Cyprus and International, Economic Analysis

Is Bulgaria’s Currency Board Sustainable?

Authors: Gikas A. Hardouvelis, Platon Monokrousos
Publication: Economy & Markets, Eurobank Research, Volume 4, Issue 7, July 2009

Main points:

  • Bulgaria’s currency board arrangement (CBA) enjoys much greater sustainability than the currency pegs in the Baltic states as it is supported by a strong fiscal position and a large pool of FX reserves, while the Bulgarian economy is in a better cyclical trajectory than the economies of the Baltic States
  • In the absence of a new severe negative international shock and/or a serious domestic policy mistake, e.g. undue fiscal relaxation, the market by itself is unlikely to force – without the Bulgarian government’s will – a devaluation of the lev and a CBA break up • A discretionary policy of lev devaluation together with ERM – II entry at a new central parity is a scenario with positive probability, but with enormous macroeconomic and prudential risks, in view of the large outstanding amount of private-sector FX loans and its potential implications for domestic growth and the medium-term inflation outlook
  • Maintaining the currency board for as long as it takes to enter the euro area is a high probability scenario and politically easier to implement as it avoids the short-run costs of devaluation and puts less of a burden on Bulgarian policy makers to change a tested policy prescription that stabilised the macro economy during the last decade, but nevertheless postpones the necessary correction of the real exchange rate and, later on, risks trapping Bulgaria in a non-competitive position within the euro area
  • Whichever policy option regarding the currency board and the exchange rate is adopted by the authorities, the date of Bulgaria’s entrance into the euro area may be more distant than recent official statements imply

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