The European Central Bank is reluctant for Bulgaria to join quickly the ERM-2 exchange rate mechanism, a stepping stone to the euro, arguing it needs to catch up more with existing euro zone economies, EU sources said.
Bulgaria, the European Union's poorest nation, wants to join ERM-2 as soon as possible to allow it to adopt the common currency by 2011-12. But the sources said the ECB believes Sofia should move much more slowly towards entering ERM-2, a two-year currency stability test for euro hopefuls.
"The ECB would like Bulgaria to join the Exchange Rate Mechanism-2 very late, once they have solved all their problems," one source said, requesting anonymity. The European Commission did not support this view, but some euro zone member states did, the source added. "What the ECB does not like is that, in practice, once you join the ERM you are certain to join the euro as soon as you respect the other conditions. They would like to have them out for a longer period, given their problem of real convergence."
An ECB press officer declined comment, beyond referring to a general policy statement on the currencies of new EU member nations which the Governing Council issued in 2003.
But one source said euro zone member states and the ECB were trying to "reason with Bulgaria" - which joined the EU only at the start of this year - to allow time for its economy to converge more with the wealthier bloc of 13 countries.
However, Sofia is still likely to join ERM-2 this year if it promises reforms and the EU agrees how to monitor them, a source familiar with the talks said. "Two months to join the ERM? - I reckon (that would be) definitely too short. Twelve months could be too long. Somewhere in between, possibly before the end of the year (is likely)," a second source said.
In ERM-2 euro zone hopefuls are supposed to keep their currencies stable against the common currency. In Bulgaria's case this, at least, should be no problem as its lev is already pegged to the euro.
But Sofia should be under no illusion that two years in ERM-2 would guarantee its euro entry. "Their euro application will be judged on its own merits, on the compliance with the nominal criteria and there will be, as always, a broader examination if this is sustainable," the second source said.
"It all depends on the ECB," the first source added. A lack of sustainable convergence was key in the rejection last year of Lithuania's bid to adopt the euro. This sparked a fierce debate about euro entry prospects of poorer, mostly eastern European EU newcomers where economic growth is high but, as a consequence, inflation is too high to qualify for the euro.
CURRENT ACCOUNT A WORRY: Bulgaria had wanted to enter ERM-2 upon its EU accession and to adopt the euro in 2010, but sceptics led by the ECB delayed those plans.
Unlike euro zone entry, there are no formal criteria for joining the ERM-2, a regime which forces a currency to trade within bands around a parity rate. But two years' ERM membership is a euro entry requirement, along with low inflation, low interest rates, debt below 60 percent of GDP and a budget deficit below 3 percent of GDP.
Bulgaria has a budget surplus and falling debt of slightly above 20 percent of GDP, but relatively high inflation due to fast economic growth. Its current account deficit, at 17 percent of GDP, is the second highest in the EU.
"It's good to enter (ERM-2) when you are as fit and proper as possible. It is clear that we have imbalances in this country including a very large current account deficit," ECB President Jean-Claude Trichet said on Wednesday.
The current account balance is one of the indicators the ECB and the Commission examine when assessing whether an economy has reached "a high degree of sustainable convergence" needed to join the euro zone, although EU law sets no clear target.
The assessment also has to take into account the development of unit labour costs, EU law says. These are still low in Bulgaria and a rapid rise could affect the sustainability of inflation or public finances, one EU source said.
CATCHING-UP PERIOD: To join ERM-2, Sofia needs the backing of all euro zone and other ERM-2 states, the ECB and the European Commission. The ECB camp argues that because Bulgaria's GDP per capita is only a third of the EU average, it will need a long catching-up period with above average growth and inflation.
Higher inflation after Bulgaria joined the euro might be a small problem for the ECB's one-size-fits-all monetary policy, given the modest size of its economy, but this would add to existing inflation divergences in the currency area.
Combined with no flexibility in exchange rate policy, higher inflation would also mean a loss of competitiveness, as to some extent Italy and Portugal have experienced, sources said. That could be partly offset by a flexible labour market where wages can fall and unemployment rise, but this could create political tensions, they said. An even tighter fiscal policy would help, but not solve the problem.
But Bulgaria is determined to enter ERM-2 and sources said it will be difficult to say "no", especially as Sofia is ready to tighten fiscal policy to secure EU backing. "It will happen in the coming months. There is no sensible reason to say 'no' to a member state running a successful currency board, let's be honest," the first source said.
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