Meeting the inflation criteria will be Bulgaria’s toughest challenge for joining the euro zone in view of Bulgarian National Bank’s (BNB) restricted monetary policy.
However, the favourable business environment and tax policies could be used as alternative tools to curb price growth, BNB governor Ivan Iskrov said on July 14.
The central bank of Bulgaria has been operating under a currency board arrangement pegging the lev to the euro since 1997 and the lack of monetary tools had left inflation the sole failure of the five EU-set criteria for euro zone entry.
“Operating under a currency board arrangement, the central bank has no direct control over the inflation rates in the country. Practically, this particular criterion will be the biggest challenge for us,” Iskrov said in a statement at a conference in Athens.
Year-on-year, consumer price inflation in Bulgaria slowed down to 8.2 per cent in June from 8.5 per cent in May. Cumulative inflation for the first six months of the year was 2.9 per cent.
Iskrov said that Bulgaria and its partner in EU accession, Romania, were in a “shooting at a moving target” situation, because given a probability that the union of 27 member-states, including Bulgaria and Romania, had three countries with rates of inflation close to zero that would require reaching inflation rates of about two percent under the inflation criterion.
The definition of the inflation criterion is that inflation in a euro-zone acceding state should not be higher than the average of the three lowest rates of inflation in the EU plus 1.5 per cent.
Iskrov also criticised the lack of flexibility in the EU assessment, which rejected Lithuania’s entry bid in May.
“A very bureaucratic approach has been used, neglecting the fact that each economy is affected by a large number of internal and external factors and this very much hinders the fulfilment of the heavily restrictive inflation criterion, especially with the absence of an autonomous monetary policy,” said Iskrov.
The European Commission and the European Central Bank said Lithuania failed to meet the inflation criterion, missing the target by 0.07 percentage points and delayed its euro entry bid until 2008.
Iskrov said Bulgaria had hoped the European Central Bank and the EU’s executive would use a more flexible approach when assessing Bulgaria.
Iskrov said that tough fiscal policy was needed to help the country meet inflation criterion, because the currency board regime left the central bank out of monetary tools to control inflation rates.
The Cabinet, pursuing one of the tightest fiscal policies in Europe, has agreed with the International Monetary Fund to aim for a budget surplus of three per cent of the projected GDP this year in order to offset possible risks stemming from the rising external account gap.
“In the particular case of Bulgaria where a fixed exchange rate regime is in place together with a very conservative fiscal policy, reserves should be looked for in promoting the competition and improving the business environment so that the economy would have greater flexibility to respond to changes in the external environment (including raw materials prices), and the supply could react faster to the increased demand (internal and external),” said Iskrov.
Harmonisation of indirect taxes with the EU minimum levels, which the Government in Sofia undertook earlier this year, is also largely determinative for decreasing the inflation rate, he added.
“The changes in indirect taxes and administered prices directly affect the inflation in the country, their catching up adjustment has to take place before the years that will be the basis for assessing the compliance with the Maastricht criteria - before 2008,” Iskrov said.
The early harmonisation of some excise duties is a step that would facilitate the compliance with the inflation criterion, because it would eliminate the inflationary influence caused by the increase in these taxes over the years that will be used for the assessment, he said.
Iskrov forecast that inflation would fall to six per cent this year, despite faster growth rates in the beginning of 2006.
Iskrov reiterated that Bulgaria aims to join the Exchange Rate Mechanism-2 (ERM-2), the so-called euro waiting room, shortly after its planned European Union entry in 2007 and possibly in the first quarter of next year.
Bulgaria has set its target date for entering the euro zone in 2010 and plans to keep the currency board with a fixed exchange rate of 1.95583 Bulgarian leva for a euro in place until its joins the euro zone.
Iskrov has said that if the country’s entry to the EU was delayed by a year to 2008, the target would also move to 2011.
