Every two years two convergence reports which assess the progress of the countries that have committed to the adoption of euro [1] are released – one from the European Central Bank  (ECB) and the other from the European Commission (EC). The presentation of the recently published documents was highly anticipated by Bulgarians, as the Bulgarian government’s intention is to officially sign up for the eurozone waiting room by the end of June.

Many of the reactions in the Bulgarian media regarding the conclusions presented in the reports show some combination of 1) not having read the reports and 2) misunderstanding their content. This is why there headlines such as “EC and the ECB do not want Bulgaria in the eurozone” and “Europe to deny Bulgaria the euro” appear in the press.

Moreover, a huge focus is placed on corruption and poverty, which are in a way “prohibitive factors” for the euro. However, reading the reports as well as putting them in the context of previous reports and the euro adoption process in general paint a very different picture.

Of course, the leading point in the whole discussion is the conclusion in both reports that Bulgaria does not meet the criteria for adopting the euro. This general conclusion is undoubtedly the most unexciting part of the reports, as in the current situation it is absolutely impossible to write anything else. Normally, such an assessment is received by all countries.

The reason is simple – no country meets the exchange rate criterion, i.e. it is not in the so-called euro “waiting room”. In other words, in order to meet all the criteria, you must first spend in the waiting room – the so-called currency mechanism (ERM II) – at least two years before you adopt the euro. Since no country is in the euro waiting room, none of them meet the criteria.

Bulgaria already meets all other criteria – price stability, public finances, and long-term interest rates. This is why Valdis Dombrovskis, the Vice-President of the Commission responsible for the Euro and Social Dialogue, congratulated the Bulgarian authorities on their willingness to join the currency mechanism (i.e. the euro waiting room), as “the criterion for exchange rate stability” will also be met.

In fact, Bulgaria was congratulated for its readiness to take the biggest step towards eurozone membership – the official willingness to enter the euro waiting room.

Bulgaria’s Position

We may compare the individual criteria for Bulgaria in the 2018 reports with the 2016 reports. In this case, we use the ECB’s reports, but the same exercise is applicable to EC reports – the overall scores on the criteria are quite similar.

Let us therefore go through the main paragraphs of the report that cover a wider framework of the criteria themselves.

Price Developments

Bulgaria fulfills this criterion. In March 2018, the 12-month average rate of HICP inflation in Bulgaria was 1.4% – below the 1.9% referred by the price stability criterion. It is also important to assess the long-term development of inflation – on average, over the last 10 years, the inflation rate has changed from “high” (report 2016) to “moderate” (report 2018).

Concerns about Sustainability of Convergence in Inflation

The new report assesses it as a “serious” concern, but otherwise the comments are identical. However, this has been fully anticipated and long-commented as a potential problem that will hold Bulgaria longer in the waiting room.

The reason is that in the process of catching up with the average European income inflation in Bulgaria is very likely to outpace the eurozone. Paradoxically, this is especially true in the good years – when Bulgaria’s growth is faster than the one in the eurozone, prices also go up.

This case, however, will govern the public space when Bulgaria enters the waiting room. Currently, it is not on the agenda.

Macroeconomic Imbalances

Discussed in the light of sustainable convergence, sound economic policy, and broad structural reforms. The big difference here is that in 2016, Bulgaria’s imbalances were evaluated as “excessive imbalances”, whereas now they are only “imbalances”.

Moreover, without having any criteria to fulfill, it is said that structural reforms need to be made, which is absolutely true. Both the old and the new report state that corruption should be significantly reduced and an independent judiciary system introduced. This recommendation keeps the pressure on national and local politicians to reduce corruption.

Financial Sector

The 2016 report refers to the CCB (Corporate Commercial Bank) bankruptcy, the inefficient supervision, and institutional problems. The new report features the asset quality review and the stress test. The results show a recovery of the banking system from the 2014 crisis as well as adequate capitalization and liquidity of the banking system.

Nevertheless, credit risk issues and the need to improve supervision of the banking and non-banking sectors are  mentioned.

Public Finance

Bulgaria continues to meet the debt and deficit criteria.

In the reference year 2017, the budget of the sector “General Government” reported a surplus of 0.9% of GDP, easily achieving the 3% deficit reference value.

The 2016 report noted that Bulgaria had a budget deficit, whereas the new one reports a surplus.

Debt is also slightly shrinking and it is expected that it will further decline.

Both reports note that Bulgaria does not have an excessive deficit procedure. In the 2016 report there is a “risk of some deviation from the Stability and Growth Pact’s preventive arm requirements”, whereas in the 2018 report mentions “compliance with the Stability and Growth Pact’s preventive arm requirements”.

Fiscal Sustainability

This area observed an important change.

In the 2016 report there are “medium risks to fiscal sustainability” in the long-run, while in 2018 there is a “low risks to fiscal sustainability” over the medium and long-run”. This shows a much more positive assessment not only for the current state of public finances, but also for their long-term state.

However, both reports state that despite the low debt a prudent fiscal policy should be maintained.

Exchange Rate Dynamics

The exchange rate in Bulgaria is fixed to the euro, so by definition here the criteria are satisfied. However, Bulgaria has not yet entered the eurozone waiting room, as mentioned above. 

The Dynamics of the Long-Run Interest Rate

Bulgaria meets this criterion in both reports.

During the last reference period from April 2017 to March 2018, long-term interest rates in Bulgaria were on average 1.4%, remaining below the 3.2% reference value under the benchmark set by the convergence criterion.

The 2018 report notes that the long-term interest rate differential (on Bulgarian government bonds) compared to the euro area average has diminished.

National Legislation

The assessment in both reports is that the legislation in Bulgaria is not in full compliance with the requirements for the euro area. In fact, “There have been no major changes in the issues mentioned in the June 2016 Convergence Report by the ECB, and therefore the comments are repeated in this year’s assessment”, to quote the recent report.

Although the overall assessment of the legislation is rather negative, it focuses on the details that will be cleared out once the euro is adopted. For example, domestic legislation does not stipulate the ECB’s powers with regard to the management of official foreign reserves. At this point, it is normal that there is no such power, it will be settled once Bulgaria enter the eurozone.

Conclusions

The general assessment shows that this is one of the most positive reports on the convergence Bulgaria has received. Despite all the critical remarks, which are fully justified, the focus falls on the formal criteria for the Eurozone membership.

Bulgaria meets them and this is clearly noted. Yet, Bulgaria still has not entered the waiting room. As the Bulgarian government has recently declared, the country is to apply for this status in the forthcoming weeks.

The fact is that the publication of the ECB and EC reports revealed the emergence of a new eurozone membership criterion, which is obviously also required for entering the waiting room. However, it is not related to the income level and corruption, which are considered to be the challenges to the convergence and the business environment but are not treated as obstacles to entering the waiting room.

The new criterion, unrecorded, but clearly intended by Mr Valdis Dombrovskis, is membership in the banking union. Obviously, as it has been clear over the past few weeks, this is the main focus of the negotiations. The question is not, however, whether to enter the banking union, but rather when and how to do it.

At the moment, watching the development of the arguments on the subject, it appears that there are no insurmountable barriers between the Bulgarian and the European positions. The stakes to enter the waiting room seems to be larger than the gap between the two sides, so this issue will rather be agreed upon by both parties.

[1] These countries currently include Bulgaria, the Czech Republic, Croatia, Hungary, Poland, Romania, and Sweden.