Bulgaria : Legacy, Transition and the Soft Underbelly of Macroeconomic Stability

At the turn of events in Central and Eastern Europe in 1989, Bulgaria inherited a weak economy whose woes were aggravated by the dissolution of the COMECON trade agreement, and the sanctions imposed on traditional trading partners like Iraq and Yugoslavia. At the same time, it avoided the bloodshed and the wars that left their mark on many of the Balkan and CIS countries. Many of the post-1989 years were frittered away by successive Bulgarian governments, and the 1990-96 period saw decline in industrial output, negative GDP growth, and fairly high inflation rates. Matters came to a head in 1996-97 and resulted in a financial-currency crisis leading to a sharp devaluation of the currency and bankruptcy of banks. The government responded by ushering in a currency board agreement that has eliminated the government's ability to incur fiscal deficit, the soft budget constraints enjoyed earlier by the banking sector, and the Bulgarian National Bank's ability to pursue an expansionary monetary policy. As a consequence, the Bulgarian government runs a fiscal surplus, inflation and interest rates remain low, and the currency remains pegged to the German mark. The paper argues that these signs of macroeconomic stability are misleading, and that credit market failure and the constraints imposed by the currency board agreement on the government and central bank's ability to pursue expansionary fiscal and monetary policy is pushing Bulgaria towards another disaster