Monetary Policy in Transition The Case of Bulgaria

Document Sample
Monetary Policy in Transition The Case of Bulgaria Powered By Docstoc
					                                    Bulgaria
                                    (Prepared by Anton Nakov)



1.1   Monetary Policy in Bulgaria

Within the group of emerging-market economies covered by this study, a salient feature of the
Bulgarian experience during the transition period is a currency board arrangement, effective since
mid-1997. By that arrangement, the central bank relinquishes its power to conduct independent
monetary policy, and instead commits to a rule of maintaining full convertibility between local
currency and reserve currency at a fixed exchange rate. In this sense, the Bulgarian transition
experience consists of two distinct episodes: prior to the introduction of the currency board, and under
the currency board arrangement.


During the first period, from the beginning of transition until mid-1997, the goal of monetary policy
was to maintain the external (exchange rate) and internal (price) stability of the national currency,
with a bias towards maintaining the exchange rate since 1992. To that end, the Bulgarian central bank
used a variety of instruments, ranging from the more conventional ones such as the base interest rate
and open market operations to less usual ones such as credit ceilings, and, in some cases, even the
closing of commercial banks. Policies, however, was subject to numerous and severe constraints,
including a low level of foreign reserves, substantial output loss, high firm indebtedness (resulting in
part from soft budget constraints on state-owned enterprises) and a high level of non-performing loans
in banks’ portfolios. An additional burden was an unsustainable fiscal position accompanied by
persistently high budget deficits (see figures 1 - 3). Moreover, as a consequence of the partial default
on the foreign debt in 1990, the country effectively had no access to the international financial
markets.


In this environment, monetary policy was subordinated to government priorities and covered fiscal
and financial losses (directly or indirectly) by printing money (figures 4 and 5). Commercial banks
were systematically refinanced, both in local and foreign currency, to avoid a banking system
collapse. The instruments of monetary policy most actively used in this period included the base
interest rate (figures 6 and 7), required reserves (table 1), and, since 1993, open market operations,
including repurchase agreements and reverse sales agreements, as well as bank refinancing. In 1995 –
1996, more than 90% of all refinancing that took place was unsecured.
The macroeconomy during this first period was marked by rapid depreciation of the national currency
(figures 8 and 9) with quick pass through to inflation (figures 10 and 11). Nominal interest rates
remained high throughout the period (figure 12), but real interest rates were negative most of the time.
Raising the base interest rate proved ineffective to stop the exchange rate depreciation and curb
inflation.


Under these hyperinflationary circumstances, and after a political crisis, the newly elected
government used its mandate for reform to introduce a currency board starting in mid-1997. The idea
was to use the straightjacket of the currency board in order to provide a nominal anchor for inflation
expectations. It should be noted that the currency board arrangement is a stronger commitment than a
conventional fixed exchange rate regime, thus enhancing credibility. At the same time, the currency
board was deemed as an instrument for forcing a tighter fiscal discipline upon the government.


Some of the main characteristics of the currency board arrangement in Bulgaria include the following:
   The exchange rate of the domestic currency is fixed to the Euro (to DEM prior to 1999)
   The monetary liabilities of the central bank are fully backed by highly liquid foreign exchange
    reserves
   BNB is committed to exchange unlimited amounts of national currency against reserve currency
    at the fixed exchange rate
   Law on BNB prohibits financing to the government in any form
   Law on BNB prohibits the refinancing of commercial banks except in the case of systemic crisis
    and against first rate collateral


At the same time the currency board in Bulgaria displays some peculiarities:
   Monetary liabilities include government accounts with the central bank
   Banks are obliged to maintain minimum reserve requirements with the central bank (since the
    introduction of the currency board reserve requirements have not been used as monetary policy
    instrument)
   The lender of last resort function is retained in a form not violating the currency board principles,
    meaning that insolvent bank are closed
   BNB may extend loans to commercial banks only in the case of liquidity risk which may affect
    the stability of the whole banking system
   Loans to commercial banks may be extended only up to the excess of the foreign exchange
    reserves over the total amount of monetary liabilities
Not surprisingly, soon after the introduction of the currency board arrangement, and following the
drastic reduction in money growth (figures 13 and 14), nominal interest rates and inflation fell to
single digit levels1 (figures 15 and 16). Since then, domestic interest rates have been on a path of
converge to interest rates in the Euro zone, and the low inflation environment, coupled with the much
needed structural reforms which were finally launched during this period, fostered sustainable
economic growth (figures 18 and 19). However, it should be noted that since the introduction of the
currency board, the central bank has lost control of its primary instrument for affecting output and
prices, and banking supervision has become the main function of BNB. Table 2 outlines the key dates
in the transition history of the Bulgarian National Bank.

1.2       Research Activity at the Bulgarian National Bank

In 1998 a dedicated Research Division was established in the Bulgarian National Bank, with 9 people
devoted exclusively to research activity. Over the period 1998-2004, the research staff has produced
some 40 discussion papers, which are available on the Internet in both English and Bulgarian. Some
of these papers are joint work with visiting scholars under the newly started Visiting Researcher
Program. The program aims at attracting experts in the area of finance, economics and econometrics,
to do research on topics of interest for the Bank. Most of the papers address topics, which are closely
related to the particular Bulgarian economic and financial environment, many of them dealing with
different aspects of the currency board, credit rationing, forecasting models etc.


Apart from the discussion papers, the bank makes periodical publications, such as a monthly bulletin,
a quarterly issue on the government securities market, a quarterly bulletin on commercial banks, a
semi-annual and an annual report.


While at present the possible impact of research on monetary policy in Bulgaria is small, for the
simple reason that the central bank follows an automatic rule, this link is expected to strengthen in the
near future as Bulgaria switches to the ERM II regime as part of its transition to the EMU. Under that
regime, the exchange rate peg will be abandoned in order for markets to determine the equilibrium
exchange rate of the Bulgarian Lev vis-à-vis the Euro. During that period until joining the EMU, the
central bank will have as its main objective maintaining the exchange rate within a certain (relatively
wide) band, leaving some scope for independent monetary policy.




                                                                  Figure 1



1     The temporary peaks in inflation during this period correspond largely to changes in administered prices and excise taxes, as well as oil
      prices.
              Change in claims on government and credit to the non-government sector Jan. 1991 - June 1996 (in
                                                         percent)
 250


 200


 150


 100


  50


   0


 -50                     Claims on the non-government sector                      Claims on government


-100
 Ju 992




 Ju 993




 Ju 994




 Ju 995




           6
  ay 2




 Ja 992



  ay 3




 Ja 993



  ay 4




 Ja 994



  ay 5




 Ja 995



  ay 6
  ar 2




  ov 2


  ar 3




  ov 3


  ar 4




  ov 4


  ar 5




  ov 5


  ar 6
  pt 2




  pt 3




  pt 4




  pt 5




        99
M 199




M 199




M 199




M 199




M 199
M 199




N 199


M 199




N 199


M 199




N 199


M 199




N 199


M 199
Se 199




Se 99




Se 99




Se 199
     -1




     -1




     -1




     -1




     -1
     -1




     -1




     -1




     -1
    l-1




    l-1
     -




     -




     -




     -




     -
     -




     -




     -




     -
   n-




   n-




   n-




   n-




   n-
    l-




    l-
 Ja




                                                              Figure 2
              Change in claims on government and credit to the non-government sector July 1996- June 1997 (in percent)

1000

900

800

700

600

500

400

300

200

100
                                Claims on the non-government sector                               Claims on government
  0
                                                                                                                  97
                     6




                                                                 6
                                         6




                                                                                                       7
                                                      6




                                                                                             7
                                6




                                                                                  97
                                                                         97




                                                                                                                           97
          6


                     9




                                                              99
                                         99




                                                                                                     99
                                                   99




                                                                                           99
                             99
       99




                                                                                                               19
                  19




                                                                                  19
                                                                       19




                                                                                                                         19
                                                            -1
                                       -1




                                                                                                    -1
                                                 -1




                                                                                           -1
                           -1
   l-1




                                                                                                              -
                 -




                                                                                b-
                                                                       n-




                                                                                                                         n-
                                                                                                           ay
                                                          ec
              ug




                                     ct




                                                                                                 pr
                           pt




                                               ov




                                                                                        ar
  Ju




                                                                              Fe
                                                                     Ja




                                                                                                                       Ju
                                    O
                         Se




                                                                                       M



                                                                                                 A
                                                          D




                                                                                                           M
              A




                                               N




                                                              Figure 3
                                              Budget deficit (-)/surplus (+)
                                                  (percent of GDP)
   2

   0

  -2

  -4

  -6

  -8

-10

-12
         1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
                          percent                                                                                percent                                                                                                                          percent
03
                                                                                                                                                                                                                                                                             100
                                                                                                                                                                                                                                                                                                     120




                                                                                                                                                                                                                                    0
                                                                                                                                                                                                                                        20
                                                                                                                                                                                                                                             40
                                                                                                                                                                                                                                                   60
                                                                                                                                                                                                                                                            80
  /1
     9




                                                                                               100
                                                                                                     200
                                                                                                           300
                                                                                                                   400
                                                                                                                           500
                                                                                                                                 600
                                                                                                                                                       700
                                                                                                                                                                    800




                                                                                           0




                20
                     40
                            60
                                    80
                                         100
                                               120




            0
06 92                                                                                                                                                                                                                     01/1992
  /1
     9
09 92                                                                                07/1996                                                                                                                              04/1992
  /1
     99
12 2
  /1
                                                                                                                                                                                                                          07/1992
     9                                                                               08/1996
03 92                                                                                                                                                                                                                     10/1992
  /1
     9
06 93                                                                                09/1996                                                                                                                              01/1993
  /1
     9
09 93                                                                                                                                                                                                                     04/1993
  /1                                                                                 10/1996
     99
                                                                                                                                                                                                                          07/1993
                                                                                                                                                                                                                                                                 M3 growth




12 3




                                                                                                                                 M3 growth
  /1
     9                                                                                                                                                                                                                    10/1993
03 93                                                                                11/1996
  /1
     9                                                                                                                                                                                                                    01/1994
06 94
  /1                                                                                 12/1996
                                                                                                                                                                                                                                                                              Reserve money growth




     9




                                                                                                                                             Reserve money growth
09 94                                                                                                                                                                                                                     04/1994




                                                                          Figure 6
                                                                                                                                                                                                               Figure 5
                                                                                                                                                                                                                                                                                                                                            Figure 4




  /1
     99                                                                              01/1997                                                                                                                              07/1994




                                                     (1992 - mid 1996)
                                                     Base interest rate
12 4
  /1
     9                                                                                                                                                                                                                    10/1994
03 94                                                                                02/1997
  /1
     9                                                                                                                                                                                                                    01/1995
06 95
                                                                                                                                                                          Reserve money and M3 annual growth
                                                                                                                                                                                                                                                                                                       Reserve money and M3 annual growth




  /1
     9                                                                               03/1997                                                                                                                              04/1995
09 95
  /1                                                                                                                                                                                                                      07/1995
     99
12 5
  /1                                                                                 04/1997
     9                                                                                                                                                                                                                    10/1995
03 95
  /1                                                                                                                                                                                                                      01/1996
     9                                                                               05/1997
06 96
  /1                                                                                                                                                                                                                      04/1996
     99
        6                                                                            06/1997
                                                                                                                            percent                                                                                       percent
                             percent
                                                                                             03




                                                                                                                                                                                                               50
                                                                                                                                                                                                                    100
                                                                                                                                                                                                                            150
                                                                                                                                                                                                                                    200
                                                                                                                                                                                                                                          250
                                                                                                                                                                                                                                                    300




                                                                                                                                                                                                           0
                                                                                               /1                                                                                              07
                                                                                                                                                                                                 /1




                                                                                                         0
                                                                                                             20
                                                                                                                  40
                                                                                                                       60
                                                                                                                              80
                                                                                                                                      100
                                                                                                                                            120
                                                                                                                                                  140
                                                                                                                                                        160




                      1000
                               1500
                                       2000
                                              2500
                                                     3000




            0
                500
07                                                                                                99
  /1
     99                                                                                              2                                                                                              99
                                                                                                                                                                                                       6
                                                                                             07
        6                                                                                      /1                                                                                              08
08                                                                                                99                                                                                             /1
  /1                                                                                                 2                                                                                              99
     99                                                                                      11                                                                                                        6
        6                                                                                      /1                                                                                              09
09                                                                                                99                                                                                             /1
  /1                                                                                                 2                                                                                              99
     99                                                                                      03
                                                                                               /1                                                                                                      6
        6                                                                                         99                                                                                           10
10                                                                                                   3                                                                                           /1
  /1                                                                                         07                                                                                                     99
     99
        6                                                                                      /1                                                                                                      6
                                                                                                  99
11                                                                                                   3                                                                                         11
                                                                                                                                                                                                 /1
  /1                                                                                         11                                                                                                     99
     99                                                                                        /1                                                                                                      6
        6                                                                                         99
12                                                                                                   3                                                                                         12
  /1                                                                                         03                                                                                                  /1
     99                                                                                        /1                                                                                                   99
        6                                                                                         99                                                                                                   6
01                                                                                                   4                                                                                         01
                                                                                             07                                                                                                  /1




                                                                                  Figure 9
                                                                                                                                                                                    Figure 8
                                                                                                                                                                                                                                                                        Figure 7




  /1                                                                                           /1                                                                                                   99
     99                                                                                           99                                                                                                   7
        7                                                                                            4
02                                                                                           11                                                                                                02
                                                                                                                                                                                                                                                  Base interest rate




  /1                                                                                           /1                                                                                                /1
                                                                                                                                                                                                                                                (mid 1996 - mid 1997)




                                                                                                                                                                                                    99

                                                                                                                                                            (1992 - mid 1996)
     99                                                                                           99
                                                                                                                                                                                                       7




                                                        (mid 1996 - mid 1997)
        7                                                                                            4
03                                                                                           03                                                                                                03




                                                      Exchange rate against USD
  /1                                                                                           /1                                                                                                /1
                                                                                                                                                        Exchange rate against USD
     99                                                                                           99                                                                                                99
        7                                                                                            5                                                                                                 7
04                                                                                           07                                                                                                04
  /1                                                                                           /1                                                                                                /1
     99                                                                                           99
        7                                                                                            5                                                                                              99
                                                                                                                                                                                                       7
                                                                                             11
05                                                                                             /1                                                                                              05
  /1                                                                                              99                                                                                             /1
     99                                                                                              5                                                                                              99
        7                                                                                    03                                                                                                        7
06                                                                                             /1                                                                                              06
  /1                                                                                              99
     99                                                                                              6                                                                                           /1
        7                                                                                                                                                                                           99
                                                                                                                                                                                                       7
                                                                                                                                                                                         percent




            0
                50
                     100
                                                                                   150
                                                                                                                              200
                                                                                                                                    250
                                                                                                                                          300
                                                                                                                                                350
                                                                                                                                                                                                                                                                   percent
Jan -1992


Apr-1992




                                                                                                                                                                                  1000
                                                                                                                                                                                            1500
                                                                                                                                                                                                   2000
                                                                                                                                                                                                          2500




                                                                                                                                                                            500


                                                                                                                                                                        0
                                                                                                                                                                                                                                                       100
                                                                                                                                                                                                                                                             200
                                                                                                                                                                                                                                                                     300
                                                                                                                                                                                                                                                                             400
                                                                                                                                                                                                                                                                                   500
                                                                                                                                                                                                                                                                                         600




                                                                                                                                                                                                                                                   0
 Jul-1992                                                                                                                                                                                                                                    06/1991
                                                                                                                                                                  07/1996
Oct-1992
                                                                                                                                                                                                                                             10/1991
Jan -1993                                                                                                                                                         08/1996
                                                                                                                                                                                                                                             02/1992
Apr-1993




                                                                                                     BNB base interest rate
 Jul-1993
                                                                                                                                                                  09/1996                                                                    06/1992

Oct-1993                                                                                                                                                                                                                                     10/1992




                           Interest rate on 1-month deposits
                                                               Interest rate on short-term credits
                                                                                                                                                                  10/1996
Jan -1994
                                                                                                                                                                                                                                             02/1993
Apr-1994                                                                                                                                                          11/1996
                                                                                                                                                                                                                                             06/1993
 Jul-1994
                                                                                                                                                                  12/1996                                                                    10/1993
Oct-1994




                                                                                                                                                      Figure 12
                                                                                                                                                                                                                                 Figure 11
                                                                                                                                                                                                                                                                                                               Figure 10




                                                                                                                                                                                                                 CPI Inflation
                                                                                                                                                                                                                                                                                               CPI Inflation




Jan -1995
                                                                                                                                                                  01/1997                                                                    02/1994
Apr-1995
                                                                                                                                                                                                                                             06/1994
 Jul-1995
                                                                                                                                                                  02/1997
                                                                                                                                                                                                                                             10/1994
Oct-1995
                                                                                                                                                                  03/1997                                                                    02/1995
Jan -1996


Apr-1996                                                                                                                                                          04/1997                                                                    06/1995
 Jul-1996                                                                                                                                                                                                                                    10/1995
                                                                                                                                                                  05/1997
Oct-1996
                                                                                                                                                                                                                                             02/1996
Jan -1997
                                                                                                                                                                  06/1997
                                                                                                                                                                                                                                             06/1996
Apr-1997
                      percent                                                                                                  percent
                                                                                                                                                                                                                         percent




      0
          1
              2
                  3
                      4
                          5
                                6
                                    7
                                        8
                                                          9
07/1997




                                                                                                                                                                                                           190
                                                                                                                                                                                                                 290
                                                                                                                                                                                                                       390
                                                                                                                                                                                                                             490
                                                                                                                                                                                                                                   590
                                                                                                                                                                                                                                         690
                                                                                                                                                                                                                                               790
                                                                                                                                                                                                                                                     890
                                                                                                                                                                                                                                                           990




                                                                                                                                                                                                -10
                                                                                                                                                                                                      90
                                                                                                   07
                                                                                                     /1
                                                                                                                                                                                          07/1997




                                                                                                                   100
                                                                                                                         200
                                                                                                                                 300
                                                                                                                                         400
                                                                                                                                               500
                                                                                                                                                     600




                                                                                                               0
                                                                                                        99
12/1997                                                                                            12 7
                                                                                                     /1
                                                                                                        9
                                                                                                   05 97                                                                                  01/1998
05/1998                                                                                              /1
                                                                                                        9
10/1998
                                                                                                   10 98
                                                                                                     /1                                                                                   07/1998
                                                                                                        99
                                                                                                   03 8
03/1999                                                                                              /1                                                                                   01/1999
                                                                                                        9
                                                                                                   08 99
08/1999                                                                                              /1
                                                                                                        99                                                                                07/1999
                                                                                                   01 9
01/2000                                                                                              /2
                                                                                                        0                                                                                 01/2000
                                                                                                   06 00
06/2000                                                                                              /2
                                                                                                        0
                                                                                                   11 00                                                                                  07/2000
                                                                                                     /2
11/2000                                                                                                 00
                                                                                                   04 0                                                                                   01/2001
                                                                                                     /2




                                                                                       Figure 15
                                                                                                                                                                              Figure 14
                                                                                                                                                                                                                                                                                               Figure 13




04/2001                                                                                                 0
                                                                                                   09 01
                                                                                                     /2
                                                                                                                                                           M3 annual growth
                                                                                                                                                                                          07/2001




                                                     Benchmark interest rate
09/2001                                                                                                 00
                                                                                                   02 1
                                                                                                                                                                                                                                                                 Reserve money annual growth




                                                                                                     /2
02/2002                                                                                                 0                                                                                 01/2002
                                                                                                   07 02




                                            (yield on 3 month government securities)
                                                                                                     /2
                                                                                                        0
07/2002                                                                                            12 02                                                                                  07/2002
                                                                                                     /2
                                                                                                        00
12/2002                                                                                            05 2                                                                                   01/2003
                                                                                                     /2
                                                                                                        0
05/2003                                                                                            10 03
                                                                                                     /2                                                                                   07/2003
                                                                                                        00
10/2003                                                                                            03 3
                                                                                                     /2                                                                                   01/2004
                                                                                                        00
03/2004                                                                                                    4
                                                                                          Figure 16
                                                                                          CPI Inflation

          14
          12
          10
           8
percent



           6
           4
           2
           0
          -2
          -4
                 07/1998

                            11/1998
                                      03/1999

                                                 07/1999
                                                            11/1999

                                                                      03/2000
                                                                                07/2000
                                                                                           11/2000

                                                                                                     03/2001

                                                                                                               07/2001
                                                                                                                          11/2001

                                                                                                                                    03/2002
                                                                                                                                              07/2002
                                                                                                                                                         11/2002

                                                                                                                                                                   03/2003

                                                                                                                                                                             07/2003
                                                                                                                                                                                         11/2003

                                                                                                                                                                                                   03/2004
                                                                                          Figure 17
                                                                                  Credit to GDP Ratio

90



80



70



60



50



40



30



20



10



   0
          1991             1992           1993             1994          1995             1996          1997             1998         1999              2000         2001              2002          2003




                                                                                          Figure 18
                                                 Changes in Gross Fixed Capital Formation and GDP Growth

40


30


20

                 Gross Fixed Capital                       GDP
10               Formation


    0


-10


-20


-30
          1991             1992            1993            1994           1995            1996          1997             1998          1999             2000         2001              2002          2003
                             Table 1. Changes in Required Reserves
                                1991     7%
                                1994     8%, 9%, 10%
                                1995     11%, 12%
                                1996     9.5%, 8.5%, 10%, 11%


                   Table 2. Key Dates in the Transition Experience of BNB
 1991          Two-tired banking system was introduced. Enacted Law on BNB, giving BNB the
               status of a modern central bank with a considerable level of autonomy
 1992          Law on Banks and Credit Activity was enacted
 1996-1997     Financial crisis. Fourteen banks closed. Hyperinflation during three months
 June 1997     Law on the Bulgarian National Bank (presently in force) was enacted. Currency
               board introduced.
 July 1997     Law on Banks (presently in force) was enacted.



References


Nenova M. 2004. “Monetary Policy in Transition: The Case of Bulgaria”, presentation at the CPS
  Workshop, June, Budapest

				
DOCUMENT INFO
Shared By:
Categories:
Tags:
Stats:
views:5
posted:9/11/2012
language:Unknown
pages:10