On July 1, 1997, a currency board was introduced in Bulgaria after months of hyperinflation.
At the beginning of 1997, Bulgaria went through a period of hyperinflation - a significant depreciation of the Bulgarian lev and a loss of confidence in the currency and the country internationally. Inflation reached 2,000% in the early months of that year and the lev depreciated literally in minutes. A cup of coffee, for example, reached a price of 200 leva with an initial price of 0.20 leva.
The Bulgarian National Bank (BNB) and the policies it implemented in the previous few years are responsible for this situation. In addition to inflation, this led to the bankruptcy of dozens of banks and significant unemployment. The presence of a political crisis in the country led to protests in the country's major cities, roadblocks and storming of buildings. Workers refused to work, and the country was also facing a crisis with basic food products. The devaluation of the lev was mainly in the interest of people with loans, because they also depreciated significantly.
The only option for maintaining the value of the lev at the current time and preventing an inflationary spiral is the “pegging” of the Bulgarian lev to another, stable currency - the German mark (one of the strongest currencies in the world at the time).
The linking of the two currencies (lev and mark) occurred in 1997, which solved the problem of confidence in the currency and limited the possibility of monetary policies by the BNB. This means that the BNB is no longer responsible for the amount of levs in circulation and does not determine the interest rates on loans to the central bank. After the introduction of the currency board, inflation gradually subsided and remained at the levels of 1997.
After the denomination of the lev in July 1999 (1,000 old levs were exchanged for 1 new lev), one lev became equal to one mark. In 2002, Germany adopted the euro and the exchange rate changed, with 1 euro equal to 1.95583. This is where the fixed lev-euro exchange rate that we still use today came from.
The currency board stimulated trade and investment between the two related countries. Most members of the European Union use the euro.
The currency board is one of the largest and most successful reforms in Bulgaria, allowing the country to escape the financial turmoil of the 1990s – complete collapse of monetary policy, chronically high inflation, uncontrollable government debt, bank failures, etc.
This is commented by the IME.
The biggest anchor on the board is undoubtedly the fixed exchange rate - the stability of money in our country comes from the justified assumption that the exchange rate of 1.95583 leva for 1 euro is unshakable. The "Issue" department in the BNB, which manages gross international foreign exchange reserves, maintains full foreign exchange coverage of the total amount of the BNB's monetary liabilities - these are all banknotes and coins in circulation, as well as all balances on accounts with the BNB, including the government's deposit and the reserves of commercial banks. Full coverage is a guarantee of confidence in the currency unit.
However, the understanding of the currency board cannot be reduced solely to the exchange rate. In fact, the board changes the monetary policy in our country more deeply than the fixing of the exchange rate itself. Before the introduction of the currency board, the central bank in our country was not independent, it refinanced commercial banks without control and without collateral, and directly financed the state's budget deficits. This is exactly what the board changes - it gives independence to the BNB, does not allow the central bank to provide loans to the government and gives very clear and strict rules for financing commercial banks - only if the bank is solvent, has a liquidity risk for the entire financial system and in compliance with strict requirements for the type and quality of the collateral provided.
All this provides the new framework for monetary policy in our country after 1997 and brings widely known positives - curbing price growth, a reasonable fiscal policy and a significant reduction in foreign debt as a share of GDP and a stable banking system, despite the bankruptcy of Corpbank in 2014. Both periods of relatively high inflation after the introduction of the board - in 2008 and now in 2022, were caused primarily by external factors, and not by shortcomings in monetary policy in our country. The board cannot guarantee growth, but it lays the foundation for two consecutive decades of economic growth in our country and a gradual catching up with the average European income levels - GDP per capita in purchasing power standards has increased from below 30% of the European average at the introduction of the board to 55% at the moment (see here). Our monetary system has successfully withstood the challenges of a series of crises in different decades - from the wars in neighboring Yugoslavia, through the great financial crisis and the Covid-19 pandemic - and Bulgaria went through them without catastrophic shocks and destruction of welfare.
However, these successes should not create an idea of some all-powerful role of the currency board. The board is a major brake on government debt, as it prohibits direct lending to the government. However, it cannot stop governments from running deficits and financing themselves on the debt markets - either at home or abroad. That is precisely why, in the medium term, government debt is expected to increase and reach nearly 30% of GDP by 2024, or at least twice the levels of 10-15 years ago. The debt debate is essentially a conversation about the budget deficit, which is currently relevant against the backdrop of the adopted budget update. Similarly, the debate about the state of banks is also a conversation about the quality of banking supervision, and not simply about the lack of possibility for uncontrolled financing of commercial banks by the central bank.