Unpegging the Lev?

From Bloomberg yesterday:

UniCredit Bulgaria CEO Warns of Any Plan to Unpeg Lev (Update2)

By Elizabeth Konstantinova

Oct. 11 (Bloomberg) -- UniCredit Bulbank Bulgaria Chief Executive Officer Levon Hampartzoumian warned against any proposal to abolish the lev's peg to the euro, saying it would destabilize the economy.

European Central Bank board member Lorenzo Bini Smaghi in a speech on Oct. 1 blamed fixed exchange rates in Bulgaria and the three Baltic states for accelerating inflation and current-account deficits because the currency board systems limit their central bankers' ability to control surging price growth.

``Loosening of the peg would mean there will be a narrow circle of so-called experts, who would be able to play with the printing machine, which is not desirable,'' said Hampartzoumian, whose bank is Bulgaria's largest, in an interview yesterday. ``It may bring some short-term advantages but in the long term will remove the anchor which is keeping the stability of the system.''

A surge in investment, imports and wages after Bulgaria's EU entry on Jan. 1 caused its current-account deficit and credit growth to balloon and its inflation rate to jump to 12 percent, the highest in the 27-nation bloc. The economic imbalances may delay its plans to join the exchange-rate mechanism, a two-year test of currency stability before euro adoption.

Different Systems

Of the 10 eastern EU members, Lithuania, Estonia, Latvia and Bulgaria have currency-board arrangements that fix their currencies to the euro. Hungary's forint has a 15 percent trade band, giving policy makers more flexibility to use interest rates to control inflation, while the rest, including Poland and the Czech Republic, have free-floating currencies.

Latvia's inflation rate was 11.4 percent in September, Estonia's rate was 7.2 percent and Lithuania's rate was 7.1 percent. By contrast, Poland's inflation rate for that month was 1.5 percent and the Czech Republic's was 2.8 percent.

Kalin Hristov, an adviser to the central bank's governor, said there is no talk in the institution to drop the currency board, pointing out that the inflation jump in Bulgaria is only recent.

``Countries with currency boards have had the lowest inflation in the past 10 years, with the exception of the past several months,'' said Kristov.

1997 Crisis

Bulgaria imposed the currency board in 1997 to recover from a financial crisis that closed one-third of the country's banks. The system bans central bank lending and ensures that money in circulation match foreign exchange reserves. Central bank Governor Ivan Iskrov said on Sept. 18 that Bulgaria plans to keep the currency board in place until it adopts the euro.

``Blaming the currency board is passing the buck,'' said Lubomir Christov, the chief executive officer of the Central Depository in Sofia, in an interview today. ``High economic growth is possible only in circumstances of monetary stability. Abolishing the currency board will be a disaster.''

The currency board has helped Bulgaria keep a lid on public spending and meet all euro-adoption requirements except inflation. The seven-month current-account gap accounted for 11.2 percent of gross domestic product and will expand to 20 percent of GDP, according to an International Monetary Fund forecast.

``In terms of predictability and stability of the system the currency peg has much more positive than negative effects,'' Hampartzoumian, 54, said. ``It is an academic discussion whether a country the size of Bulgaria can have an independent policy. It is better to stay pegged.''

Growth Rates

The nation of 7.8 million people, which is the EU's poorest country, needs faster growth than in the 13-nation euro region to catch up with western European living standards. The $31.5 billion economy grew 6.6 percent in the second quarter driven by investment and consumption.

``The current-account deficit is supported by increasing exports and economic growth,'' Hampartzoumian said. ``If we have sustainable growth and a high current-account deficit, it is quite clear that inflation is to be an issue especially in regard to joining the ERM-2 and subsequently adopting the euro.''

On the prospects for when the nation should adopt the euro, Hampartzoumian said that from a business perspective ``the sooner, the better.'' Still, he said, ``there are prerequisites.'' The country extended its euro-adoption target to after 2011 so it can bring wages and labor productivity closer to EU levels. The nation's GDP per capita is now one-third of the EU average.

Bulgaria's economy ``has a lot of room to grow'' as the country needs new roads, seaports and airports and improvements in its communal services infrastructure, Hampartzoumian said.

System Reforms

Reforming Bulgaria's Soviet-style health-care and education systems to meet the demands of a market economy is crucial to sustaining long-term growth, Hampartzoumian said.

``The costs associated with these segments of the economy have to be reduced, and at the same time their efficiency has to increase dramatically,'' he said. ``For many reasons, mostly political, these sectors were not the subject of serious attention by the politicians in the past five or six years and now it's time to rethink the approach and design an implementation plan.''

Commercial banks' lending growth surged to 47 percent in June forcing the central bank to raise minimum reserve requirements from Sept. 1.

``This is a measure that has some effect, but this is not a panacea,'' Hampartzoumian said. ``We will still have double-digit growth in lending in the system as a whole. The extensive opportunities for growth are becoming limited.''