The European Central Bank (ECB) joined the Bulgarian National Bank (BNB) in criticising the Cabinet's plans to use Silver Fund money to buy its own securities, saying such a move could distort the domestic securities market while at the same time promoting indirect discrimination of debt issued by other EU member states.
The Silver Fund, created to shore up the state pension system at a point in future, is part of the country's fiscal reserve, which underpins Bulgaria's currency board agreement, upholding which is the main mandate of the BNB.
On April 11, the Cabinet approved legislative amendments drafted by the Finance Ministry, which would give the ministry the right to use the Fund's money to buy Bulgarian government debt. The bill still needs approval by Parliament, but that its passing is seen as a foregone conclusion, given the parliamentary majority of ruling party GERB and its allies.
According to the draft law, the Cabinet would be allowed to use up to 30 per cent of the Silver Fund to buy its own bonds this year; the ceiling would increase by 10 percentage points each year before peaking at 70 per cent in 2016.
Currently, the Fund is allowed to invest in foreign bonds above a certain credit rating, but the option was never exercised. Instead, the money has been kept in low-interest short-term deposits with the BNB, which has resulted in zero, or even negative yield in most years.
In a statement dated April 13, the ECB said that its opinion was in response to an inquiry made by Bulgaria's Finance Ministry in March.
"The ECB notes that the draft law does not require an investment grade credit rating to apply to securities issued by the Bulgarian government, whereas the other debt securities do require such a rating," the ECB said.
"This leads to unequal treatment of the different investment instruments, which could create competition and market distortions. It puts the government in a privileged position compared to other issuers."
Given the discrepancy, "an issue of indirect discrimination arises that may lead to unjustified restrictions on the free movement of capital contrary to Article 63 of the [European] Treaty."
Furthermore, give the small size and liquidity of the market for Bulgarian government securities, "the investment of significant Fund resources in the market for Bulgarian government securities could have some implications for the volume and the yields of the Bulgarian government securities."
The ECB said that the changed investment framework envisioned by the amendments "may distort domestic securities markets", skewing yields on the primary and secondary market. "Thus, if the Fund purchases the envisaged amounts, exclusively in the primary market or in the secondary market, the prices and yields of Bulgarian government securities will not reflect the true state of the Bulgarian economy and the position of the country’s public finances," the ECB opinion said.
"In addition, some investors might stop participating in a debt securities market dominated by a public sector fund, which is under the control of the issuer."
Furthermore, such a distortion of the domestic market could "undermine the credibility and accuracy of the fulfilment of the long-term interest rates criterion" - one of the five Maastricht critieria that Bulgaria must meet in order to adopt the euro. Bulgaria is required by the terms of its European Union accession treaty to adopt the euro, although there is no deadline on joining the euro zone.
Citing the ECB opinion, Bulgaria's central bank asked the Cabinet on April 18 to withdraw the bill from Parliament and make it subject to "an in-depth discussion between the BNB, Finance Ministry and the Financial Supervision Commission, as the institutions responsible for the macroeconomic and financial stability of the country. No such discussion had happened prior to the drafting of the current bill, BNB said in its statement.
Also on April 18, in a letter to ECB governor Mario Draghi, Bulgaria's Finance Minister Simeon Dyankov attempted to allay ECB's fears, saying that the government securities would issued specially to the Silver Fund and would be untradeable, but would carry interest rates based on market benchmarks.
The special debt issues to the Silver Fund would not influence the size and yields of normally traded debt, nor would such debt (by virtue of being a special issue) be subject to ECB monitoring for convergence with Maastricht criteria, the letter, published on the Finance Ministry website, said.
The Silver Fund, currently at about 1.8 billion leva, is expected to see its endowment increase to two billion leva by the end of the year by incorporating privatisation and concession revenue. This means that the Cabinet could have as much as 600 million leva of the Fund's money to purchase its own securities.
Bulgaria has to repay 818.5 million leva worth of debt in January 2013, which it must refinance this year.