Johns Hopkins Gazette: March 24, 1997

Economist's Recovery
Plan For Bulgaria

Federal monetary board
puts faith in currency
board advocate

After months of economic chaos--including an annual inflation rate last year of 300 percent--the government of Bulgaria has agreed to accept a host of economic reform measures put forth by the International Monetary Fund. Among them, the Bulgarians will establish a currency board to help end hyperinflation and promote a stable exchange rate for the lev, the Bulgarian basic unit of exchange.

Steve H. Hanke, professor of applied economics in the Zanvyl Krieger School of Arts and Sciences, left Baltimore March 20 to fly to Sofia, Bulgaria, where he will oversee the creation and implementation of the currency board. He was named on March 3 the economic adviser to Bulgarian president Petar Stoyanov, a former opposition party leader who successfully led a national effort to oust the previous socialist-led government.

The currency board concept has been championed by Hanke in many situations. It is an independent body which sets and maintains the value of a nation's currency based upon a set level of foreign currency held by the nation in permanent reserve. Called in Bulgaria "the father of the currency board," Hanke has been advocating currency board reform as an alternative to central banks for more than a decade.

In 1991, he developed a blueprint for Argentina to adopt a currency board system. Hanke said that the year before the currency board was enacted, Argentina labored under a hyperinflation rate of 2,315 percent a year. In 1996, Argentina's inflation rate was negative 0.3 percent, the lowest in the world. He has also helped implement currency boards in Estonia (1992) and Lithuania (1994) with similar results: the 300 percent-plus inflation rate in both countries has been reduced to about 20 percent with a slow, steady drop, Hanke said.

The IMF made the currency board reforms one of the prerequisites for approving a package of $700 million in new loans to Bulgaria. According to the Bloomberg Financial News Service, the new IMF agreement would replace an earlier deal that was suspended last September. At that time, widespread political unrest throughout the country and a general feeling that the socialist government was unwilling or unable to implement needed economic reforms led the IMF to halt planned payments.

General elections are now scheduled in the country for April 19. In the meantime, an interim government in cooperation with President Stoyanov has agreed to limit the budget deficit, promote a stable exchange rate and lift price controls on food, gasoline, electricity and heating.

Bulgaria, like Albania, which lies to the west on the other side of Macedonia, was considered one of the most repressive and hard-line socialist countries of the Soviet bloc. When political and economic change swept through Eastern Europe in 1989, many of the reforms that reached Poland, Czechoslovakia and other former Soviet satellites were slow to arrive in Bulgaria. Now that country appears poised to make some of the wrenching changes needed to move from a command to a free market economy.

Hanke will advise Stoyanov on the exchange rate for the country's currency--the lev--and on the currency to which it should be linked. He then will help draft the law that will put into place a currency board, which then will serve as the framework for other economic reforms including massive privatization, price liberalization and a balanced budget. Hanke said all political parties in Bulgaria support the currency board system and that it can be put into place in weeks, or at the latest shortly after the April 19 national elections.

One of the most difficult aspects of the changeover is maintaining popular political support for reforms that seem, at least initially, to drive up prices and diminish living standards without providing immediate economic benefit. Often, central banks will willingly debase the value of the currency in order to meet financial obligations to veterans, pensioners and state employees.

In Russia, for example, the central bank proved willing to print however many rubles were needed to fulfill political obligations to pay certain sectors of the economy. The value of the currency quickly plummeted as a result, falling from an artificially high one ruble to the dollar to nearly 6,000 rubles to the dollar today.

In Bulgaria, the lev, which had been trading at about 500 to the dollar at the end of 1996, fell to 2,937 to the dollar by Feb. 14 of this year, according to news reports. Recently, that rate has improved to 1,500 lev to the dollar.

Before flying to Bulgaria, Hanke told the Bloomberg Financial News Service that the most important job in creating a currency board is protecting it from political pressure when times get tough.

"The only way you can have stability and reform is to put handcuffs on the monetary authorities, which in effect puts handcuffs on the fiscal authorities," Hanke said. "It should be a very orthodox board with no loopholes to allow the politicians any wiggle room. If it is orthodox, I think the Bulgarians will be in a much stronger position to renegotiate debt."

Hanke reportedly is set to recommend the lev be tied to the U.S. dollar. This would require the Bulgarian government to acquire and hold a fixed number of dollars in permanent reserve for as long as the currency board exists. Hanke told reporters that, in Bulgaria's case, the board should be set up to exist for as much as a decade or longer. Politicians tend not to like currency boards because they severely limit the government's ability to use monetary policy as a means of achieving fiscal objectives. Although any stable currency can be used, dollars are often the currency reserve of choice.

In addition to his work in Bulgaria, Estonia and Lithuania, Hanke is also at work on a similar plan for the former Yugoslavia. His work as economic adviser to Zivko Pregl--vice president of Yugoslavia in 1990 and '91--culminated in the adoption of Article VII of the Dayton/Paris Treaty, initialed in November 1995, requiring that a currency board be established for Bosnia and Herzegovina.

Hanke also is on the steering committee of the G-7 Council in Washington, D.C., and is a fellow at the World Economic Forum in Geneva. His books include Alternative Monetary Regimes for Jamaica (1996), Currency Boards for Developing Countries (1994) and Russian Currency and Finance (1993). He also is a columnist for Forbes magazine.

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