Bulgaria's currency board arrangement (CBA) enjoys much greater sustainability than the currency pegs in the Baltic states, says an analysis of the Greek EFG Eurobank, owner of local Postbank.

The bank's analysts say Bulgaria's CBA continues to be supported by a number of factors, which differentiate it from other FX pegs in Central Eastern Europe - strong public and constitutional support, a large pool of foreign exchange reserves and a strong fiscal position, mild economic recession and a well-capitalized banking sector.

Another positive factor are the forecasts that the economic downturn in Bulgaria will be much milder than in the Baltic States. The IMF now forecasts real GDP of -3.5% for Bulgaria this year, while expects economic contraction of more than 10% in Baltic States (-18% in Latvia).

Another issue that relates to the sustainability of a currency board, especially in periods of increased demand for foreign currency by domestic economic agents, is the degree of foreign exchange cover of broader monetary aggregates, including deposits that may be converted into cash upon request, the analysis says.

In May 2009 the exchange rate reserves amounted to around 81.3% of the lev-denominated portion of M2 (M1 + quasi-money). This was lower than the corresponding coverage ratio in both August and May 2008 (97.2% and 92%, respectively) but still sufficient to meet the greater part of the hypothetical demand for foreign currency that could arise under a scenario in which all economic agents decided, at once, to convert their lev coins, bills and deposits into hard currency.

According to the analysis in the absence of a new severe negative international shock or a serious domestic policy mistake the market by itself is unlikely to force a devaluation of the lev and a CBA break up.

The maintenance of the present currency board arrangement would prevent a de facto lev devaluation from inflicting immense pain on domestic household and corporate balance sheets, it points out.

A more realistic scenario is for the local authorities to devalue the lev and abandon the CBA concurrently with entry into ERM-II and the establishment of a new and credible central parity, perhaps even a new currency board.

The analysis does not rule out some form of financial support from the IMF or other international organizations.

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