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Bulgaria could turn out to be the latest test case both for the future of currency boards and the IMF’s new approach to reform. With some analysts predicting the possible demise of the Bulgarian currency board in 2001, advocates of both approaches must be sweating a little.
Bulgaria’s problem is that of all other transitional economies: how to transform state-owned industrial behemoths into something sleek and modern while steering through the minefield of different interest groups. The verdict on Bulgaria’s progress until the start of this year was pretty abysmal.
The currency board introduced in 1997 – and which has created “the lowest level of inflation in the world”, to quote an IMF representative, out of the ruins of hyperinflation – has been the bright spot in an otherwise gloomy picture. It brought stability to a country which came close to being the first ever to default on Bradies and whose banking system had collapsed.
But the danger of the currency board is of being lulled into a false sense of security. By providing what seems like an instant fix, governments put off doing the more difficult and essential tasks of structural reform. Privatization programmes never take off, price reform and subsidies remain in place. An uncompetitive economy then operates with an overvalued currency, reflecting the value and underlying economy of the currency to which it is fixed rather than its own. In Bulgaria’s case the lev was originally linked to the Deutschmark and subsequently the euro. This means it has to bring its economy up to the standards of western Europe in a pretty short space of time or face a widening current account deficit that will eventually destroy the currency board.
It’s a tall order and small wonder there are doubts. “We have some concerns about the outlook for the Bulgarian economy. Because of the Kosovo crisis [which disrupted exports since half the country’s pre-crisis exports travelled through Yugoslavia] economic growth this year will be zero at best and could contract.,” says David Riley, director of emerging Europe with rating agency Fitch Ibca which has drawn attention to the weaknesses that could undermine the currency board. “By 2001 there will be a sharp increase in external debt payments falling due, and if the current account deficit were to persist, they would need $1.5 billion of external financing which is 10% of GDP and a pretty substantial amount. There is also a general election in 2001. If the reforms aren’t starting to feed through to the supply side of the economy it would be the first major test of the currency board.”
Adds Riley: “The bottom line with a currency board is that if you don’t get improvements in the supply side of the economy and substantial productivity growth then the sustainability of the board is brought into question.”
Unlike Argentina, which has had a currency board since 1991 and has bridged its financing gap by borrowing in the international bond markets, Bulgaria doesn’t really have this option. Investors do buy Bulgarian Bradies – IABs and Flirbs – as well as local dollar-denominated instruments, known as Zunk bonds, which have the added attraction that they can be exchanged at par in privatization deals, but the spreads at which they might be persuaded to buy Bulgarian Eurobonds have kept a long-awaited government offering at the talking stage for two years.
Enter the IMF. Along with other international financial institutions it will contribute an estimated $440 million towards bridging Bulgaria’s initial financing gap of $615 million in 1999. The other third will come from the EU, Jexim and others. This gives the IMF considerable leverage over Bulgarian macroeconomic policy.
This means that if Bulgaria does what it’s told and there are no major extenuating circumstances such as a new Balkans war, then if the currency board does collapse it will be back to the drawing board, once again, for IMF policymakers. Where IMF policy towards Bulgaria differs from that for say Russia is the insistence on actual structural reform rather than the mere pushing for credible monetary and fiscal regimes in the belief that the market will magically do the rest.
“Markets don’t work if you don’t have the institutional fabric in place that allows economic rationality to prevail. There is increasing recognition by the international financial institutions that for the market to work you must have structural changes, ” says Philip Poole, director of eastern European research for ING Barings who shares the concerns that Bulgaria may not reform quickly enough to keep pace with the demands of its currency board.
“It’s crucial that they push ahead with privatization and increasing competition in the market,” says Poole. “Once you have a fixed exchange rate regime you have to generate levels of productivity that allow you to keep up with members of the currency regime you are linked to. Fixed exchange rate regimes are very good when it comes to dealing with hyperinflation. [Bulgaria’s] has been highly successful in this respect. There is more of an issue long-term because it takes away flexibility in particular over the price at which you interact with the rest of the world.”
Most analysts think Bulgaria’s reform efforts were pretty feeble last year but have been more encouraged this year with the high point being the sale of the Bulgarian telecom company. Deputy prime minister Alexander Bozhkov said recently that the government had hit its end-June target agreed with the IMF for privatizing or liquidating 41 loss-making companies.
“Privatization of the big serious enterprises falls short of our expectations,” said IMF executive Peter Stella in an interview with a Bulgarian publication recently. On the positive side Stella drew attention to the government’s isolating of enterprises in readiness for privatization.
Could this small country with only 8.5 million people and a $10 billion economy, a tenth the size of Portugal’s, be the next in line to cause IMF policymakers sleepless nights? Brian Caplen
