How can financial stability be achieved in the Balkan countries?

How can financial stability be preserved through currency boards and monetary policy in the Balkan countries?


Maintaining monetary stability is the primary objective of the currency board regime, especially after political and economic crises, such as the 1990s Balkans crisis. The central bank’s very limited role has disciplined financial institutions and governments. However, it is not conducive to long-term growth and employment. This policy ties the domestic currency to the “peg” currency, leading to inflationary tendencies in the country whose currency is used as the “peg”. Currently, high inflation rates are caused by the pandemic crisis and the war in Ukraine.  The findings suggest that inflation in these two nations is influenced by two factors: the monetary policies implemented by the European Central Bank and the inflation patterns observed in the EMU (mainly due to the Ukrainian war leading to the current energy and food crisis).

Currency board – a good choice or not?

The transition of the Balkan countries to a market economy was rather slow, burdened by the scars of war, destroyed factories and fragmented markets. The main objective was to achieve financial stability amid substantial currency fluctuations and hyperinflation while ensuring fiscal security. This was the main reason for the introduction of a monetary policy regime, to “peg” the domestic currency and enable monetary security. However, the high degree of euroization of the Western Balkan economies significantly affects the efficiency of monetary policy instruments.

Over the past decade, the Western Balkans have experienced a geopolitical landscape characterised by growing influence from both “great powers” and regional actors. The countries in this region perceive membership in the European Union (EU) as both inevitable and desirable. Still, the EU’s internal disagreements regarding enlargement have cast uncertainty over the integration process.

The analysis of the recent inflation in the EMU in Bosnia and Herzegovina and Bulgaria prompted a discussion on the conditions and reasons for the introduction of the currency board as a specific monetary policy arrangement in the Balkan countries. The establishment of the future currency regime took into account the countries’ wartime period, profound exchange rate crisis, and banking crisis. However, these two countries’ regimes differ significantly, leading to variations in economic indicators. The common thread among countries that adopted the currency board is their experience of severe crises in the past. Civil wars, market collapses, excessive government spending and different sanctions have all led to significant inflation. Conversely, Bulgaria had to contend with a severe financial crisis that affected both the banking sector and negative fluctuations in exchange rates.

EU Deposit Protection Scheme-the inflation under the currency board

The research was conducted considering two aspects that show the strength and impact of imported inflation. The first aspect focuses on the relationship of imported inflation between imported inflation and the inflation of the currency of the linked country. The observed countries experienced higher imported inflation, primarily attributed to the intensity, duration, elevated level, and global spread of the war in Ukraine.

The first part of the analysis uses inflation in Bosnia and Herzegovina (BiH) and Bulgaria as dependent variable in the model. The ECB balance sheet, ECB deposit rate, M3 aggregate in the EMU, as well as in BiH and Bulgaria, along with oil prices and wages in both countries, are regarded as explanatory factors. The findings of the linear regression model revealed that inflation in BiH and Bulgaria during the COVID crisis was affected by the ECB rate, M3 in the ECB, and the inflation trend in the EMU. The findings reveal that countries with a currency board arrangement tend to import inflation and monetary policies from the country whose currency is used as a peg currency.

Figure 1. Statistical analysis results

The results show that EMU inflation, changes in M2 in BiH and changes in the level of wages in BiH positively impact the inflation trend in BiH. In contrast, other variables have a negative impact on inflation in BiH. The regression model shows that the positive impact on inflation in Bulgaria, i.e. the factors that influenced inflation during the observed period, is the inflation in EMU and the monetary aggregate M3 in Bulgaria, while other factors had a negative impact. We can conclude that EMU inflation positively and statistically significantly impacted observed countries.

The second part of the research indicates that the conflict in Ukraine has resulted in higher prices for essential goods such as food and energy, disrupted trade and supply chains, and increased refugee flows. The situation is complex, and it is likely to affect the growth of costs and prices, given that Russia and Ukraine are major producers of goods. These disruptions will have a long-term impact on the increase in global prices, especially for oil and natural gas, resulting in expectations of prolonged inflation.

Future trends

Currently, macroeconomic indicators indicate a notable decrease in economic metrics, particularly foreign direct investment and export demand, in the Balkan countries as a result of the pandemic crisis and the ongoing war in Ukraine. Alongside a passive monetary policy, these nations are anticipated to encounter additional price hikes, a profound recession, a substantial growth slowdown, and prolonged economic recovery stagnation.

Considering the limited monetary policy instruments, it is necessary for fiscal policy to help fight inflation by limiting current consumption. The general recommendations for mitigating the current crisis to the authorities would be a less expansive fiscal policy, higher interest rates to curb inflation and measures to preserve financial stability. This analysis highlights the advantages of the currency board system, which imposes discipline on financial institutions and preserves financial stability. Fiscal stability and sustainability, alongside financial stability, have been attained. However, it is evident that the economy of BiH is not experiencing rapid development under the currency board regime, as demonstrated. Therefore, there is no justification to further impede its progress and burden business operations with higher interest rates. Currently, interest rates are lower than the EU average, which should be leveraged as an advantage.


Journal reference

Topić Pavković, B., & Šoja, T. (2023). Post-Pandemic Inflation and Currency Board Arrangements in the Balkans. Journal of Balkan and Near Eastern Studies, 1-27. https://doi.org/10.1080/19448953.2023.2167165

Branka Topić Pavković is a professor of economics and business studies at the Faculty of Economics, University of Banja Luka, Department of Economic Theory, Analysis, and Policy. She holds a PhD in economics and has been an active researcher in several areas, including public finance, monetary economics, banking, and financial markets. Her research findings have been published in numerous international journals. An important aspect of her research is scientific collaboration and participation in various research/consultancy projects at the national and global levels, including the Balkans. She is also involved as an expert in evaluating projects funded by EU programs.

Tijana Soja is a finance professional who holds a PhD in Economics (Economic Theory, Analysis, and Policy) from the University of Banja Luka. She is currently an Assistant Professor at the University of Travnik. Tijana has extensive experience as an economist, with expertise in credit analysis, advisory roles, portfolio management, financial and market risk, business planning, and analytical skills. She possesses strong experience in both central and commercial banking, specifically in areas such as credit analysis, portfolio management, financial investment, financial instruments, foreign reserves market, credit risk, and business advisory. Tijana has actively participated in numerous international seminars and workshops. Additionally, she has authored several scientific papers that have been published in esteemed international journals.