Analysis-Bulgaria's euro zone entry threatened by election stalemate

By Tsvetelia Tsolova

SOFIA (Reuters) - Bulgaria's longstanding political deadlock threatens to delay its plan to adopt the euro on Jan. 1, 2024, at a time when the eurosceptic and pro-Russian Revival party is increasingly vocal and Bulgarians themselves are deeply divided about the euro.

Joining the euro zone would help Bulgaria, the European Union's poorest member state, attract more foreign investment and secure credit ratings upgrades that could reduce its debt financing costs, economists say. The Balkan country has long pegged its lev currency to the euro.

Nearby Croatia, which is similarly dependent on tourism revenues, is on track to adopt the single currency in January 2023. But Bulgaria, rattled by a series of elections that produced yet another hung parliament last month, has lost momentum in its euro entry plans, the Bulgarian central bank chief and rating agencies said.

Its main political parties support the 2024 target, but they have kept the polarizing issue on the sidelines, fearful of losing voters in the run-up to an Oct. 2 election.

At the same time, the nationalist Revival party, which has become the fourth largest faction in parliament, vocally campaigns against the euro, saying it would "destroy the economy."

This strikes a chord with many Bulgarians amid an economic slowdown, who fear that switching to the euro would fuel already high inflation.

A Eurobarometer survey in June showed that 44% of Bulgarians were in favour of joining the euro -- down from 54% in spring of 2021 -- while 54% were against it, versus 44% the year before.

"If we adopt the euro, prices will certainly go up, but I doubt the salaries will," said Desislava Alexandrova, 36, a young mother who was buying cucumbers in Sofia's bustling Krasno Selo market with her 1-year-old baby.

"Thankfully, I am getting my maternity payment and my husband works, so we are relatively OK. But my parents, who are retired, are really struggling."

Many people fear abusive price setting during the changeover to the euro could push up prices. A European Central Bank report which analysed the 2002 introduction of the euro in 12 countries found "no evidence of a significant impact on prices at the aggregate level as a result of the euro cash changeover."

For many young Bulgarians in better-paid jobs, adopting the euro is the only way forward for the country which joined the EU in 2007.

"I do not see why we should not adopt the euro, especially as they plan to keep the current peg. It would help our tourism and will make it easier for Europeans to visit," said Georgi Alexiev, 29, a self-employed architect.

HURDLES TO CLEAR

After last month's election, the fourth in less than two years, Bulgaria faces difficult talks on forming a government. A further snap election cannot be ruled out, which could put at risk the adoption of laws required for euro entry.

Central Bank Governor Dimitar Radev told parliament last month that Sofia was falling behind on technical deadlines.

"The question ...is whether Bulgaria will remain indefinitely in the future anchored in the deep periphery of Europe with its inherent poverty, corruption, institutional weakness ... or whether a general effort should be made to change this through speeding up the already seriously delayed process of joining the euro zone," Radev said.

After his speech, parliament passed a resolution urging the caretaker government to speed up work with EU institutions to ensure Bulgaria does not miss its 2024 target date.

The two largest political parties, the centre-right GERB and reformist PP, backed it. The Revival faction voted against it, while the Russia-friendly Socialists and the Bulgarian Rise party abstained.

Rating agencies Standard & Poor's and Fitch, which rate Bulgaria at investment grade BBB, have said euro entry would be credit positive for Bulgaria.

"We still see that there is general commitment by the country to follow the euro adoption process... but the political instability is definitely dragging on the prospects," said Malgorzata Krzywicka, an analyst with Fitch Ratings.

An EU official familiar with the process told Reuters on Monday that EU institutions were flexible and "could work both with regular and interim governments, given that there is a clear political mandate and such was recently given."

"We would also need to see a moment where inflation in Bulgaria is easing," the source added. "If work is sped up, the country could still meet its target date."

NOMINAL CRITERIA

Deputy Prime Minister Atanas Pekanov said the interim government was determined to step up work so Bulgaria can join the euro on time.

The country meets most of the nominal criteria to adopt the single currency, except for inflation. In September, the average inflation rate in the euro zone was 9.9%, while Bulgaria's EU-harmonised figure was 15.6%.

Another potential hurdle is the lack of a clear fiscal policy plan for next year, after the caretaker government said it would not present a draft 2023 budget to parliament, while the fiscal deficit could jump to 6.6% of GDP.

Analysts say while there could be some flexibility on nominal criteria, euro zone peers still need to be convinced that Bulgaria can combat widespread corruption, and implement money laundering rules efficiently.

"Some of these reforms will be very hard to achieve without a functioning government," said Niklas Steinert, a sovereign ratings analyst with Standard and Poor's.

A senior euro zone official said, however, that the convergence criteria was all that mattered.

"If they are fit, they are in," the official said.

(Additional reporting by Jan Strupczewski in Brussels and Francesco Canepa in Frankfurt, Editing by Krisztina Than and Toby Chopra)