Anne-Marie Gulde  Courtesy IMF

Bulgaria’s latest stabilization program, which included the introduction of a currency board, marked the end of a period of economic turmoil and near-hyperinflation. What accounts for its success?

After several failed stabilization attempts, Bulgaria introduced a currency board on July 1, 1997. Controversial and difficult to implement because of Bulgaria’s serious structural problems, the currency board has been a crucial factor in the success of the country’s latest stabilization program. Combining a traditional, rule-based exchange arrange-ment with legal and structural measures that addressed pressing banking sector and fiscal issues, it was well designed for the task at hand—credible but flexible enough to allow Bulgaria to tackle a systemic banking crisis.

Initial conditions

In late 1996, Bulgaria was in the midst of a banking crisis and entering a period of hyperinflation. Support for the government was declining and popular protest calling for new elections was widespread. In view of the failure of the country’s earlier stabilization programs, a perception was developing that, to be credible, a renewed stabilization attempt would require a visible, rule-based system, such as a currency board. Nevertheless, the economic and financial problems confronting Bulgaria seemed insurmountable at first.

Macroeconomic and structural setting. The depth of the macroeconomic crisis was daunting. On an annual basis, inflation had soared to almost 500 percent in January 1997 and surpassed 2,000 percent in March. The causes of the rapid acceleration of inflation included liquidity injections to support the country’s weakening banking system, continued central bank financing of the budget deficit, and—increasingly important—faltering confidence in the Bulgarian lev, which reduced domestic money demand. In an effort to soften the currency’s depreciation—from lev 487 to lev 1,588 per US$1 in the first quarter of 1997—the central bank depleted its international reserves; remaining reserves covered less than two months of imports. At the same time, falling output and growing tax evasion caused tax revenues to plummet, from almost 40 percent of GDP (annualized) to 14.7 percent of GDP in February 1997. To finance the fiscal deficit, the government issued treasury bills with successively shorter maturities and higher interest rates. Real output, which had grown in 1994 and 1995, contracted by more than 10 percent during 1996.

Full Report

https://www.imf.org/external/pubs/ft/fandd/1999/09/gulde.htm