Should Bulgaria join the euro now?
The short answer is: no – not yet. While the Bulgarian case for joining the euro seems strong at first glance, neither Sofia nor Brussels should move too fast now. Not only does Bulgaria lack the institutional capacity to be a reliable member of the club, it would also lose important degrees of freedom to foster growth and deal with crises at home. The Maastricht criteria may be a necessary, but by no means a sufficient condition for successful membership. Bulgaria’s accession should be based on prudence rather than precipitancy.
As to the prospect of his country joining the euro, Bulgarian Prime Minister Boyko Borisov has a clear position “We have done our homework for the Eurozone. […] Any moment they invite us, we can enter in,” he stated in January.[i] Commission President Jean-Claude Juncker backs the cause. In his 2017 State of the Union address, Mr. Juncker argued that “all Member States that want to join the euro must be able to do so.” With regard to Bulgaria in particular, he added in January this year: “I have to say bluntly that Bulgaria is ready”.[ii]
The question when Bulgaria can and should join the euro is about more than the efforts of a country. It is about whether the criterial we apply today to measure a country’s readiness to join the single currency are still the right ones given the lessons of the crisis. And more fundamentally, it is about finding the right balance between deepening and enlarging the currency union. The euro crisis has taught us two important lessons: first, that meeting the Maastricht criteria is a necessary, but by no means a sufficient condition for a country to be a reliable member of the common currency; second, that adopting the euro as fast as possible might not always be in a country’s own best interest.
The Maastricht Criteria
To enter the Eurozone, the EU Member States must meet the so-called “convergence criteria”. These are economic and legal conditions agreed in the Maastricht Treaty in 1992 and are also known as “The Maastricht Criteria”. All EU Member States have committed to adopt the euro except Denmark and the United Kingdom which have opt-out clauses in the EU Treaties, exempting them from introducing the euro. These two countries may nevertheless apply for membership of the euro area if they so decide.
Currently, the eurozone consists of 19 Member States: Austria, Belgium, Germany, Greece, Estonia, Ireland, Spain, Italy, Cyprus, Latvia, Lithuania, Luxembourg, Malta, The Netherlands, Portugal, Slovakia, Slovenia, Finland and France. Estonia, Lithuania and Slovenia entered the currency mechanism less than two months after their accession to the EU in 2004 – an almost automatic admission. Lithuania, however, had to stay in the exchange rate mechanism for over 10 years until the institutions decided that it was ready to be a member of the euro area. Bulgaria, Romania and Croatia are the next three real candidates in the process.[iii]
The Maastricht criteria are the only ones (together with the central bank independence requirement) that are formally laid down as a condition for accession to the euro area. Formulated back in 1992 and reproduced in the Treaty and Protocol No. 13, they describe schematically the so-called nominal convergence, i.e. the requirement for price, currency and fiscal stability.
The criteria include five main requirements:
1) Inflation measured by the harmonised index of consumer prices – the inflation rate of member states must not exceed by more than 1.5 percentage points above the average rate of the three best performing member states;
2) Government budget deficit – the deficit as % of GDP must not exceed 3%. The rule permits deficit above the limit in exceptional conditions only.
3) Government debt – the debt as % of GDP must not exceed 60%. In case of downturn the rule permits debt above 60% if it is expected to fall below the limit in the near future.
4) Long-term interest rate (average yield on ten-year government bonds) – long-term interest rate should not exceed by more than 2 percentage points the average rate of the three best performing member states.
5) Exchange rate stability – the exchange rate stability rule is more flexible than the others. Applicant countries should not have devalued the central rate of their euro pegged currency during the previous two years.
A model student?
On first site, the Bulgarian case seems strong. The country formally meets the convergence criteria set out in the Treaties, its public finances outperform those of most euro-area member states, and its currency, the Lev, has been pegged to the euro since 1999 (and before that to the German Mark) by way of a currency board.
However, neither Sofia nor Brussels should move too fast now because the truth is that it would be too early for Bulgaria to join. This is because the country lacks the institutional capacity to be a reliable member of the club, in particular at a moment when the process of EMU deepening is still incomplete and banking union is still in its infancy. Also, it might even be in Bulgaria’s own interest to continue to develop its economy without having to take into account all the constraints of euro membership too early. The crisis lesson should not be forgotten. Being a euro member in good times is easy. But being a member in crisis simply means that there are fewer degrees of freedom to deal with a crisis.
Hence, grounding Bulgaria’s accession process on prudence rather than precipitance would mean both sides can seize the opportunity to show that they have learned from the challenges of the past and at the same time optimize economic benefits.
The case of Bulgaria’s recent push to join the euro rests largely on its strong performance with regard to the Maastricht criteria. Agreed upon by member states in Maastricht in 1991, the so-called convergence criteria provide a set of economic benchmarks designed to ensure sufficient economic convergence before entering the Eurozone.
In spite of recent crisis experience, these rules have remained essentially unchanged ever since the inception of the euro in 1999. Measured solely against this check list, Bulgaria indeed appears to be ready to join the euro. With a consumer inflation rate of 1,32% over the past twelve months, it remained far below the current assumed reference value of about 2%. Government finances are in good shape as well: at about 25,6% public debt was below the required 60% of GDP in Q3 2017; and in 2016, the government remained well above the deficit limit of 3% and even ran a balanced budget. Regarding long-term convergence as measured in government bond interest rates, Bulgaria also stayed below the assumed threshold for its ten-year government bond yield over the last twelve months.
At the same time, even if imbalances are no longer labelled as excessive, Bulgaria remains very much in the scope of the Macroeconomic Imbalance Procedure (MIP). It continues to experience imbalances and major vulnerabilities, in particular in the financial sector. Alas, compliance with the reformed governance framework, and that includes the MIP, is not a criterion for joining the euro as the criteria predate the post-crisis reforms.
The criteria: necessary but not sufficient
The sovereign debt crisis has clearly revealed one thing: the existing convergence criteria may be necessary, but not sufficient conditions to assess a country’s readiness to become part of the euro. While the Maastricht Criteria remain key measures of macroeconomic readiness, the last decade has clearly highlighted their limitations in other respects. With Portugal, Spain and Ireland, the Eurozone already witnessed three former Maastricht model students falter for reasons not covered by the current convergence criteria.[iv] There are actually many factors for which a country might face severe difficulties inside the euro area in spite of meeting the Maastricht criteria. They range from low factor mobility to a strong domestic bias in the financial sector and an overall buildup of imbalances in the Eurozone.
In the case of Bulgaria, the main issue remains institutional readiness.[v] A concept that goes far beyond the current formal requirements on certain bank independence, it is best explained by looking at one of the euro area’s most important post-crisis remedies – the banking union. Being part of the banking union means being part of a common system of supervision and ultimately resolution of banks. For it to work, European supervision and resolution authorities need to be able to rely on national judicial systems to do their job in issuing rulings, e.g. to draw on collateral or to settle disputes over non-performing loans. In a situation where the judicial system does not work, a bank could risk going into resolution because it cannot work out non-performing loans at a fast-enough speed, then relying on the Single Resolution fund for support.
This is not a tenable situation, in particular because the banking union is still only at an infant stage and deepening the monetary union is not near completion. In this situation more than ever institutional quality is not only a question of mere efficiency and effectiveness but one of the fundamental functioning and credibility of the system. When domestic institutions fail to deliver their part of the bargain, the reputation and operation of the system as a whole is at stake. Therefore, in sum, it does not seem to be a good idea from the perspective of the European partners to let Bulgaria joint the euro for now as long as questions of institutional quality are not addressed.
Prudence, not precipitance
Then again, the same can be said from the perspective of Bulgaria.It is still the poorest country in the European Union; its GDP per capita is half of that of the poorest Eurozone member, Latvia. In light of this, and while its prudent fiscal policy is commendable, it seems clear that keeping debt and deficit levels low should not be Bulgaria’s primary concern. Instead, it would be best to invest in catching up with the rest of the European union. This is particularly true when considering that a number of Member States suffered from unsustainable booms induced by a sudden drop in interest rates after their euro adoption rather than featuring a steady and sustainable catch-up growth before finally joining the euro.
Today Bulgaria is already well-positioned to achieve this type of prudent convergence. It already enjoys the monetary stability provided by the currency board but is not yet subject to the much stricter governance framework applicable to euro-area members. This is all the more true when it comes to the Stability and Growth Pact, where potential sanctions have a different format outside the Eurozone. Bulgaria should use this opportunity rather than constrain itself too early.
Bulgaria would make a big mistake if it gave up another piece of its sovereignty to join the Eurozone. If Bulgaria joined the Eurozone, it would have to discard one of the few Bulgarian institutions that works well, is supported by the public and is controlled by Bulgarians.[vi] This would be in exchange for an unclear and potentially unstable arrangement that Bulgaria cannot control and cannot opt-out of. This sovereignty is valuable, particularly if the euro gets in trouble. If that happens, Bulgaria can immediately switch to a superior alternative without asking permission from any other country or organisation. Why would anyone want to give up known rules of the road and fiscal discipline for a moral hazard that encourages bad fiscal behaviour – like that of Greece?
All this suggests that it would neither be in Bulgaria’s own interest to pass the point-of-no-return of joining the euro, nor would it be a good idea from the perspective of its European partners. At the same time, we should think about adapting the convergence criteria to the new post-crisis reality. Institutional readiness should be as important as economic convergence because joining the euro means joining the banking union. Another obvious criterion would be compliance with the reformed governance framework. Such an update will take time. In the meantime, we should not repeat the mistakes of the past.
[i] Prof. Dr. Henrik Enderlein, Max Emanuel Mannweiler, Lucas Guttenberg, Should Bulgaria join the euro now?, Jacques Delors Institut, April 2018, available at https://www.delorsinstitut.de/en/all-publications/should-bulgaria-join-the-euro-now/
[ii] EU backs Bulgaria’s bid to join eurozone – despite being bloc’s poorest country, Express, available at https://www.express.co.uk/news/world/988326/eurozone-news-bulgaria-euro-bid-european-central-bank-request
[iii] Romania joins Bulgaria and Croatia in seeking euro adoption, The Irish Times, available at https://www.irishtimes.com/business/economy/romania-joins-bulgaria-and-croatia-in-seeking-euro-adoption-1.3494420
[iv] Darvas, Zsolt, After the crisis: what new lessons for euro adoption?, available at http://bruegel.org/wp-content/uploads/2017/11/Darvas_2017-11-15_Zagreb_euro_adoption.pdf
[v] Eastern European Nations Face a Tougher Route to the Euro, Bloomberg, available at https://www.bloomberg.com/news/articles/2018-07-18/eastern-european-nations-now-face-a-tougher-route-to-the-euro
[vi] Hanke, Steve, Long Live The Lev: Bulgaria Should Hold On To Its Currency Board, Forbes, January 2018, available at https://www.forbes.com/sites/stevehanke/2018/01/30/bulgarians-love-their-currency-board-and-their-lev-long-live-the-lev/#b76bc696a0e2
