Convergence Report 2020 and ERM II

16.06.2020

On 10 June, The European Commission (EC) and the European Central Bank (ECB) published the long-awaited 2020 Convergence Report (Report 2020), which reports to the EU Council on the progress made by non-euro area Member States in fulfilling their obligations in relation to the economic and monetary union (i.e. the progress made towards joining the single currency).

The convergence reports, as such,  are part of the regular reviews carried out by the ECB and the EC in relation to the economic and monetary union, which – according to Art. 140 of the Treaty on the Functioning of the European Union (TFEU) – should be carried out at least once every two years or at the request of a Member State that is not part of the Eurozone, in the latter case the relevant Convergence Report forms the basis on which the decision on the respective Member State’s euro accession is made (e.g. the Convergence Report 2013 on Latvia, which was prepared before the country’s accession to the Eurozone).

Seven of the eight non-euro area EU Member States – Bulgaria, Czech Republic, Croatia, Hungary, Poland, Romania and Sweden, are covered by the Report 2020. It should be noted that Denmark enjoys a special derogation, according to which it does not have the (same) obligation to adopt the euro and is thus, not subjected to the review. The review, itself, consists of an assessment of:

1) The state of economic convergence, as prescribed in the four criteria of Art. 140 TFEU:

a. Price stability, where the inflation does not exceed by more than 1.5 percent that of the three best performing Eurozone Member States;

b. Stable and sustainable public finance, where the government deficit cannot exceed 3 percent of GDP and the government debt cannot be more than 60 percent of GDP;

c. Exchange-rate stability, where the Member State seeking to join the Eurozone needs to participate in the exchange rate mechanism (ERM II), for at least two years, during which it should respect the normal fluctuation margins provided for by the ERM II exchange rate and its national currency should not devalue its bilateral central rate against the  euro during that period;

d. Long-term interest rate that does not exceed by more than 2 percent  that of the three best performing  Eurozone Member States.

2) Compliance of the national legislation with the TFEU, the Treaty on European Union and the Statute of the European System of Central Banks and of the ECB, as well as compliance with the legal requirements for the relevant national central bank to become an integral part of the Eurosystem.

It should be noted that none of the seven Member States included in Report 2020 meets all of the convergence criteria. On one hand, none of the countries meets criteria 1.c. regarding the ERM II membership, as to date Denmark is the only ERM II participant that is not an Eurozone member. On the other hand, all of the countries included in Report 2020, except Romania, meet the requirements related to public finances (1.b.) and long-term interest rates (1.d.).

The first negative effects of the COVID-19 pandemic, however, were also observed in relation to stable public finances (1.b.) and price stability (1.a.). With regard to Bulgaria, Report 2020 notes that while the country met the requirements for price stability with inflation of 1.4 percent during the 2018 review, this is no longer the case as of April 2020, i.e. officially Bulgaria no longer meets criteria 1.a. with inflation of 2.6 percent. Nevertheless, it should be noted that the full impact of the COVID-19 pandemic on the economic convergence would only be assessed with the publication of the next report, as the current one covers the period until 23.04.2020.

Another element of the criteria that Bulgaria does not meet is the one related to the compliance of the national legislation with the EU legal framework and the requirements for the Eurosystem (criteria 2). Report 2020 – as well as the previous ones – notes that the national legal framework does not cover all requirements related to the efficient performance of tasks concerning the Eurosystem, the independence of the central bank and the prohibition of monetary financing within the meaning of Art. 123 TFEU on the provision of overdrafts or other types of credit facilities by the BNB or the ECB for the benefit of EU bodies or of the Bulgarian national, regional or local public authorities.

In this regard, Report 2020 points out that the main weaknesses of the Bulgarian legislation are related to the grounds for dismissal of members of the Governing Council of the Bulgarian National Bank (BNB) on the basis of established conflict of interests with an enforceable legal act under the Counter-Corruption and Unlawfully Acquired Assets Forfeiture Act (CCUAAFA), as the EU framework does not provide for relieving one from office based on those grounds. It is also noted that the Law on BNB provides for judicial control only over the decisions to dismiss the Governor but not other  of the Governor of the BNB but not other members of the BNB Governing Council, who are involved in the performance of the European System of Central Banks related tasks, which according to the EC and ECB reduces legal certainty.

Report 2020 also takes into account the peculiarities of the currency board in Bulgaria and the ban on the BNB to provide loans to banks (with some exceptions). In this regard, it is noted that the Law on BNB should be amended in the part stipulating that the BNB may not provide loans and guarantees in any form to the Council of Ministers, municipalities, other state institutions, organizations, etc., nor to purchase directly debt instruments from the above, where the references to the primary and secondary markets in Art. 45 para. 3 related to the purchase of debt instruments issued by the Bulgarian government, the municipalities and the public sector organizations and entities from the public sector should be removed, as Art. 123 TFEU stipulates that the purchase of such instruments on the secondary market is admissible in so far as it is not used to circumvent the objectives of the TFEU itself. Report 2020 also points out a number of other amendments to be introduced in the Law on the BNB, mainly related to the powers of the ECB in the field of monetary policy, payment systems, etc.

Despite the fact that Bulgaria is not fulfilling all of its obligations in connection with the achievement of the economic and monetary union, it is important to note that this should not have a direct impact on the country’s accession to ERM II, per se. Nevertheless, the accession to and participation in ERM II is part of the criteria (1st c.) and thus it should also be met; as Report 2020 points out the ECB and the EC are monitoring the implementation of a number of commitments made by Bulgaria in this regard (for more information see our publication on the subject here). In this context, Bulgaria should be part of ERM II for at least 2 years, during which it needs to meet the aforementioned criterion; this in practice means that although desirable, it is not mandatory to meet all other convergence criteria before joining ERM II.

Should you wish to learn more or require additional information please reach out to:

Kristina Dimitrova, Associate, Attorney-at-Law
kristina.dimitrova@tbk.bg

Nikolay Bebov, Managing Partner, Attorney-at-Law
nikolay.bebov@tbk.bg