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Bulgaria joined the Fund in 1990. Prior to the program in April 1997 that eventually launched the currency board, it had four stand-by agreements with the Fund (1991, 1992, 1994 and 1996); all but the first of these were not completed.
The budgetary problem reflected initially a heavy domestic debt burden, which, in spite of significant primary surpluses, caused sizeable overall deficits. Closer to the height of the crisis, the fiscal problem was aggravated by faltering tax revenues.
Problems and delays in the payment system were clear symptoms of banking sector distress. Later, more obvious signs such as negative cash flow, mounting uncollected interest, and a further deterioration of the loan portfolio became apparent.
The July 1996 program followed a money-based stabilization approach and faltered mainly because of fiscal slippages.
Examples of countries where such arrangements are successfully in place include inter alia Argentina, Estonia, Hong-Kong and Lithuania. See Baliño et al (1997) for details.
In both Estonia and Lithuania, significant banking sector difficulties only emerged after the currency boards had been operating for a while. In addition, and in contrast to Estonia, Lithuania and most other transition economies, banking and financial services in Bulgaria were of significant size, with bank deposits prior to the hyperinflation amounting to about 40 percent of GDP.
The political crisis of the fall of 1996 thwarted initial plans to implement the CBA effective February 1, 1997. Internal strife led to a complete political stalemate and the inability to run economic policy. No budget for 1997 was approved and the government resigned just before end-December.
These so called “Zunkbonds” originated from a previous round of bank recapitalization. After the hyperinflation most state banks were long in foreign currency, due to their holding of “Zunks.”
Currency board arrangements differ quite significantly in specific details. See, for example, Baliño et. al. (1997), for a description of country-specific features.
The basic design of the currency board was set up during an MAE mission in December 1996. Estonia and Lithuania follow a similar design, while others, like Argentina and Hong Kong, maintain all accounts on a unified balance sheet.
The Banking Department is responsible for monitoring financial market developments to keep usage of loans to banks to a minimum.
Central bank profits would increase the deposit of the Banking Department with the Issue Department, with a balancing increase of the capital and reserve accounts in the Banking Department.
The Banking Department is the “fiscal agent for Bulgaria’s relations with the IMF.” This means that IMF credit will be channeled through the Banking Department to be on-lent to the government or deposited to the Banking Department account at the Issue Department. Both operations do not affect the foreign reserve cover and were decided to be consistent with the currency board rules.
It also states that the peg will be to the euro after the deutsche mark enters the monetary union.
Including the State Fund for Reconstruction and Development, a principal borrower from international bodies such as the World Bank, the EBRD, and the European Union.
Other features improving liquidity management among banks, in particular a reserve requirement regime that allows averaging of required reserve holdings, as well as the infrastructure to support smooth interbank transactions, had been instituted previously as part of ongoing reforms in the monetary operations framework.
Except to minimize exchange rate exposure, funds needed to repay foreign loans denominated in other currencies, for which investments in the respective currencies will be maintained. While gold essentially poses the same problems as other non-deutsche mark assets, the BNB is, by law, not permitted to the sell the country’s “strategic gold reserves.”
The Bulgarian currency board includes a provision that the public can exchange Bulgarian lev for deutsche mark and vice versa at the central bank and its branches. To cover the costs of the operations, there is a small spread; one deutsche mark is sold for lev 1000, whereas the BNB purchases the deutsche mark for lev 995.