In the past weeks, the convergence reports of the European Commission and the European Central Bank were published. The result for Bulgaria is expected – the inflation rate is higher than the reference value and therefore the country does not meet this Eurozone membership criterion. In practice, this puts an end to the question of whether the country can adopt the euro on 1 January 2025 – no, there is no such possibility.
What is the purpose of these reports? They are analytical documents that assess the degree of economic convergence of countries that are members of the EU but not part of the euro area and the readiness of each country to adopt the euro. At the moment, these are Bulgaria, the Czech Republic, Hungary, Romania, Poland, and Sweden (Denmark has an opt-out clause, but the Danish krone is in EMU2). This is part of the procedure set out in the Treaty on the Functioning of the European Union, which governs how a member state joins the euro area.
Based on the conclusions in the reports, the European Commission makes the relevant proposal to the European Council, which, after consultation with the European Parliament and discussion, decides to introduce the euro in the country concerned.
The reports seek to answer the questions of whether the country’s legislation, including the central bank’s constitutional laws, is compatible with EU law and whether a “high degree of sustainable convergence” has been achieved. It is the latter that is measured by the much-talked-about “numerical criteria”. What the reports tell us in a nutshell:
- Bulgaria meets the other three quantitative criteria for membership, namely: stability of public finances (size of the budget balance and public debt), exchange rate, and long-term interest rate. This currently “closes” the periodic raising of the issue of a possible violation of the criterion for the stability of public finances, in terms of the size of the budget deficit.
- The assessment in both reports is that national legislation can be considered compatible with EU law and that the obstacles discussed in previous convergence reports have been overcome. This is important because this is precisely the direction in which the recent amendments to the BNB Act were made. However, the case created by the amendment of the Constitution and the possibility for the Governor or one of the Deputy Governors to be appointed as a caretaker Prime Minister cannot be underestimated. To avoid a potential impact on the independence of the Central Bank, a possible solution is an amendment of the BNB Act to provide sufficient and effective safeguards for the independence of the BNB in line with EU law requirements.
- As expected, Bulgaria does not meet the price stability criterion. The average annual inflation rate as of May 2024 in Bulgaria is 5.1%, while the reference value of the criterion according to the European Commission report is 4.1% (the average inflation in the Netherlands, Italy, and Latvia, after excluding Denmark, Finland, and Belgium).
- However, there is a clear trend towards convergence of inflation in Bulgaria with the euro area average. If we look at the average annual rate, in Bulgaria it is already 5.1% vs. 3.4% for the euro area, while in March 2023 the value in Bulgaria was 14.1% vs. 8.8% on average for the euro area – the distance is visibly shortened. However, if we look at the monthly values of the annual price change, Bulgaria has practically caught up with the euro area inflation over the last two months – around 2.5-2.6%. In fact, since the beginning of the year – i.e. the month of May on a December 2023 basis – inflation in the euro area has averaged 1.8%, while in Bulgaria it is just 0.6%, three times lower.
- In the 2022 assessment, Bulgaria also exceeded the criterion benchmark by 1 percentage point. A longer look back shows that Bulgaria has met the benchmark on several occasions, once being one of the three countries with the lowest inflation used for its calculation, and another time being excluded because inflation was too low.
In the reports, the more interesting part, and certainly the most important to be read by the politicians who will form the future government, is the discussion on the risks and recommendations for necessary reforms. In practice, this is a kind of “roadmap”, in which the ECB and the EC “guide” the Bulgarian government towards a package of measures to pave the way towards a future “yes” or fulfillment of the criteria, giving in aggregate a positive assessment for achieving sustainable convergence.
Here we see recurring problems and, accordingly, the necessary actions, starting from prudent budgetary policy, structural reforms for more efficient public spending, rule of law and functioning of the judiciary and institutions in general, improving the investment environment, raising productivity through better and more relevant education, etc.
We note here only two important recommendations included in the ECB report, which may be a test of the seriousness of the intentions of a future government in Bulgaria to join the euro area:
- Bulgaria’s sustainable convergence requires stability-oriented economic policies and comprehensive structural reforms. These are crucial to attract foreign direct investment, boost potential growth, and increase productivity. They include Bulgaria’s commitment to further reduce corruption, ensure an independent and effective judiciary, and improve education. Reforms are also needed to strengthen competition in product markets and liberalize regulated sectors.
- Bulgaria should continue to pursue a prudent fiscal policy. In addition, the quality and efficiency of capital spending should be improved through better management of public investment, including through a long-term investment strategy. Further improving tax collection and shrinking the informal sector, bettering the performance of state-owned enterprises, as well as enhancing expenditure efficiency, are essential measures to safeguard medium-term fiscal sustainability.
What is next? If the trends in price dynamics continue, Bulgaria will continue to narrow the inflation gap with the best-performing countries in the EU in the coming months. This is, undoubtedly, in the absence of external economic or geopolitical shocks, as well as prudent domestic policies. If the price stability criterion is met and there is political will, the government can request an extraordinary convergence report – this is part of the envisaged procedure and has already been done in the past – thus allowing for a positive assessment and a recommendation from the EC to decide in early 2025.
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