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 – significant devaluation of the Bulgarian lev and loss of confidence in the currency and in the country internationally. Inflation reached 2,000% in the early months of the same year and the lev was devalued literally in minutes. A cup of coffee, for example, reaches a price of BGN 200 at an initial price of BGN 0.20.
The Bulgarian National Bank (BNB) and its policies in the previous few years are responsible for this situation. This, in addition to inflation, led to the bankruptcy of dozens of banks and significant unemployment. The presence of a political crisis in the country leads to protests in the country's major cities, road blockades and storming of buildings. Workers were refusing to work, and the country was also facing a crisis with basic foodstuffs. The depreciation of the leva was mainly positive for people with credit, because they also depreciated significantly.
The only option for retaining the value of the leva at the particular moment and preventing an inflationary spiral is the “attachment” of the Bulgarian lev to another, stable currency – the German mark (one of the strongest currencies in the world at the time).
The connection of the two currencies (lev and mark) happened 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 BGN 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 there is no mention of the levels throughout 1997.
After the denomination of the leva in July 1999 (1,000 old leva is exchanged for 1 new leva), one leva becomes 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 comes from, which we have been using until now.
The currency board stimulates trade and investment between the two associated countries. Most members of the European Union use the euro.
The currency board is one of the biggest and most successful reforms in Bulgaria, which allowed the country to get out of the financial mess of the 90s – complete collapse of monetary policy, chronically high inflation, uncontrollable government debt, bank failures, etc.
This is what IPI commented on.
The biggest anchor on board is undoubtedly the fixed rate – the stability of money in our country comes from the well-founded assumption that the exchange rate of BGN 1.95583 for 1 euro is unshakable. Management “Emission“ in the BNB, which manages the gross international currency reserves, maintains full currency coverage of the total sum of the monetary liabilities of the BNB – these are all banknotes and coins in circulation, as well as all balances on BNB accounts, including government deposit and commercial bank reserves. Full coverage is a guarantee of confidence in the currency.
Understanding the currency board, however, cannot be reduced to the exchange rate alone. In fact, the board changes the monetary policy in our country more deeply than just fixing the exchange rate. Before the introduction of the currency board, the central bank in our country was not independent, it refinanced the commercial banks without control and without collateral, and directly financed the budget deficit of the state. This is exactly what the board is changing – gives independence to the BNB, prevents the central bank from granting loans to the government and gives very clear and strict rules for financing commercial banks – only if the bank is solvent, there is a liquidity risk for the entire financial system and subject to strict requirements for the type and quality of the collateral provided.
All this gives the new framework of the monetary policy in our country after 1997 and brings widely known positives – curbing price growth, prudent fiscal policy and a significant reduction in external debt as a share of GDP and a stable banking system, despite the bankruptcy of KTB in 2014. Both periods of relatively high inflation after the introduction of the board – in 2008 and now in 2022, are mainly caused by external factors and not by shortcomings of the 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 catch-up to the average European income levels – GDP per capita in purchasing power standards rose from below 30% of the European average when the board was introduced to 55% currently (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 passed through them without catastrophic upheavals and destruction of well-being.
However, these successes should not create the impression of any all-powerful role of the monetary board. The board is a big brake on government debt because it prohibits direct lending to the government. However, it cannot stop governments from running deficits and financing themselves in the debt markets – either at home or abroad. That is why, in the medium term, the 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 debate about the debt is essentially a conversation about the budget deficit, which is still relevant at the moment against the background of the adopted budget update. In a similar way, the debate about the state of the 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.