Why does pandemic recovery seek the hearts and souls of nations?
As she sought to become a member of the EU in the early 2000s, Sofia began to debate its possible membership of the euro zone. And, frankly, the number of at least somewhat hesitant experts and politicians is not small. Moreover, no country has adopted the common currency since 2015, when Lithuania abolished its currency after its Baltic neighbors. Against the backdrop of Brexit and the pandemic-induced double-dip recession, it’s hard to imagine the stall ending now. Yet Bulgaria has a permanent commitment to adopt the common European currency affirmed in the 2007 Accession Treaty. Thus, many say the country remains in the eurozone waiting room with no clear path out of it.
The national plan for the introduction of the euro
But with his National plan for the introduction of the euro (NPIE), Bulgaria is trying to turn the tide. According to the document, Bulgarians will only undergo one month of adjustments before they can no longer use Lev. This means that the euro and the lev will both have legal courses in the country for barely a month. The only help for the consumer will be the use of dual currency price tags for an additional five months.
According to this tight schedule, Bulgaria would need to consolidate its public finances during the next biennium. In fact, before a country can adopt the common currency, it has to stick to a few strict macroeconomic criteria. In particular, the candidate must prove that his currency is stable and that his public finances are sound. Fortunately for Bulgaria, exchange rates are not a problem thanks to the peculiarity Monetary advice it was adopted in 1997. However, even a brief overview of the four remaining requirements clearly shows how difficult it will be to join the euro area.
Inflation: soon a new challenge
First of all, one of the most difficult criteria for a country like Bulgaria to meet is that of inflation. Intuitively, since inflation measures the price change in an economy, there is a simple reason behind this benchmark. Indeed, allowing a country where prices are rising too quickly to join can destabilize its peers and weaken the euro. Historically, Bulgaria has had lower inflation rates than its Western Balkan neighbors which are mostly outside the EU. Nevertheless, prices fluctuated quite strongly from the end of the 1980s until the hyperinflationary crisis of the winter of 1996-1997.
In technical terms, the country’s 12-month average inflation rate (year-on-year) should be contained within the so-called reference value. That is, the benchmark is equal to the average of the three lowest inflation rates among EU countries plus 1.5 percentage points. Significantly, using data from March 2021, Bulgaria exceeds the target by only 0.066%. Nevertheless, the crisis induced by the pandemic slightly skewed these calculations, giving the impression of downward convergence between EU countries. In fact, the collapse of supply and, above all, of demand caused a reduction in inflation at all levels. In addition, the inequality of the post-crisis rebound – a so-called k-shaped recovery – creates a new gap. In fact, Bulgaria now comfortably meets the criteria, as its 12-month average inflation is 0.13% below the benchmark.
However, other EU governments will soon phase out budget support and their economies are expected to absorb the ongoing spike in inflation. Thus, the structural differences between the Bulgarian economy and its weaknesses will most likely prevail in the near future. In fact, before the pandemic, Bulgarian inflation exceeded the threshold of 0.67%. Therefore, it is to be expected that Sofia’s difficulty in coming out of the crisis will reappear in a persistent overrun of inflation.
Budget deficit: a legacy of the pandemic
Another, perhaps better known, “convergence criterion” concerns budget deficits and surpluses, or more precisely their ratio to GDP. In simpler terms, a government runs a budget deficit when its spending exceeds its revenue stream. The State must therefore cover the missing amount by means other than tax revenue. More often than not, the Bulgarian government has withdrawn money from the “tax reserve” – mostly from past savings. In addition, Bulgaria also solicits money on international markets by issuing different types of government bonds. Obviously, when revenues are greater than expenses, the budget shows a surplus. Over the past two decades, thanks to its rapid economic growth, Bulgaria has managed to meet this target (Figure 2).
To adopt the euro, a country’s public deficit / relative GDP surplus must not exceed 3% in the previous year. In addition, the forecast published by the European Commission of deficit / surplus of GDP should also be less than 3%. In general, the EU interpreted these rules strictly, thus considering the figures “slightly above the limit” as unacceptable.
Historical data shows that Bulgaria’s budget deficit to GDP ratio has been consistently within an acceptable range between 2009 and 2019. Apparently, this suggests that Bulgaria should not have any particular problem successfully meeting this requirement. But the pandemic-induced recession radically changed that simple fact. In fact, the latest data for 2020 shows a deficit of around -3.4%, which is even better than the Eurozone’s -7.4%. And all forecasts suggest that the health of the Bulgarian public finances will only get worse.
Public debt: the test ahead
The third convergence criterion is strictly linked to the second with regard to public debt and its ratio to GDP. To understand this link, we can imagine a debt resulting from the accumulation of deficits over time. In fact, savings or “reserves” can help cover the deficit for a period of time when needed. But running massive deficits for many years will lead to the exhaustion of all savings. So, prolonged deficits will end up creating a huge pile of debt in the same way that surpluses lead to savings. Since Bulgaria mostly had a balanced budget, it has also boasted of low debt over the past decades (Figure 3).
Adoption of the euro is conditional on a country’s debt-to-GDP ratio being below the 60% limit as a general rule. However, there may be exceptions in particular cases if the ratio has “fallen sufficiently and [is …] approaching the reference value at a satisfactory pace ”. Clearly, the data shows that for Bulgaria it will be difficult to miss the debt-to-GDP target anytime soon. In fact, this indicator has been consistently within the acceptable range between 2009 and 2020. Nonetheless, as noted in the previous paragraphs, the pandemic-induced recession has significantly worsened the country’s public finances. On the contrary, Bulgaria is already on the verge of asking the markets for several billion euros in loans in 2021. So, if the deficit is not quickly brought under control and GDP growth does not restart, the debt will increase.
Likewise, if the debt increases, Bulgaria could also face higher interest rates. But, to join the euro zone, the security of a 10-year country should not pay more than that of the EU. reference value. Predictably, to determine this rate, the EU follows the same procedure as it does for the inflation benchmark. Thus, Bulgaria could miss the fifth convergence criterion due to growing debt. Although this scenario is still unlikely given the data (Chart 4).
Beyond the numbers: national and international political consequences
In short, the macroeconomic obstacles to Bulgaria’s adoption of the euro are not only numerous, but above all urgent. But fixing the economy – which is easier said than done – is not enough. To embrace such a fundamental change, we have to get out of the institutional trench warfare in which Bulgaria is still stuck.
In this regard, it is fundamental that the Coordination Council for the preparation of the Republic of Bulgaria for accession to the euro area which prepared the NPIE has sat under the joint chairmanship of the Governor of the National Bank of Bulgaria (BNB) , Dimitar Radev, and the Acting Minister of Finance, Asen Vassilev. Considering that the current cabinet and the BNB have already been on the right track, this is rather a good sign. Indeed, by the presence of Radev, the BNB marked its concrete and immediate availability to move forward with the NPIE.
However, this agreement between the technocratic elites and part of the political establishment is not enough for the successful adoption of the euro. After all, few of the countries that joined the eurozone under the spur of a similar consensus have performed well. On the contrary, the country must build a sincere national agreement on the acceptability of painful and bound sacrifices. Otherwise, like other weaker economies that have joined the eurozone without educating their populations first, Bulgaria risks suffering massive setbacks. Nevertheless, it is in the interest of the EU to help the Bulgarian authorities to forge this national consensus. After long years of failures, delays and internal fragmentation, Bulgaria’s adoption of the euro may finally turn things around. Most importantly, such an achievement has the potential to restore the confidence of other Balkan countries in the EU. We can therefore dream of Bulgaria’s accession to the euro zone to relaunch engagement and relaunch the dynamics of enlargement. However, if Bulgaria