Speaking Points for the conference on Bulgaria in the Eurozone—Advantages and Opportunities
December 9, 2022
Introduction
It is a great pleasure to be here in Sofia today.
Let me start with my bottom line:
In my view, becoming a full member of the euro area offers important benefits for Bulgaria—strengthened institutions and a seat at the table when the ECB determines monetary policy for all euro area members.
But joining the euro area is not a panacea for all of Bulgaria’s challenges; and completing the accession process will require more policy work and the determination to overcome the obstacles that are still ahead.
So, there is some work ahead, but Bulgaria has shown in the past that it can meet crucial challenges like these.
Let me discuss these arguments in more detail.
Bulgaria’s Currency Board Experience
While euro area membership comes with challenges, Bulgaria has over two decades of experience with an unmovable exchange rate.
Formally introducing the euro means giving up monetary independence for good. This is a consequential decision. But Bulgaria has operated a currency board since 1997, when it traded exchange rate flexibility as a tool to absorb external shocks for the external stability promised by a credible fixed exchange rate regime which since 2000 has been pegged to the euro.
So, monetary policy has been tethered to the decisions of the ECB for almost a generation, and Bulgaria’s policymakers are already well aware that, in such a setting, fiscal and structural policies are the main tools for macroeconomic management and for fostering economic convergence.
I would add that the currency board has served Bulgaria well.
One reason is that the currency board has brought economic stability. This is largely because it was supported by disciplined fiscal policy, thanks to which Bulgaria enjoys one of the lowest public debt ratios among all EU member countries. This is a key asset in the current turbulent environment which is characterized by increases in long-term yields and spreads across Europe.
We have also seen some progress on structural reforms, even though more work is ahead in this area to foster faster income convergence with EU peers and to increase living standards.
I would also argue that Bulgaria’s currency board and strong fiscal position were among the factors that helped shield it from some of the financial market stresses that affected many of the Eastern European economies following the tightening of financial conditions since the summer.
Euro Benefits
It is clear that adopting the euro promises important benefits.
First, joining the euro would reduce transaction costs for trade and financial flows by eliminating all currency conversion costs, thereby increasing economic efficiency.
Second, and perhaps more importantly, euro introduction would remove uncertainty about the country’s future policy framework, strengthen external credit ratings and further reduce public and private funding costs. This would help foster foreign and domestic investment and thus higher economic growth.
Third, while joining the euro will not eliminate sovereign crisis risk, it would largely shelter Bulgaria from volatile capital flows and eliminate any residual risks of speculative attacks against the currency that disproportionately affect small, open economies.
This means, it would further strengthen financial sector stability, including by giving Bulgarian banks access to the ECB’s lending and emergency facilities to support liquidity needs in emergency situations. This would add to the already large gain from having joined the banking union.
Last but not least, introducing the euro would give Bulgaria a seat at the table where monetary policy that affects the country is decided. Under the currency board, Bulgaria “imports” the ECB’s monetary policy decision without any input into the decision making.
The experience of Euro adopters—the Baltic countries
The Baltics are a good example of how strong post-accession policies can help make euro area membership a success:
The underlying fiscal position strengthened, particularly in Latvia and Lithuania, with fiscal balances close to zero post-euro adoption and prior to the Covid crisis. In this context, the cost of public debt fell, with government bond spreads vis-à-vis German Bunds being about 2 percentage points lower, on average, after adoption.
Before the energy crisis triggered by Russia’s invasion of Ukraine, the inflation gap with the euro area remained positive but small and stable, at about 1 percentage point. It was sustainable because strong structural policies supported a positive productivity differential vis-à-vis the euro area. Among these policies were sound and stable labor market institutions that, by delivering labor market flexibility, also ensured that real wages remained broadly in line with productivity. This, in turn, contributed to maintaining strong external competitiveness.
In addition, strong supervisory and macroprudential policies helped sustain financial stability.
Overall, the three Baltics gradually but steadily built significant policy and macroeconomic buffers post-adoption, building on the efforts they had already displayed prior to adoption.
And euro membership itself also contributed to a vast reduction in risks of disorderly capital outflows or sudden stops during periods of stress. This, in turn, also facilitated the conduct of fiscal policy.
Lessons for Bulgaria
What does this mean for Bulgaria? In a nutshell, to thrive before and after euro adoption, Bulgaria will need to keep up the good work—maintaining strong policy discipline, retaining flexible labor markets, and carrying out growth-enhancing structural reforms.
But let me be more specific:
Bulgaria should continue its tradition of fiscal responsibility and preserve the hard-won gains in this area. This will be important to continue fostering macroeconomic and financial stability under the euro.
Importantly, accelerating reforms to boost productivity and competitiveness is needed to make euro adoption a success. This is crucial, as trend unit labor costs have been growing faster in Bulgaria than in the euro area because wage growth, pushed by labor shortages, outpaced productivity improvements.
- Strengthening governance, increasing transparency, and fighting corruption are crucial to improve the business environment and increase the efficiency of public spending and the quality of public investment. This will promote a more productive and more inclusive economy.
- Investing in human capital to align education, health, and social protection outcomes with those of EU member states is also important. For example, education outcomes remain well below the averages of EU member countries or newer EU member states.
- In addition, Bulgaria will benefit from addressing skill mismatches and boosting labor force participation to help ease labor market pressures.
And continuing to promote the green transition and digitalization will help sustain growth over the longer term. For instance, the use of digital technology by businesses and digital skills are among the lowest in Europe, notwithstanding progress made in building the supporting digital infrastructure and developing e-government.
Let me close.
Bulgaria’s currency board has fostered a commitment and discipline that has contributed to the economic success of the past quarter century. With equally strong commitment and discipline, euro adoption could contribute to an equally successful journey in the next quarter century.
Thank you.