It is deeply frustrating to see the dire, very risky and potentially disastrous measures that are being taken to revive lending and restore confidence in Bulgaria’s economy. Yes, things do not look good.
Simeon Djankov, the ex-top World Bank economist, now finance minister told FT yesterday that they (because it’s not only his call here) have indeed decided on the unpopular measure of
allocating € 511m of the fiscal reserve (12%) for short-term deposits
at Bulgaria’s commercial banks. At least only at the foreign owned ones which to my knowledge hold more than 80% of the market share.
Now why is this so problematic? Virtually everyone else seems to have loose monetary policy today. However, this is an attempt at loosening monetary policy where monetary policy is by definition and by law extremely limited. The purpose of a currency board arrangement (CBA), especially in Bulgaria’s case, is clearly to prevent such
discretionary central banking practices
that affect domestic lending. Not only would that distort equilibrium in the banking sector, but it would also negatively impact the credibility of the currency board. The currency board is only as good as its credibility. Yes, it may successfully be argued that in the current crisis, economically this monetary loosening measure makes sense. And true, Bulgaria’s new government has done some drastic fiscal cuts in a frantic mid-year budgetary rescue mission. These cuts could have been better executed (more targeted) but have nonetheless helped restore some kind of confidence in the country, as reflected in the significantly tightened CDS-spreads. In sum it’s a very risky undertaking and I surely hope that Djankov manages to execute it properly.
But still, I think that the symbolic value of 1 bn BGN is only a trial version of what could potentially bubble up to something much bigger that would, and most probably will, result in a
controlled currency devaluation
if the crisis continues to persist in 2010. This is exactly the Plan-B strategy that Djankov has in mind. My bet goes for a 20% devaluation in late spring of 2010, i.e.
2,34 BGN for 1 EUR.
I expect many CEE/SEE analysts to start coming up with similar expectations and guesstimates so let us follow the newsflow closely and keep our deposit cash away from Buglarian banks in the meantime.
If anyone is interested as to why and how fiscal reserve operations do damage to the currency board I remember coming across a 2003 article by Prof Steve Hanke (one of the initial authors of Bulgaria’s currency board arrangement) that explains just that.
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