Every two years the European Central Bank and the European Commission publish its so-called convergence reports. They follow the development of the EU countries that have not yet adopted the Euro and evaluate the meeting of the convergence criteria, known also as the Maastricht criteria. The reports cover seven member states – Bulgaria, Czechia, Croatia, Hungary, Poland, Romania, and Sweden. Denmark is excluded due to its special derogation on the matter of joining the Eurozone.
This year there was a lot of anticipation for the reports, since permission for Croatia for Eurozone accession on January 1st, 2023, depended on them. After their release, it could be said that the country is almost certain to adopt the Euro next year, though there are a few more procedures along the way.
The other news is that Bulgaria does not fulfill all criteria for accession. However, it has been known that the country could join the Euro Area on January 1st, 2024, at the earliest.
Why was Croatia given a green light, despite its high public debt, and do those reports hinder the adoption of the Euro in Bulgaria? Despite the attention that the convergence reports received recently, these two questions seem to have remained mostly ignored. Let us first focus on Croatia since it is the more significant case as of now.
The Criteria Are Not Always Simple
Even before the publishing of the reports, Croatia was expected to be allowed to proceed with the final steps of joining the Eurozone. The concerns lay with price stability, given high inflation in the whole of Europe, as well as with the size of government debt, which is well above 60%. Both criteria, however, have aspects that are not widely known and allow for subjectivity in evaluation.
The inflation requirement is based on the average increase of the harmonized consumer price index for the three countries with the lowest inflation (in this case for the period from May 2021 until April 2022) plus 1.5 percentage points. The subjectivity here comes with the fact that some countries could be discarded when determining the maximum allowed inflation rate when they look like exceptions due to some specific economic factors.
This is exactly what happened in the last series of reports which disregarded Malta, because of the government assistance to the state-owned energy company that kept energy prices on the island stable, unlike in the rest of the world. The other excluded country was Portugal, where milder price increases in the service sector keep inflation down (tourism is a major part of the local economy and the sector is still recovering from the pandemic, hence the lower prices).
With the exclusion of Malta and Portugal, the three countries with the best price stability were France (3.2% inflation rate), Finland (3.3%), and Greece (3.6%). After taking the average and adding 1.5 percentage points we get a reference value of 4.9%. Croatia barely manages to fit in with an inflation rate of 4.7%. What is important here is the fact that the supposedly precise number-based criteria could be pretty flexible when necessary.
The debt criterion is even more interesting, given that Croatia exceeds the 60% threshold by a wide margin. Here the confusion comes from the fact that the requirement is often slightly misunderstood. Formally it says that the debt-to-GDP ratio should either be below 60% or demonstrate a clear downward trend. The second part of the criterion is not so well-known since it is easier to convey just the specific reference number to the public.
The authors of Croatia’s report precisely mention this detail when explaining why the country fulfills the requirement. The ECB’s evaluation is that, even though public debt in Croatia was 79,8% of GDP in 2021, this was a drastic reduction from 87,3% in 2020, hence the meeting of the criterion. This reading of the situation is subjective though, given that there is no clear definition of what level of reduction in public debt is acceptable.
Moreover, Croatia’s debt increased rapidly in 2020 due to the crisis and fell sharply afterward. Even before the pandemic, the debt-to-GDP ratio was around 70%. In other words, despite the sharp decrease in 2021, Croatia’s public debt has been sitting well above the 60% of GDP threshold and it is up to debate whether the country would manage to meet the criterion in the coming years.
Bulgaria Awaits a New Report in 2023
The analysis on the price stability and debt criteria above is important since it leads us to two relevant conclusions. Firstly, the requirements are more complicated that the specific numbers that the public associates them with and could be interpreted subjectively.
Secondly, Croatia’s example confirms that in the last couple of years a political consensus seems to have emerged on a European level on the matter of both Croatia and Bulgaria joining the Eurozone. Yes, the two countries had to fulfill additional requirements before joining the ERM II, but afterward, the process of accession has been going steady – after all, Croatia is to adopt the Euro after the minimal required stay in the so-called waiting room.
The last reports on Bulgaria are important not so much as an evaluation of the country’s prospect of joining the Eurozone in 2024 but as a marker of the challenges ahead. Though the reports come out every two years, each country could request the writing of a new one at any point in time. The expectation is that Bulgaria would do so in 2023.
Given the visibly positive attitude of the European partners, accession seems to be mostly an internal matter – whether in the next year and a half there would be a political consensus on adopting the Euro and whether the country would meet the criteria. Like Croatia, Bulgaria may be able to benefit from a subjective reading of the requirements but only if there is visible progress, actions, and reforms in pursuit of stable convergence, paired with reasonable policies.
On the other hand, if actions are in the exact opposite direction and some criteria are missed by a lot, the outcome would not be as favorable.
Establishing political consensus within the country is certainly not going to be easy. It is evident from public discussions that some parties in the parliament, and more specifically in the governing coalition, are willing to prolong the adoption of the new currency.
Accession to the Eurozone would also have to come after changes in the Law on the Bulgarian National Bank, which means that tensions on the matter in parliament are yet to get high. Even if the fragile consensus in favor of the Euro withstands, there is always the risk of political instability coupled with a series of parliamentary elections, which could hinder quick accession.
Even if the political risk proves not to be an issue, the other hurdle would be the criteria. For Bulgaria, the inflation requirement would be the largest problem since we are among the countries with the fastest rising prices. The harmonized consumer price index marked a 15.6% increase compared to May 2021 and the monthly inflation for this May is 1.2%.
Assuming that the prospect is to adopt the Euro on January 1, 2024, inflation would be measured for the period from May 2022 to April 2023. Meeting this requirement would be difficult if rising prices are not tamed on a monthly level soon.
The other criterion in question concerns the budget deficits. In 2021 the government expenses exceeded revenues by 4.1% of GDP, while the Maastricht threshold is 3%. The open debate on fiscal policy, including the upcoming budget update, points to the question of how big of a deficit we would have in 2022. Given that even now there is a surplus, politicians bear sole responsibility for meeting this criterion. That is not the case with inflation, which is driven largely by external factors.
All that has been said here demonstrates not only the challenges before the adoption of the Euro in Bulgaria, but also the importance of implementing the right policies – not just for the sake of fulfilling one requirement or another, but so that our economy becomes more competitive and gradually catches up with richer countries.
This is why one of the conclusions of the ECB’s report is that establishing an environment that favors a steady convergence requires policies aiming at economic stability, as well as wide structural reforms. This statement holds regardless of whether we will adopt the Euro or not.