
The attitude that the distinction between current account
convertibility and capital account convertibility is already
outdated and does not correspond to present-day realities has
widely been asserted in the literature of the recent decade.
Turbulent processes of deregulation of financial markets in the
industrial countries and their close interdependence have been
pointed out in favour of this argument. The opinion that capital
account convertibility is as much significant now for the smooth
functioning of the world economy as current account convertibilty
was after World War II (and still remains) for free international
trade has been gaining increasing support.
Among the favourable implications which deregulation of
capital flows would have on the economy of a country, those most
frequently spelled out are:
• the rise in social welfare, possible due to the access to
foreign savings which expand the local resource base. This is an additional
opportunity to increase investment and accelerate growth;
• the drop in national spending originating from occasional temporal
(seasonal) disparities between periods of overconsumption or overproduction;
• easier access of countries to international financial markets,
reducing, in effect, the price of the funds borrowed from abroad;
• more opportunities for risk diversification in the trade with financial
assets, which otherwise would have been absent;
• greater competition in the financial sector, easier specialization
in the supply of financial services, and more incentives for financial
innovation.
Although these potential favourable implications are not being
disputed at present, the number of the countries (particularly
less developed ones) which have introduced capital account
convertibility is, in practice, much lower than that of the
countries having introduced current account convertibility. The
reasons for such an outcome are two: a) the conditions needed to
maintain capital account convertibility are much more rigid than
those needed to maintain current account convertibility; and b)
the opinion that retention of controls on capital transactions
has its logical and practical motivation is still widely spread.
The arguments in favour of maintaining restrictions on capital
transactions are normally associated with their role:
• to facilitate the management of balance-of-payments crises
and exchange-rate instability, which could have otherwise been exacerbated
by fluctuations in short-term capital flows;
• to direct domestic saving to financing investments within the country
instead to acquiring foreign assets, and to restrict foreign ownership
on local factors of production;
• to extend the opportunities for the state to tax financial transactions,
income and property;
• to prevent capital flows from offsetting efforts for stabilization
and implementation of structural reform programmes.
These arguments do have some pragmatic sense, although being
difficult to defend from theoretical grounds.
Balance-of-payments crises or instability of the exchange
rate, however, could have hardly been put under control through
restrictions on capital transactions only. External balance
problems have their roots and fundamental causes outside capital
flows, and therefore imposition of restrictions on the latter
cannot replace the actions needed to eradicate the true causes of
the mentioned crises. Capital restrictions are, at best, just
palliating, and may be put into action only until any suitable
policy measures have manifested their effect.
It is also unlikely that restrictions on capital flows may be
successful in retaining domestic saving within the country in the
absence of sufficient incentives for such a behaviour. It should
be once more underlined in this case that outflows of capital are
usually caused by other factors and policy actions should be
directed at such factors themselves.
It is unlikely as well that taxation of capital transactions
may be assisted by restrictions on capital flows. Naturally, when
local tax rates on capital transactions exceed considerably
foreign ones, imposition of capital controls may be useful for
keeping the tax base safe from erosion. Yet it must be also
admitted that the efficiency of such restrictions over longer
spans of time cannot be guaranteed if incentives for
circumventing these restrictions are still available.
As for the usefulness of controls on capital transactions in
assisting the efforts for stabilization and reform, such an
argument sounds realistically only for relatively short periods
of time. In assessing the relevance of this type of restrictions
to objectives such as successful stabilization and reform it
should be taken into account that the existence of restrictions
itself may impair credibility of reforms undertaken, even if only
due to the fact that it allows the reforms to be protracted.
All arguments in support of the maintenance of restrictions on
capital transactions are implicitly based on the proposition that
these restrictions are efficient. Analysis of this question has
indicated that restrictions on capital transactions are most
efficient when combined with foreign-exchange and trade
restrictions to preclude both current and capital account
convertibility. In developed as well as in less developed
countries, introducing current account convertibility creates
numerous channels for hidden capital flows as well. When
incentives for their use (such as, for instance, anticipated
significant changes in the exchange rate) are at hand,
substantial flows may pass through these channels.
3.2.4 Preconditions for Introducing Capital Account
Convertibility
In the recent 15-20 years the United Kingdom, New Zealand, and
Mexico managed to successfully introduce capital account
convertibility, while Chile, Argentina, and Uruguay did not and
had to return to the regime of restrictions. Lessons from these
episodes suggest that if a country is to successfully and
irreversibly introduce capital account convertibility and reduce
related financial risks, it should have conducted in advance
certain policy creating the preconditions for opening the capital
account. If such a policy and the necessary preconditions have
not been established, substantial speculative flows might emerge,
making it difficult to sustain convertibility prematurely
introduced. In decreasing order of importance, these
preconditions include:
Accomplished fiscal reform. As a consequence of the
fiscal reform, the government budget deficit should have
considerably been reduced, and that part of it which still
remains should be financed in a non-inflationary way. A
substantial government budget deficit financed through the
printing of money would stimulate residents to export their
savings abroad in order to circumvent the inflation tax. For the
purpose of sending a signal to the public that the opening of the
capital account has been irreversible, even a much more
significant decrease in the government budget deficit might be
needed compared to that which is consistent with price stability
and stable growth. Completion of the tax reform and availability
of a broad and stable tax base are thus imperative for a lasting
reduction of the government budget deficit.
Conduct of financial policy that minimizes divergence
between external and domestic conditions prevailing in financial
markets. This means that domestic interest rates of
"traded" financial instruments must be comparable (with
an adjustment for anticipated changes in the exchange rate) with
those prevailing in international financial markets. Furthermore,
the domestic financial system must be strengthened so that it
could successfully compete with foreign financial institutions
and survive periods of large fluctuations in asset prices. As a
minimum, this would require restructuring of those financial
institutions which have a large share of uncollectible loans in
their assets and consolidation of the capital base of the entire
financial system.
Strengthening and "rendering safe" the domestic
financial system. Elimination of restrictions on capital
transactions would lead to the introduction of new financial
techniques and instruments, new sources of funds and new
participants in local financial markets. These changes would
increase competitive pressure which might eventually lead to a
higher efficiency of financial markets, introducing at the same
time substantially complicated elements of risk. This might
result in a sharp discontinuation of payments and credit flows
when risks that have not been foreseen suddenly materialize. That
is why improving the local system for supervision of financial
institutions before opening the capital account is of essential
importance.
Elimination of restrictions on flexibility of wages and
prices. Since the 1980s, periods of substantial volatility of
asset prices have been recurring, so countries, and in particular
those having introduced capital account convertibility, have to
adapt their economies and, especially, their financial structures
in order to survive the mentioned volatility of asset prices. The
volatility being discussed here may have highly unfavourable
consequences on employment, production, and wealth in economies
which have been administratively restricting flexibility of
wages, prices and interest rates. Elimination of this type of
restrictions before introducing capital account convertibility is
an important precondition if the economy is to react more
flexibly to real and financial shocks.
Tax evasion stimulating capital flight. The experience
of developed countries has shown that harmonization of local
taxes on financial transactions with those prevailing in the
other countries is necessary. Such harmonization must be achieved
before the final abolition of controls on capital transactions in
order to avoid possible large tax-motivated capital flows.
4. Current Account Convertibility of the Lev and International
Payments
4.1 Historical Overview
In the beginning of February 1991 Bulgaria virtually
introduced, by Decree No. 15 of the Council of Ministers, current
account convertibility of the lev, as part of the radical
economic reform launched. The most important restrictions which
remained in force after this decree became effective were the
(then) unresolved problem of the debt of the Bulgarian Foreign
Trade Bank (BFTB), about a dozen inherited bilateral payments
agreements with countries such as Afghanistan, Brazil, etc., and
the limits on the amount of foreign currency purchased by
Bulgarian residents for tourism abroad. This restricted internal
convertibility of the lev introduced at the start of the reform
has been surviving for five years now the political and
macroeconomic turbulence of the Bulgarian transition, as
restrictions have gradually been abolished or relaxed. Thus, the
assumption of the BFTB debt by the state and the deal concluded
with the London Club commercial creditors eliminated perhaps the
most significant restriction on external payments and on the
current account convertibility of the lev. And the
"tourist" limit, officially increased from the foreign
currency equivalent of BGL 10,000 to USD 2,000, is very easily
circumvented in practice. Liberalization in Bulgaria was much
more decisive right from the start of the reform compared to that
in such "diligent front-runners" of transition as the
Czech Republic and Hungary. In the Czech Republic, for example,
legislation is now being prepared to permit residents to open
accounts in foreign currencies in local banks, as a step toward
the adoption of IMF Art. VIII status. This paper is not the right
place for a detailed analysis of this matter, yet we are of the
opinion that Bulgaria has already paid the price for introducing
current account convertibility of the lev without taking full
advantage of its fruits.
4.2 International Obligations
Bulgaria has assumed direct international responsibilities
with regard to the current account convertibility of the lev by
its membership in the IMF and by its European Agreement.
4.2.1 Art. VIII of IMF Articles of Agreement
Bulgaria's IMF status is in compliance with Art. ХIV of the
Articles of Agreement of this international institution. In
essence, such a status permits to a country to maintain and adapt
exchange restrictions which it has applied as of the date of its
admission as a member of the IMF. Art. ХIV status is considered
as temporary. Any member country is expected to accept
obligations under Art. VIII. Although this should be a voluntary
act of the respective country, Art. ХIV provides for a mechanism
of supervision and initiative on behalf of the Fund for the
acceptance of Art. VIII and for possible sanctions
(discontinuation of the purchases of IMF credit).
A country with Art. VIII status assumes obligations under
items 2, 3 and 4 of the mentioned article not to introduce
restrictions on payments and transfers related to international
transactions, not to apply discriminatory exchange practices and
multiple exchange rates (coefficients), and to repurchase its
currency from other member countries (external convertibility).
A country which accepts the obligations under Art. VIII
practically declares that its foreign-exchange regime is free of
the restrictions mentioned in Art. VIII. Formally, this is
implemented through a letter to the Managing Director of the
Fund. Before that an IMF team reviews in detail the
foreign-exchange regime and practices of the respective country.
By adoption of Art. VIII status a country signals to its
foreign partners that it will conduct prudent macroeconomic
policy and, thus, will not be forced to resort to exchange
restrictions with regard to current account payments and
transfers.
As of 31 July 1995, 104 countries from a total of 178 IMF
members have accepted Art. VIII status. Among these, 7 are
economies in transition - Lithuania, Latvia, Estonia, the Kyrgiz
Republic, Croatia, Moldova and Poland. Slovenia has announced its
intention to accept the obligations under Art. VIII from 1
September 1995, and the Czech Republic and Hungary are in a
preparatory process to do the same from 1 January 1996. By the
end of 1995 Bulgaria will lose its image of a country applying a
more liberal foreign-exchange regime than that of a number of
other transition economies, an image that it has not even been
insistent to avail in order to demonstrate determination to
reform.
4.2.2 Europe Agreement
Articles 60-62 of Bulgaria's Europe Agreement refer to the
payments regime. Although these texts are formally defined as
mutual obligations, they represent, in practice, unilateral
obligations of Bulgaria, insofar the currencies of all members of
the European Community (EC) are fully convertible.
Analysis of the articles mentioned allows to draw at least two
conclusions:
1) Art. 60 provides for an obligation of Bulgaria to maintain
current account convertibility on the transactions that
"concern movement of goods, services, or persons [between
the Parties] which have been liberalized pursuant to this
Agreement". With some approximation it could be stated that
this would mean that Bulgaria has agreed to assume obligations
analogous to those under IMF Art. VIII with respect to the EC.
2) Articles 61 and 62 approach in detail the convertibility of
the lev on some capital transactions, mainly those related to
direct investments. These texts suggest that, even as early as at
the stage of association, Bulgaria's European partners cannot be
contented with only current account convertibility of the lev.
They have reached an agreement for an immediate obligation for
convertibility with respect to the repatriation of profits and
the depreciation of direct investments. This, by the way, is in
compliance with the Bulgarian Law on Foreign Investment of 1992.
In addition, Bulgaria has assumed a commitment to introduce
capital account convertibility of the lev through a phased
approach. In particular, Art. 62 stipulates that this country
shall take measures "permitting the creation of the
necessary conditions for the further gradual application of
Community rules on the free movement of capital", following
an initial five-year period.
4.3 Rights of Bulgaria Pursuant to International
Contracts and Defence of Bulgarian Interests
With regard to the payments regime and convertibility, it is
good for the Bulgarian party to clearly formulate, first and
foremost for itself, what are its rights and interests in. Are
they in the avoidance or delay, for as long as possible, of the
transformation of the lev into a convertible currency? We do not
find arguments in favour of such a thesis. International rules
are clear, and established long before Bulgaria's opening to the
world. Convertible currency, together with all the preconditions
needed for its introduction and sustainability, is an essential
element of the linkage of the Bulgarian economy with the world
economy, and an essential component of the reform. From this
viewpoint Bulgaria's rights, as provided for in international
contracts, pertain to ensuring transitional periods during which
the necessary preconditions for transition to convertibility of
the lev should be achieved.
What contradicts, and what could harm, Bulgaria's interests is
giving up the transitional periods, not doing the preparatory
work needed.
4.4 Proposals and Time-Frame
In essence, Bulgaria is ready to introduce immediately
full current account convertibility of the lev by accepting IMF
Art. VIII status. In the recent four years Bulgaria has
been exercising de facto current account convertibility.
The regime of a floating exchange rate currently applied in this
country, the prospective sharp fall in inflation and the
reduction of the government budget deficit as a percentage of
GDP, being imposed also due to some other reasons, over the next
few years, as well as the level of foreign-exchange reserves and
the prospective balance-of-payments situation in 1995 do support
such a conclusion.
There are just two formal obstacles remaining which still
prevent the adoption of Art. VIII status:
- the limit on the purchase of foreign currency by residents
for touristic purposes of up to USD 2,000 per annum, which in practice
is inactive; and
- the formal existence of 10-12 bilateral payments agreements, most
of them also inactive. These agreements are viewed as an instrument for
applying multiple exchange rates and discriminatory foreign-exchange policy.
A possible sequencing of the necessary steps for the
acceptance of Art. VIII status is the following:
1. The Ministry of Trade and Foreign Economic Cooperation
(MTFEC) reviews and analyzes the bilateral payments agreements.
All of these are operated by the Bulbank (the former BFTB).
Analysis must indicate which of them are active and which are
not. Depending on the specific results, a time-frame should be
adopted for a gradual elimination of this type of agreements
following their expiry and non-renewal, while in cases where
possible elimination should be immediate.
2. The Governor of the Bulgarian National Bank (BNB), in
his capacity of Governor of the IMF for Bulgaria, invites an IMF
mission to review Bulgaria's exchange-rate regime and practices
in connection with its intention to accept Art. VIII status. The
mission is then being informed about the government's intentions
and time-frame for the elimination of the bilateral payments
agreements, or about the fact that those of them which need to
remain in force, this being duly substantiated, do not violate
the obligations under Art. VIII.
3. The Council of Ministers adopts an amendment to its
Decree No. 15 and abolishes the limit for resident individuals to
purchase foreign currency.
With the acceptance of Art. VIII of the IMF Articles of
Agreement, Bulgaria automatically fulfils the obligations under
Art. 60 of its European Agreement.
Limits on the purchase and exportation of currency for
touristic purposes have usually been motivated by the need for
efficiency of capital controls. Elimination of the limit on the
purchase of foreign currency for touristic purposes may be
replaced by modifications in the administrative procedures
regarding the issuance of foreign currency permits for
"invisible operations". It is possible, for instance,
to retain the licensing regime for free transfers abroad, the
permits up to a certain amount (let's say USD 5 or 10 thousand
per annum) being automatic, while above this amount the control
should be strengthened and requirements for documentary evidence
for the issuance of a permit increased. By the way, prevailing
practices in Bulgaria at present are much more restrictive with
regard to "invisible" operations, in particular
transfers for medical treatment, financial support to students,
etc., than with regard to the "touristic" limit. Taking
its decisions on the basis of an outdated and contradictory legal
and regulatory framework, the administration is in a position to
issue such permits in a quite arbitrary fashion. It is even more
important, however, that the administration deals with trivial
matters related to modest sums of several hundreds of USD, while
at the same time capital outflows in huge amounts are not a
problem at all.
4. In our opinion, assuming international obligations with
regard to the current account convertibility of the lev makes it
imperative to stabilize the legal and regulatory framework of the
related subject matter through the adoption by the National
Assembly (NA) of a Law on the Foreign-Exchange Regime and
Exchange Controls. A draft for such a law may be worked out
within a term of one year. (There is, actually, one draft, from
1992, for a Law on Transactions in Foreign Currency Assets and
Exchange Controls.) In elaborating the draft, the
contradictions among currently effective laws and regulations on
this subject matter, having been adopted and amended in different
years, need to be made consistent or removed. The most important
among the latter are:
• Law on Transactions in Foreign Currency Assets and
Exchange Controls (1966)
• Law on the Economic Activity of Foreign Persons and for Protection
of Foreign Investment (1992)
• Law on Banks and Credit Activity (1992)
• Law on the Bulgarian National Bank (1991)
• Decree of the Council of Ministers No. 56 (1989)
• Decree of the Council of Ministers No. 15 Amending the Foreign-Exchange
Regime (1991)
• Ordinance for the Import and Export of Foreign Currency Assets
(1994)
• Rules for the Implementation of Decree No. 56 of the Council
of Ministers
• Ordinance on Payments (1992)
• Ordinance on the Extraction and Processing of Gold, Silver, Platinum
and Transactions Therewith... (1966)
5. Capital Account Convertibility of the Lev and International
Payments
As clear from item 3.2.4, Bulgaria
is not ready to announce capital account convertibility of the
lev right now, without becoming prone to substantial economic and
financial risks. That is why we propose here a phased and gradual
approach.
5.1 Current State
Although the lev is officially inconvertible for the purposes
of capital account transactions, the administrative capacity to
enforce existing restrictions is remarkably weak. Anecdotally,
the conviction has been spreading out that it was short-term
capital flows, from nearby countries with more unstable
macroeconomic conditions in particular, that have played a
substantial role for the several significant deprecations of the
lev, mostly in November 1993 through March 1994. It will not be
surprising if it eventually turns out that the stability of the
lev in early 1995 is due to a much larger extent to an inflow of
capital rather than to an improved trade balance. Unfortunately,
a quantified account for these processes is rather difficult to
present. This is due, in particular, to the poor quality of
balance- of-payments statistics.
5.2 International Obligations
If Bulgaria wishes to join the EU in the future, it should
accept its rules on capital transactions without any
restrictions. In particular, this country has future commitments
in this respect under its European Agreement. Art. 61, item 2
envisages that after the elapse of the fifth year since the entry
into force of the agreement, Bulgaria shall not introduce
"any new foreign-exchange restrictions on the movement of
capital and current payments connected therewith between
residents of the Community and Bulgaria and shall not make the
existing arrangements more restrictive". Furthermore, Art.
62 defines a time-frame (within the two stages of the Agreement)
for the methods and measures Bulgaria should adopt for
"enabling Community rules on the movement of capital to be
applied in full".
5.3 Rights of Bulgaria Pursuant to
International Contracts and Defence of Bulgarian Interests
Ensuring transitional periods for the introduction of capital
account convertibility of the lev may, in fact, be considered as
defending Bulgarian interests. If these transitional periods,
however, are not used to prepare the conditions necessary for
such a purpose, the country risks to suffer either the economic
and financial hazards of a transition to full convertibility
without the availability of the minimum necessary conditions, or
the foreign political hazard of demanding a prolongation of the
transitional period.
5.4 Proposals
Cognizant of Bulgaria's unreadiness for introducing full
convertibility of the lev, we would propose a gradual approach.
The process should be guided by two principles: priority of external
to internal capital account convertibility and of long-term
to short-term transactions. In more detail, the sequencing might
be the following:
1. External convertibility of direct investments;
2. Convertibility of trade credits;
3. Convertibility of long-term portfolio investments;
4. Convertibility of short-term portfolio investments.
In order to achieve a gradual implementation of the opening of
the capital account, in the Law on the Foreign-Exchange Regime
and Exchange Controls proposed in item 4.4 future actions to
liberalize capital transactions must remain within the competence
of the government. The aim of such a Law is to bind future
governments not to restrict current account convertibility.
External convertibility of the lev with regard to direct
investments, because of its currently existing domestic legal and
regulatory framework - the Foreign Investment Law, can be
guaranteed immediately by the law mentioned in the preceding
paragraph.
The necessary minimum of preparatory measures, directly
relevant to the issue discussed, we would recommend includes the
following:
1. The BNB should be required to comply with its legally
entrusted obligation to compile Bulgaria's balance of payments
and to specify its information sources, improve the compilation
methodology and discuss and coordinate it with other interested
institutions, such as the National Statistical Institute (NSI)
and the MTFEC, in order to minimize the inconsistencies between
customs and banking statistics. To this end, the BNB should
strengthen the staffing of its respective organizational unit.
Highly-qualified experts are presently employed in it, but only
three in number. Having coped with this personnel problem, the
BNB could then apply for technical assistance by the IMF on
matters related to the balance of payments.
We would remind in relation to the above-said that in 1992 the
World Bank extended a technical assistance loan (TAL) in the
amount of USD 17 million earmarked for the establishment of an
information group on Bulgaria's foreign debt. USD 3 million of
this loan were disbursed. The Foreign Debt Group was constituted
within the BFTB and carried out an immense technical work on the
reconciliation of the BFTB (in fact, Bulgarian sovereign) debt to
external creditors. Following the completion of this process the
Group, insofar its staff was retained, was transformed into an
organizational unit within the BFTB. In the meantime, official
liabilities to the IMF, the World Bank, the EU, Japan and other
individual G-24 countries have been accumulating, while the
information regarding the structure, maturities, interest-rate
conditions, etc., on these new official credits remained
dispersed in the Ministry of Finance (MoF) and the BNB and is
being maintained (at least at the BNB) on an almost voluntary
basis.
Without a reliable information basis for the processes in the
external sector of the Bulgarian economy any decision regarding
the convertibility of the lev could not avoid elements of
gambling. The NA Economic and Budgetary Committees could invite a
hearing of the Minister of Finance and the Governor of the BNB on
the issue of the information basis of the foreign debt service.
2. The administration which deals with the implementation
of the regime regarding the permitted capital operations should
be strengthened. The "division of labour" between the
MoF and the BNB in this respect should be clarified.
3. The necessary measures (organizational as well, if
needed) to enhance banking supervision, and to monitor external
foreign currency open positions of banks in particular, should be
undertaken.
4. A joint task force comprising representatives of the
MoF and the BNB should be appointed to involve in the following
activities:
- to examine in detail the literature on the experience of
both developed and less developed countries which - successfully or not
- have achieved full convertibility of their currencies in the recent
15 years or so;
- to make forecasts for the macroeconomic parameters needed to minimize
the financial risks originating from the transition to full convertibility
of the lev;
- to assess the order of the likely risks;
- to propose to the government measures and a time-frame for the
liberalization of the regime of capital transactions as a preparation
for the examining of "ways for enabling Community rules on the movement
of capital to be applied in full" envisaged by Art. 62, item 2 of
Bulgaria's European Agreement.
6. Incorporation of Bulgaria into the EMU
6.1 What are the Gains?
The most essential likely positive effects for Bulgaria from
its inclusion into the EMU are associated with:
1) "import" of stability of the national currency;
During the years of transition following the liberalization of
the domestic foreign exchange market the lev has enjoyed
relatively long periods of stability, but has also suffered
several shorter periods of disturbances and jump-like crises. Its
replacement by the ECU - in compliance with the expectations for
a high degree of stability of the European currency unit - would
have rendered stable the relatively variable value of the legal
tender within the territory of Bulgaria.
2) "import" of price stability; Insofar
macroeconomic theory and practice point to the instability of the
national currency as a major source of price and economic
instability - for small and very open economies in a regime of a
floating exchange rate such as Bulgaria, in particular - the
change-over from the lev to the ECU would also stabilize the
domestic price level.
3) "import" of central-bank reputation; The
reputation of a central bank is being established decades after
decades by the pursuit of prudent, independent, long-run,
non-inflationary monetary policy. As performing the functions of
a central bank from quite recently and under the circumstances of
an unprecedented in economic history, and, therefore, bearing a
high degree of uncertainty, transition from a command
administration of the national economy to markets, the BNB -
although hard-working - has not managed yet (due to objective
reasons, but not only) to establish for itself a reputation
comparable to that of the future ECB - independent and modelled
according to the Deutsche Bundesbank. Subordination of the BNB to
the ECB within the ESCB would raise the confidence of economic
agents in the central-bank institution and in the policies it is
conducting.
4) lower uncertainty and greater predictability of
macroeconomic environment and macroeconomic policy; In
combination, the first three effects lead to the fourth one.
5) lower inflation expectations; In combination, the first
four effects lead to the fifth, which is very important for the
macrodynamics of prices and output and establishes a favourable
environment for a non-inflationary growth and higher employment.
6) elimination of the foreign-exchange risk within the EU (at
the same time the foreign-exchange risk with respect to the
transactions with countries outside the EMU remains), and hence
growing incentives for trade in goods, services and financial
instruments within the territory of the Union, which, in turn -
through scale economies and comparative advantage - will
contribute to a more rational use of scarce resources, increased
efficiency and productivity, and higher growth.
7) participation in an "optimal currency area "
(according to its standard definition by Mundell as an area of
free movement of factors of production), and hence - by analogy
with the arguments in support of the effect outlined in the
preceding paragraph - growing incentives for long-run economic
growth and a gradual approximation of living standards in
Bulgaria to those in west European countries.
6.2 What are the Losses?
The most essential likely negative effects for Bulgaria from
its inclusion into the EMU are associated with:
1) loss of the relative autonomy of monetary (including
exchange-rate) policy (i.e. the monetary instrument of
macroeconomic regulation is handed over to the future ECB, while
the fiscal one, as a consequence, undergoes a substantial
modification); this loss is, in fact, the principal one - it can
be decomposed into elements in accordance with the possible
alternative variants of the targets, mechanisms and instruments
of monetary policy (and their interdependence with those of
fiscal policy) over different time periods and reduced to a set
of specific modifications of theirs. Within a more general
economic and political context this principal loss could lead to
the following (derivative to the sacrificed independence of
monetary policy) major unfavorable consequences:
2) loss of the ability to adjust (level out) the balance of
payments and stimulate GDP through changes in the exchange rate
(in particular, through a depreciation (devaluation) stimulating
net exports directly and, eventually, aggregate demand and
production);
3) relative loss of national sovereignty (the central bank
could not finance - through the government budget - expenditures
which can be substantiated from a national viewpoint, such as for
"cushioning" economic shocks or for defence);
4) danger for materialization of the anticipated by many
experts long-term pro-deflationary bias of the future ECB
(influenced by the price stability priority provided for in the
Treaty of Maastricht and by its structuring according to the
Deutsche Bundesbank model), which may constantly radiate
recessionary impulses for the economies - especially harmful
under conditions when there is no synchrony in the economic
cycles of the participant countries (a situation typical for
western Europe during the recent recession, despite aspirations
and efforts for convergence);
5) another aspect of the lost, to a large extent,
sovereignty of national economic policy is related to the
inability to conduct active industrial policy in support of
desired structural changes, including such for infant industries;
we deem, however, that such a "loss" is illusory:
possible earlier accession to the EU will rather be a means for
restructuring the nation's productive and export potential
according to comparative advantage and through competition in
international markets. That is why a quicker incorporation into
the EMU is recommendable. The sooner the institutionalization of
the market in Bulgaria, the more prepared for accession the
country.
6.3 Legal and Regulatory Implications
The monetary aspects of the legal and regulatory implications
of Bulgaria's incorporation into a future EMU relate to the need
to harmonize Bulgarian laws and regulations (some of which are
quite outdated) regulating the areas of:
- monetary policy;
- foreign-exchange policy;
- fiscal policy;
- economic policy, as a whole.
Substantial changes will be necessary in the laws on the
central bank and the government budget.
As regards international laws, Bulgaria will have to join, at
a certain stage, the EMU, signing and ratifying the following
international treaties:
- the Treaty of Rome establishing the European Community;
- the Single European Act;
- the Basle Act on participation in the European Monetary System;
- the Treaty of Maastricht on Economic and Monetary Union.
Moreover, it will be necessary to constitute and
institutionalize the structural units and mechanisms of the
common European monetary integration in legal forms, both
domestic and international, by achieving harmonization of
Bulgarian law with international law, as well as of national with
the common European policy and the instruments of its
implementation, in connection with:
- the establishment and functioning of the EMI (the ECB);
- the establishment and functioning of the ESCB;
- the need to modify the objectives, structure and functions of the BNB
in conformity with its future role of one of the "national central
banks" within the ESCB.
In compliance with the proposals further on (item 6.5) related
to the establishment and functioning of certain institutions and
mechanisms facilitating Bulgaria's accession to the EMU,
legislative constitution and definition of the activity of some
of the following possible structures (alternatively) will be
needed:
- national stabilization fund;
- regional (east European) stabilization fund;
- agreement within the ESCB for coordinated multilateral stabilizing interventions;
- currency board;
- national fund for mitigating the effects of economic shocks (shock-absorber
fund).
Explanation concerning the role of such structures is given in
item 6.5 of the present paper.
6.4 Implications for Macroeconomic Policy
According to the provisions of the Treaty of Maastricht, the
incorporation of a country into the EMU would cause serious
changes in the targets, mechanisms and instruments of
macroeconomic policy on a national level. In brief, the
implications of the Maastricht principles for national
macroeconomic policy could be presented as a division of the
centres for administration and regulation of its two major
components: common (supranational) monetary (including
foreign-exchange) policy is being formulated and implemented in a
centralized manner by the ECB, independent and legally devoted to
price stability, while - despite some common guiding rules which
considerably modify it - fiscal policy remains to a large extent
decentralized on a national and regional level through the
autonomy of local government budgets. Apart from the two
principal components (monetary and fiscal) of maroeonomic policy,
integration processes - even in this case much earlier before
entering the stage of the EMU - influence, and in western Europe
in practice have already influenced, its remaining components
(trade, incomes and structural policies). The result is: loss of
trade policy as an instrument of macroeconomic regulation on a
national level (due to its transfer to a supranational level of
regulation within the EMU); modified (unified at a supranational
level) incomes policy; modified (coordinated at a national and
supranational level) structural (supply-side) policy.
Due to the high degree of mutual interdependence of the
components of macroeconomic policy and their joint impact on the
economic environment, changes in all of them - directly or
indirectly - have serious implications for monetary policy as
well. The strongest, however, is the interrelationship between
monetary and fiscal policy, that is why the emphasis of the
analysis further down is placed on the link between them itself.
The loss of monetary (and foreign-exchange) policy as an
instrument of macroeconomic regulation on a national level
(resulting from its transfer to a supranational level of
regulation within the EMU) has two direct consequences for the
revenue side of the government budget:
- loss of the inflation tax as a source of revenue for the government
budget;
- loss of seigniorage as a source of revenue for the government budget.
At the same time, participation in the EMU would mean access
to substantial items in the expenditure side of the EU budget and
would provide opportunities for:
- subsidies for national agriculture in line with the Common Agricultural
Policy (CAP) of the EU;
- subsidies for the structural development of backward regions in line
with the Structural Funds (SF) of the EU.
In such a way the national budget could be relieved from the
need to make certain expenses, and this would partly compensate
the losses of the above-mentioned revenue sources and contribute
to some extent to its balancing.
Besides the direct impact on monetary policy, an incorporation
of Bulgaria into the EMU could have indirect implications too;
the latter result from the modified fiscal policy discussed and
are related to:
- the requirement for balancing (with permissible small deviations
and exceptions) the national budget;
- the imposition of a limit on government indebtedness;
- the inability for direct financing of the government budget deficit
by the central bank by virtue of a legislative act of the national parliament;
- the prohibition for financing through an overdraft of the central and
local government budgets.
Another macroeconomic problem arising from the accession in
the EMU is associated with offsetting aggregate demand and supply
/price/ shocks. Standard prescriptions of modern macroeconomic
theory for adjustment to an external price shock or for
countercyclical stabilization policy assign an essential role to
monetary policy. Through changes in the money supply the central
bank can "cushion" the effect from a price shock and to
"smooth" fluctuations and the cyclical pattern of
economic activity (at the expense of certain increase in the
price level over a medium term - mostly in the former case). As a
consequence of the centralization of manipulation with the
monetary instrument on a supranational level, accommodative
monetary and countercyclical stabilization policies could be
conducted only within the entire EMU, i.e. when the shock has
common European, and not national, dimensions. In such a sense,
non-accommodated economic shocks with a regional or national
significance could cause changes in production and employment. To
offset them to a certain degree, the states within the EMU could
use national fiscal instruments, such as shock-absorber funds
operating as automatic stabilizers of the local economy.
6.5 Stages, Institutions, Mechanisms
Differing opinions and forecasts about the future course of
economic convergence in Europe are quite natural, given its high
degree of uncertainty today. Views on its chronological,
organizational and institutional implementation are, therefore,
still varied and widely discussed. However, from the perspective
of the transition to a monetary union, a process of accession of
Bulgaria into the EMU is further down outlined; it could possibly
evolve over the following several stages (certain institutions
and mechanisms relevant to each one of the stages are also
suggested):
1) Stage I - a regime of a managed float of the lev implying a
gradual narrowing of the fluctuations of its exchange rate vis-a-vis
the European currency unit (ECU) until finally pegging to it
(within broader or narrower fluctuation margins); possible
duration: 3-5 years; such an exchange-rate regime could be
substantiated from an economic point of view within the context
of:
- deepening integration processes, which imply a gradual equalization
of price levels resulting from the mobility of the factors of production;
- the conduct of prudent macroeconomic and monetary policies, consistent
with the approximation of the Maastricht EMU membership criteria;
- receding inflationary processes due to the progress to later stages
in the transition (i.e. due to the movement away from the initial price
jump typical for the first, and strongest, wave of post-socialist price
liberalization and the several weaker ones that followed, and together
with the gradual marketization of the economy through the processes of
privatization, imposition of hard budget constraints for all economic
agents, and development of institutional structures to regulate the economy
within a market environment).
The biggest difficulties for the gradual long-term
stabilization of the lev before its final pegging to the ECU will
arise in connection with the need to maintain a positive, or at
least leveled-out, (overall) balance of payments with view to the
commitments of this country to the repayment of its foreign debt.
However, opportunities for a reasonable corrective policy still
remain (before, rather than after, the inclusion of Bulgaria into
the EMU), since the current and capital accounts react in the
opposite way to an appreciation/depreciation of the national
currency unit (or a rise or fall of local interest rates). The
inflow of lasting receipts from exports (before the
liberalization of capital flows) and/or of direct foreign
investment (after it) into the country could have a stabilizing
impact on the exchange rate in the setting of a
non-debt-accumulating and non-inflationary growth.
2) Stage II - pegging the lev within admissible fluctuation
margins, implying that the latter could be gradually narrowed or
defined in a straight-forward, one-time fashion right within the
"normal" ERM fluctuation margin. If the approach of a
gradual pegging in several steps is preferred (which does not
exclude the variant of a crawling peg), the second stage
discussed here might be, in fact, a first stage, as an
alternative to the period of the managed float outlined in the
above paragraph. The possible phases for the narrowing of the
fluctuation margin could be at least three: within plus-minus 15%
(the present-day ERM "band"), plus-minus 6% (the recent
ERM "broad band") and plus-minus 2.25% (the recent ERM
"narrow band") of the fixed rate of the lev vis-a-vis
the ECU (this second stage also leaves room for an alternative -
a managed float (implicit or explicit) within the same
fluctuation margins); probable duration: at least 2 years, so
that the requirements for participation in the third stage of the
EMU are met; in case the pegging of the exchange rate does not
evolve over several phases but is instead directly introduced
within the "normal" fluctuation margin, the period of
managed float would have preceded it (and would perhaps have
continued within a longer time horizon than in the case of being
followed by a phased pegging).
During the stages enumerated above, the following institutions
could be established and functioning in Bulgaria:
- stabilization currency fund - national or regional (i.e. east
European) according to its objectives and territorial scope, or - as a
better alternative:
- an agreement within the ESCB for coordinated stabilizing interventions,
in which the BNB should be a party.
In the first case the central bank could have at its disposal
a fund in a liquid form and in a sufficient (from the viewpoint
of the turnover of the local foreign exchange market) volume
representing a basket of currencies (including currencies of
non-EMU countries) which could be used for interventions
stabilizing the national currency (if the national variety of the
stabilization fund is opted for) and/or the currencies of the
countries of central and eastern Europe (if the regional variety
is chosen).
In the second case stabilizing interventions could be
coordinated and jointly conducted by all ESCB banks at a much
larger scale, thus achieving a much stronger effect. Both
variants have had their material or ideal historical precedents.
The first variant - in its national variety - was applied by
Poland, pursuant to an agreement with the IMF right after the
pegging of the Polish zloty. The regional variety, on the other
hand, has been discussed since the early 1990s by the Association
for Monetary Union of Europe within the context of a future
incorporation of the countries of central and eastern Europe into
the exchange-rate mechanism of the EU. As regards its
implementation, the establishment of an ECU-Zone Surveillance
Board has been proposed to manage the reserves of the fund and
its short-term financing mechanisms, to monitor macroeconomic
policies of the participant countries and, if necessary, to
enforce adjustment of their economies. This Board was supposed to
include representatives of the east European countries, the EMI
(and the ECB at a later stage), the IMF, as well as of the
European Bank for Reconstruction and Development (EBRD) and the
Bank for International Settlements (BIS) in Basle.
The second variant of cooperation is provided for by the
Treaty of Maastricht, insofar close consultation and coordination
of actions in the area of monetary and foreign-exchange policy
within the EMI and the ESCB (under the second and third stage,
respectively) is envisaged.
The benefit from such mechanisms for the stabilization of east
European currencies through the provision of additional resources
for foreign-exchange interventions is apparent. Their major
possible negative effect is, however, also clear: insofar these
mechanisms would be established on a multilateral basis, the loss
of a certain economic and political independence is unavoidable.
3) Stage III - final and irrevocable pegging of the lev to the
ECU (without allowing any deviations from the peg) and/or
replacement of the lev by the ECU.
In the final stage of a possible monetary integration of
Bulgaria into the EMU and before the lev is finally replaced by
the ECU as a legal tender, an institution similar to the currency
boards operating in some post-socialist economies could be
established. Within this context, analysis of the experience of
countries such as Estonia and Latvia could be quite useful.
Another institution which could be created and functioning
during the last stage is related to the lack of national immunity
against the impact of economic shocks. Insofar monetary policy is
transferred to a supranational level, and fiscal policy is, as a
result, modified, accommodative and/or countercyclical
stabilization policies remain possible only at a common European
level. To mitigate the effects of such shocks special
shock-absorber funds, similar to the reserve funds of banks,
which should operate on the principle of the automatic
stabilizers of the economy (transfers and taxes) could be
applied. These funds may be characterized as a fiscal instrument
which replenishes (self-finances it) in times of economic boom or
favourable aggregate demand and supply /price/ shocks through
automatic (calculated through formulas and obligatory) or
voluntary installments from the increased profits and/or incomes
in order to be used for equilibrating aggregate demand and supply
or for stabilizing the overall price level in times of recession
or unfavourable shocks.
Conclusion
Insofar the transition of the incumbent EU members themselves
to a single currency unit and a common monetary policy within the
overall convergence of their macroeconomic parameters by the year
2000 - despite their commitments undertaken in the Treaty of
Maastricht - is to a high degree still subject of an uncertainty
with serious economic and political implications, the convergence
process of the east European countries with association
agreements toward the Maastricht EMU criteria appears to be quite
indistinct and problematic. That is why flexibility of
legislation and policies will be needed in the pursuit of this
ambitious, supranational, common European goal to guarantee
timely reaction on the part of Bulgaria to deviations and
possible changes along the road to or within the EMU itself.
Within this context, the opinions and thoughts exposed above
regarding the benefits, the costs and the probable stages,
institutions, and mechanisms of a possible accession of Bulgaria
into the EMU correspond to the current state of this problem and
are not insured against potential corrections or variants in the
path of the European integration and convergence, and, therefore,
should not be considered as firmly accepted or universal.
August 1995
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