Trade, convergence and exchange rate regime: evidence from Bulgaria and Romania

The aim of the paper is to reveal the similarities and differences of export and import demand functions of Bulgaria and Romania over the period 2000-2008 using quarterly data. On one hand, the countries are similar in respect to the convergence process with the euro area that they are undergoing, on the other hand they have different exchange rate regimes: Bulgaria has a currency board arrangement, Romania’s exchange rate regime is characterized by a managed float. The empirical analysis will therefore contribute to the debate if the countries with flexible exchange rates are in a more advantageous position concerning competitiveness compared to the countries with fixed exchange rates. The study shows that the export dynamics of Bulgaria and Romania over the period of investigation is largely explained by the EU growth, while the increasing market shares of the two countries are partly due to strong FDI inflows. A key conclusion of the paper is that the real exchange rate appreciation, which was more prominent in Romania than in Bulgaria, did not have significant impact on export developments of neither of the two countries. This is mainly due to the fact that the real exchange rate appreciation during this period of convergence is likely to reflect an upward movement in its equilibrium value, not a loss in competitiveness. Another important conclusion is that the convergence process in respect to trade in both economies is similar irrespective of their exchange rate regime, currency board or managed float.