Банкеръ Weekly

Briefs

EXPERIMENTS IN FINANCIAL POLICY ARE UNHEALTHY

Will the future ruling coalition continue the policy for Bulgaria's accession to the European Monetary Union, pursued since 1998? This question could be formulated in another way, too. Will the next government follow a financial policy, adequate to the requirements in the Maastricht Agreement of 1992? They are five and seem foolproof at first sight, but their fulfilment has been often onerous even for countries which are far ahead of Bulgaria in their economic development. After the parliamentary elections on June 25 most political leaders declared that the observation of these requirements would be a priority for the future rulers. However, it is much more important if they will become a fact. The first requirement is that the annual inflation does not exceed by more than 1.5% the average rate of this indicator in the EU (it is calculated on the basis of the average inflation in the three EU countries which have reported the lowest price increase of commodities during the previous year). The second requirement is connected with the setting of a long-term interest rate, which is based on the yield of 10-year bonds, issued in the respective country. It should not exceed by more than 2% the rate in the three EU countries with the lowest inflation rate. Maintaining the budget deficit below 3% of GDP is the third criterion, and the fourth one is that the external debt should not be more than 60% of GDP. The fifth requirement regardsthe exchange rateOn applying for membership in the European Monetary Union, which could be made after the respective country is accepted in the EU, the state announces the exchange rate of its national currency to the euro and undertakes to maintain it during the following two years. If the exchange rate is a floating one it may not deviate by more than 15% from the initially announced during that period. The European Central Bank (ECB) and the central bank of the respective country undertake to intervene on the domestic market when necessary in order to maintain the deviation from the announced exchange rate within the above-mentioned 15% range. When a country declares that it wants to enter the Eurozone with a fixed exchange rate of its national currency to the euro, it undertakes to maintain it for two years without any deviations whatsoever. Moreover, the ECB does not undertake to intervene in order to maintain the fixed rate. A year agothe government of Simeon Saxe-Coburg-Gotha and the BNB declaredthat Bulgaria would become a EU member with a currency board arrangement and the present pegging of BGN1.9556 per EUR1. Under the same conditions our country will enter the 2-year period when the euro will become Bulgaria's national currency. Where will the new government head to after taking office? This question is quite appropriate because back in 1999 some economists in this country were launching the thesis that the currency board arrangement should be suspended before Bulgaria applied for membership in the Eurozone. At first sight that seems logical because it will be assisted by the ECB in order to maintain a floating exchange rate of the BG lev to the euro. But suspending the currency board arrangement would result in an additional instability on the domestic market. And the EU practice already shows that the countries with a currency board arrangement - Estonia, Lithuania and Latvia - are financially the most stable new EU members. That enabled them to apply for joining the Eurozone immediately after they were admitted into the EU. Contrary to the assertionsof some economists that the currency board arrangement was limiting economic growth, Lithuania, Latvia and Estonia reported the fastest increase of their GDP as compared to the other EU members. Lithuania's GDP went up by 9.7% in 2004 and is expected to rise by 6.7% this year. The respective figures for Latvia are 7.5% and 8.5%, and for Estonia - 5.1% and 6.2 per cent. The three countries also reported some of the lowest inflation rates within the EU. Commodities in Lithuania depreciated by 1.1% in 2004, while in Latvia their prices rose by 2.9%, and in Estonia - by 1.4 per cent. The latter reported a budget surplus of 3.7% of GDP, while the budget deficit in Lithuania and Latvia did not exceed 2% of GDP. The external debt in these two countries was less than 22% of GDP, while Estonia's external liabilities were just 5.3% of GDP in end-2004. What could be a better proof of stability than these macroeconomic indicators?It is interesting that Poland, the Czech Republic, and Hungary, which analysts were estimating until recently as the excellent performers in the transition perioddo not satisfy all Maastricht requirements. This is probably the reason why neither of them has applied for entering the 2-year mechanism for introducing the euro as a national currency. The Czech Republic reported a very low inflation rate in 2004 - 1%, but its budget deficit was 11.7%, and the GDP growth was quite modest - 3.7 per cent. Prices in Poland increased only 0.7%, but the country's budget deficit was 3.8%, and its GDP growth was just 3.8 per cent. The situation was the worst in Hungary where 2004 inflation stood at 4.7%, the budget deficit was 6.2%, and GDP growth was only 3 per cent. According to some observers of macroeconomic processes in the EU, Hungary won't be able for several more years to satisfy the Maastricht criteria, and apply for introducing the euro as its national currency. The reason for that is the social policy, pursued by the leftist Government of the socialist leader Ferenc Gyurcsan, which raised by 50% the salaries of civil servants as soon as it assumed power two years ago. That forced the private sector to increase remunerations, too, which resulted in higher corporate expenses and shook firms' financial stability. And the budget reported a significant deficit, which according to some estimates the Hungarians would not be able to overcome within the next two or three years. The increase of salaries lead to higher consumption as well, and hence - to a price increase of commodities (4.7% inflation) and higher imports. At that situation the current account deficit of Hungary's balance of payment reached 9 per cent.It might sound incredible, butBulgaria stands quite well in terms of macroeconomic indicatorson the background of the other ex-socialist countries. Thanks to the fiscal policy, followed by the governments of Ivan Kostov and Simeon Saxe-Coburg-Gotha, the country presently satisfies all Maastricht criteria except one - inflation. In their reports (at the seminar in Hisarya on July 8 and 9, 2005) BNB's Vice Governor Tsvetan Manchev and Deputy Finance Minister Lyubomir Datsov compared Bulgaria's macroeconomic indicators for 2004 with the Maastricht requirements. It became known that in terms of GDP growth, which was 5.6% last year, our country rates third after Lithuania and Latvia. Bulgaria is the only country besides Estonia that reported a budget surplus - 1.7% of GDP, and the external debt amounted to 40% of GDP. The average interest rate of long-term credits is 5%, vs 5.5% for the ten new EU members, and 6.5% as per the Maastricht requirements. Only inflation rate - 6.1% in 2004 - exceeded the Maastricht criteria (2.9% annually). The reviewof the above-mentioned macroeconomic indicators leads to think that the future cabinet should at least follow the economic and fiscal policy of its predecessors. This means that the budget should continue to report a surplus, direct taxes and social insurance rates should be cut down, and the administration and judicial system should be reformed in order to raise their efficiency. Practice has shown that only such a policy ensures financial stability to the country which follows it and helps to attract more foreign investments, covering the current account deficit of the balance of payment. Social experimentssuch as a steep increase of remunerations and pensions - as promised prior the parliamentary elections by Coalition for Bulgaria - may only result in a higher inflation and budget deficit, and stimulate imports, but not domestic production. Such a policy would lead to a higher deficit in the current account of the balance of payment, and as a whole create the next financial instability in the country. And if we arrive at that situation it is certain that the EU would consider seriously a postponement of Bulgaria's membership in the EU.

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