THEN € NOW

"The Bulgarian economy is stable." The words former Finance Minister Plamen Oresharski uttered in October 2008 seem more than just a little out of place a year later. The economic crisis is in full swing and, according to the most optimistic forecasts, will reach its peak from October to December 2009. As a result of the generous spending indulged in from the valuable budget surplus that Bulgaria accumulated over the years when foreign investment flowed in, the picture is far from rosy. The IMF predicts a dramatic 7 percent drop in the country's GDP – compared to a 6 percent increase in 2008.

Against this catastrophic background, Simeon Djankov, even before he became finance minister in the Citizens for European Development of Bulgaria, or GERB, government, announced out of the blue: "In November Bulgaria will be ready to enter the ERM II." Prior to getting involved with Boyko Borisov's party, the 38-year-old was chief economist of the finance and private sector of the World Bank.

ERM II is not just one of those acronyms that bureaucratic Brussels loves so much. The European Exchange Rate Mechanism guarantees the smooth transition from the local to the common EU currency, a task that is best described by its informal name: the waiting room for euro adoption. Each country that wants to introduce the currency – and does not have the audacity of Montenegro and Kosovo to take this decision unilaterally – must have been in the ERM II for at least two consecutive years. During this time they have to meet five criteria. The inflation rate must not be more than 1.5 percentage points higher than the average of the three member states with the lowest inflation. The ratio of the annual government deficit to GDP must not exceed 3 percent. The ratio of gross government debt to GDP must not be over 60 percent. The nominal long-term interest rate must not be more than two percentage points higher than that of the three best performing member states. The exchange rate of the local currency to the euro must be stable.

Oresharski never supported the adoption of the euro. When Bulgaria acceded to the EU in 2007, he stated that the adoption of the common EU currency was not a priority. The country was supposed to enter the euro area in 2012 and the waiting room in 2010. In April 2009 Oresharski confirmed his opinion. The issue of entering the ERM II and adopting the euro is not a current priority under the existing economic circumstances, he told the IMF.

If Bulgaria did not dare to knock on the euro door in 2007–2008, when its economic growth bubble was soaring, how will it do it now? Djankov's promise may be interpreted as an internal publicity stunt rather than a serious assertion of a change in policy. But it would be wrong to view it from this perspective alone.

"What Djankov has formulated as a political intention is a view widely held by the expert community," comments Roumen Avramov, a programme director and economic researcher in the Centre for Liberal Strategies, and author of the recent summary report "Economic and Political Challenges of Acceding to the Euro Area in the Post-Lehman Brothers' World" written for the Open Society Institute, or OSI, a liberal think tank.

"Djankov shows that the new government will implement a strict pro-European policy. Economically, entering the ERM II will be a strong sign for the markets that Bulgaria is stable and has the support of the ECB and the EU," says Georgi Angelov, senior economist with the OSI.

Bulgaria operates under a currency board arrangement, introduced in 1997 due to the economic crisis and hyperinflation caused by the previous Socialist government. The Bulgarian lev was first pegged to the German mark, and after 2000 to the euro. The country's fiscal affairs have been governed by the IMF. So what is the difference between the board and the ERM II?

The IMF is a life-saving remedy in an emergency. It shows that the country can't manage by itself. The ERM II is a positive strategy. It shows that the country is stable, even in times of difficulty – and this will help it get outside support," Angelov says. Avramov agrees: "There are no minuses from entering the ERM II for economies with monetary councils, such as Bulgaria. The country has been living under conditions that are even stricter than those of the ERM II for 12 years." The Baltic countries are in a similar position. Lithuania, Latvia and Estonia have monetary authorities, but unlike Bulgaria, they are already in the waiting room. All these countries have agreed to guarantee their stability by keeping the currency board until the moment they enter the euro area.

Post 2007: the same statue propagates the virtues of the euro

Why isn't Bulgaria in the waiting room then?

"The country could have entered the ERM II and the euro area during its economic good times but it missed out. Now it will have to pay for this mistake, like the other countries in the region," Angelov says. "There was a time when all member states had approved the accession of the country to the ERM II. Only the ECB was to give its consent. At that point, the government got scared of the ECB and withdrew its attempt to enter the waiting room."

Avramov is even more categorical: "From a purely economic point of view, Bulgaria was completely ready for the ERM II as early as 1 January 2007." Back then, it met four out of the five euro convergence criteria. The only one it did not meet was the inflation rate.

However, Bulgaria did not follow in the footsteps of Slovenia, which joined the EU and the ERM II in 2004 and adopted the euro in 2007. Slovakia also entered the euro area in 2009 and is now reaping the rewards of its efforts. "Its interest rate is lower than in the countries outside the euro area and nobody thinks that it will have to sign an agreement for funding with the IMF, something that the rest could have to do," Angelov says.

Bulgaria had bargaining chips which, if used sensibly, would have got it into the ERM II two years ago. "Bulgaria was one of the first member states to ratify the Lisbon Treaty. This should not have happened before entering the waiting room," Angelov thinks. "The government could have defended the view that the country must obtain its ERM II membership first and sign the treaty only afterwards."

They missed their chance. "For the first two and a half years of its EU membership Bulgaria did not manage to convince the other member states and the ECB that it was ready to enter the ERM II. To some extent, this was due to a lack of effort. Then came the world financial crunch and the severe criticism over the absorption of EU funds, the judicial system and crime. It is hard to expect a benevolent attitude to a country that the EU does not trust and has suspended its EU funding for corruption," Angelov says.

"There are not strict criteria to enter the ERM II – and this gives diplomacy room for action and allows for purely political considerations and ambiguous interpretations," Avramov comments. "The ECB has the final say at the 'entrance' to the ERM II, but has no veto right at the 'exit.' Bulgaria allowed itself to be drawn into this game with indistinct rules, where its small chances were gambled away by a weak, faceless government."

How can GERB's government change things? "Not only should the new government have a good macroeconomic policy, but it should also win the trust of EU institutions. They have to see tangible progress regarding the absorption of EU funds, the judicial system, corruption and organised crime," Angelov says. "Paradoxically, the role of non-economic factors will be nearly as important for Bulgaria's entry into the ERM II as economic policy."

"Unfortunately, a bad reputation is hard to lose," Avramov says. "If the government does not take advantage of its potential, we'll quickly find ourselves back at square one."

Bulgaria is not the only new EU member state seeking a safe harbour from economic instability in the euro area. Avramov's report shows that this is a common trend for the countries of the former Eastern bloc. Only two of them have adopted the euro: Slovakia and Slovenia. The Baltic states are in the ERM II while Bulgaria, Poland, Hungary, the Czech Republic and Romania have delayed their accession.

All of them, apart from Bulgaria, wanted to take maximum advantage of the floating exchange rate of their national currencies to the euro to achieve their main aim: attracting foreign investment.

But when the crisis struck, as the report points out, investment stopped and the countries experienced a severe shock. The euro area suddenly became attractive. Poland is a typical case. Until 2008 the country did not show any serious signs of intending to give up the zloty. However, the crisis made it set itself the overambitious task of introducing the euro in 2011. Later, the date was put off until 2012, as Avramov relates in his report. At the beginning of 2009, the countries in this group focused on the adoption of the euro in 2012–2014.

They have to "hurry slowly" on the road to this goal. The EU will be the last institution to allow a precipitate enlargement of the euro area. The union has powerful bargaining chips, such as the funds.

It may be that the rock of EU bureaucracy will turn out to be stronger than the economic storm, but Avramov does not agree with such simplifications. "This is not a matter of bureaucracy. The EU is a conservative institutional union, but its boldest creation is the euro and it is particularly jealous of it. At present, the situation is schizophrenic. The crisis has made the euro attractive but at the same time driven it further away from those that are not using it.

On the one hand, economic logic recommends a faster homogenisation of the EU. On the other, rules should not be disregarded even in the most revolutionary situation. The principles of equal treatment of the countries in the euro area and those outside it are not empty rhetoric. The fear of the negative repercussions that the accession of unprepared economies would have on the euro is not entirely groundless."

The forecast is not optimistic: "In the near future, the chances of relaxing or changing the mechanisms for entering the euro area are zero," Avramov says. The applicant countries have to assess their decision carefully. "The countries with a floating exchange rate doubt whether they will be able to keep their currency within the permitted fluctuation band. In this respect, risks have increased dramatically over the past few months," Avramov says. The crisis has also affected the way that countries meet the euro convergence criteria.

"To some extent, it is easier to reach the required inflation rate, but most countries have moved away from the budget deficit and long-term interest rate standards," Avramov says.

As things are, Djankov won't have an easy task. The new government has to avail itself of the small advantage it has: the very fact that it is new and has nothing to do with Stanishev's hesitant cabinet.

"November could even be regarded as too late to enter the ERM II. They can do what is necessary to achieve this as early as September. In August, there is nobody in Brussels anyway," Avramov says.