EUROPEAN COMMISSION Brussels, 10.6.2020 SWD(2020) 107 final COMMISSION STAFF WORKING DOCUMENT CONVERGENCE REPORT 2020 Accompanying the document REPORT FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT AND THE COUNCIL CONVERGENCE REPORT 2020



(prepared in accordance with Article 140(1) of the Treaty on the Functioning of the European Union) {COM(2020) 237 final}



Member States BG Bulgaria

CZ Czechia HR Croatia HU Hungary PL Poland RO Romania SE Sweden EA Euro area EA-19 Euro area, 19 Member States EA-18 Euro area, 18 Member States before 2015 EA-17 Euro area, 17 Member States before 2014 EU-28 European Union, 28 Member States EU-27 European Union, 27 Member States before July 2013 (i.e. EU-28 excl. HR) and from February 2020 (i.e. EU-28 excl. UK) EU-25 European Union, 25 Member States before 2007 (i.e. EU-28 excl. BG, RO and HR) EU-15 European Union, 15 Member States before 2004 Currencies EUR Euro BGN Bulgarian lev

CZK Czech koruna HRK Croatian kuna HUF Hungarian forint PLN Polish zloty RON Romanian leu (ROL until 30 June 2005) SEK Swedish krona USD United States dollar Central Banks BNB Bulgarska narodna banka (Bulgarian National Bank – central bank of Bulgaria) ČNB Česká národní banka (Czech National Bank – central bank of Czechia) HNB Hrvatska narodna banka (Croatian National Bank – central bank of Croatia) MNB Magyar Nemzeti Bank (Hungarian National Bank – central bank of Hungary) NBP Narodowy Bank Polski (National Bank of Poland – central bank of Poland) BNR Banca Naţională a României (National Bank of Romania – central bank of Romania) Other abbreviations AMR Alert Mechanism Report BoP Balance of Payments CAR Capital adequacy ratio

CBA Currency board arrangement CEE Central and Eastern Europe CIT Corporate Income Tax CPI Consumer price index CR5 Concentration ratio (aggregated market share of five banks with the largest market share) EC European Community ECB European Central Bank EDP Excessive Deficit Procedure EMU Economic and monetary union ERM II Exchange rate mechanism II ESA European System of Accounts ESCB European System of Central Banks EU European Union Eurostat Statistical Office of the European Union FDI Foreign direct investment FGS Funding for Growth Scheme FSA Financial Supervisory Authority GDP Gross domestic product HICP Harmonised index of consumer prices HFSA Hungarian Financial Supervisory Authority

IDR In-Depth Review MFI Monetary Financial Institution MIP Macroeconomic Imbalance Procedure MTO Medium-term objective NCBs National central banks NEER Nominal effective exchange rate NIK Najwyższa Izba Kontroli (Poland's Supreme Chamber of Control) NPL Non-performing loans OJ Official Journal OJL Official Journal Lex PIT Personal Income Tax PPS Purchasing Power Standard REER Real effective exchange rate SGP Stability and Growth Pact TFEU Treaty on the Functioning of the European Union ULC Unit labour costs VAT Value added tax The Convergence Report and its Technical Annex were prepared in the Directorate-General for Economic and Financial Affairs. The main contributors were Lucian Briciu, Balázs Forgó, Adriana Reut,

Matteo Salto and Ulrike Stierle-von Schütz.

Other contributors were Ronald Albers, Laura Bardone, Wojciech Balcerowicz, Barbara Bernardi,

Stefan Ciobanu, Karl Croonenborghs, Patrick D'Souza, Enache Enache, Isabel Grilo,

Leire Ormaetxea Igarzabal, László Jankovics, Andreas Kappeler, Willem Kooi, Ivan Kusen,

Júlia Lendvai, Ivan Lozev, Maria Maierean, Allen Monks, Sylwia Nowak, Mona Papadakou,

Gábor Pellényi, Arian Perić, Francesco Perticari, Lucia Piana, Diana Radu, Hugo Ferradans Ramonde, Juan Antonio Salazar Romero, Maja Šamanović, Michael Stierle, Septimiu Szabo, Henk Van Noten, Martina von Terzi, Bartlomiej Wiczewski, Rafał Wielądek, Marcin Zogala. Statistical assistance was provided by Ulrike Stierle-von Schütz, Eric McCoy and André Verbanck, administrative assistance by Erdemia Malagrida and Sien Vangompel. The report was coordinated by Balázs Forgó and Lucian Briciu under the supervision of Eric Ruscher, Head of Unit and approved by Lucio Pench, Director, Declan Costello, Deputy Director General, and Maarten Verwey, Director General. Questions and comments may be referred to Balázs Forgó ( balazs.forgo@ec.europa.eu ). Convergence Report 2020 Convergence Report 2020 - Technical annex 1.Introduction 1.1.Role of the report 1.2.Application of the criteria 1.2.1.Compatibility of legislation 1.2.2.Price stability 1.2.3.Public finances 1.2.4.Exchange rate stability 1.2.5.Long-term interest rates 1.2.6.Additional factors 2. Bulgaria 2.1.LEGAL COMPATIBILITY 2.1.1.Introduction 2.1.2.Central Bank independence

2.1.3.Prohibition of monetary financing and privileged access 2.1.4.Integration in the ESCB 2.1.5.Assessment of compatibility 2.2.Price stability 2.2.1.Respect of the reference value 2.2.2.Recent inflation developments 2.2.3.Underlying factors and sustainability of inflation 2.3.Public finances 2.3.1.Recent fiscal developments 2.3.2.Medium-term prospects 2.4.Exchange rate stability 2.5.Long-term interest rates 2.6.Additional factors 2.6.1.Developments of the balance of payments 2.6.2.Market integration 3.Czechia 3.1.LEGAL COMPATIBILITY 3.1.1.Introduction 3.1.2.Central Bank independence 3.1.3.Prohibition of monetary financing and privileged access

3.1.4.Integration in the ESCB 3.1.5.Assessment of compatibility 3.2.Price stability 3.2.1.Respect of the reference value 3.2.2.Recent inflation developments 3.2.3.Underlying factors and sustainability of inflation 3.3.Public Finances 3.3.1.Recent fiscal developments 3.3.2.Medium-term prospects 3.4.Exchange rate stability 3.5.Long-term interest rates 3.6.Additional factors 3.6.1.Developments of the balance of payments 3.6.2.Market integration 4. Croatia 4.1.Legal compatibility 4.1.1.Introduction 4.1.2.Central Bank independence 4.1.3.Prohibition of monetary financing and privileged access 4.1.4.Integration in the ESCB

4.1.5.Assessment of compatibility 4.2.Price stability 4.2.1.Respect of the reference value 4.2.2.Recent inflation developments 4.2.3.Underlying factors and sustainability of inflation 4.3.Public finances 4.3.1.Recent fiscal developments 4.3.2.Medium-term prospects 4.4.Exchange rate stability 4.5.Long-term interest rates 4.6.Additional factors 4.6.1.Developments of the balance of payments 4.6.2.Market integration 5.Hungary 5.1.LEGAL COMPATIBILITY 5.1.1.Introduction 5.1.2.Central Bank independence 5.1.3.Prohibition of monetary financing and privileged access 5.1.4.Integration in the ESCB 5.1.5.Assessment of compatibility

5.2.Price stability 5.2.1.Respect of the reference value 5.2.2.Recent inflation developments 5.2.3.Underlying factors and sustainability of inflation 5.3.Public finances 5.3.1.Recent fiscal developments 5.3.2.Medium-term prospects 5.4.Exchange rate stability 5.5.Long-term interest rates 5.6.Additional factors 5.6.1.Developments of the balance of payments 5.6.2.Market integration 6.Poland 6.1.LEGAL COMPATIBILITY 6.1.1.Introduction 6.1.2.Central Bank independence 6.1.3.Prohibition of monetary financing and privileged access 6.1.4.Integration in the ESCB 6.1.5.Assessment of compatibility 6.2.Price stability

6.2.1.Respect of the reference value 6.2.2.Recent inflation developments 6.2.3.Underlying factors and sustainability of inflation 6.3.Public finances 6.3.1.Recent fiscal developments 6.3.2.Medium-term prospects 6.4.Exchange rate stability 6.5.Long-term interest rates 6.6.Additional factors 6.6.1.Developments of the balance of payments 6.6.2.Market integration 7.Romania 7.1.fLEGAL COMPATIBILITY 7.1.1.Introduction 7.1.2.Central Bank independence 7.1.3.Prohibition of monetary financing and privileged access 7.1.4.Integration in the ESCB 7.1.5.Assessment of compatibility 7.2.Price stability 7.2.1.Respect of the reference value

7.2.2.Recent inflation developments 7.2.3.Underlying factors and sustainability of inflation 7.3.Public finances 7.3.1.Recent fiscal developments 7.3.2.Medium-term prospects 7.4.Exchange rate stability 7.5.Long-term interest rates 7.6.Additional factors 7.6.1.Developments of the balance of payments 7.6.2.Market integration 8.Sweden 8.1.LEGAL COMPATIBILITY 8.1.1.Introduction 8.1.2.Central Bank independence 8.1.3.Prohibition of monetary financing and privileged access 8.1.4.Integration in the ESCB 8.1.5.Assessment of compatibility 8.2.Price stability 8.2.1.Respect of the reference value 8.2.2.Recent inflation developments

8.2.3.Underlying factors and sustainability of inflation 8.3.Public finances 8.3.1.Recent fiscal developments 8.3.2.Medium-term prospect. 8.4.Exchange rate stability 8.5.Long-term interest rates 8.6.Additional factors 8.6.1.Developments of the balance of payments 8.6.2.Market integration

LIST OF Tables 2.1. Bulgaria - Components of inflation 2.2. Bulgaria - Other inflation and cost indicators 2.3. Bulgaria - Budgetary developments and projections (as % of GDP unless indicated otherwise) 2.4. Bulgaria - Balance of payments 2.5. Bulgaria - Market integration 3.1.Czechia - Components of inflation 3.2.Czechia - Other inflation and cost indicators 3.3.Czechia - Budgetary developments and projections (as % of GDP unless indicated otherwise) 3.4.Czechia - Balance of payments

3.5.Czechia - Market integration 4.1. Croatia - Components of inflation 4.2. Croatia - Other inflation and cost indicators 4.3. Croatia - Budgetary developments and projections (as % of GDP unless indicated otherwise) 4.4. Croatia - Balance of payments 4.5. Croatia - Market integration 5.1.Hungary - Components of inflation 5.2.Hungary - Other inflation and cost indicators 5.3.Hungary - Budgetary developments and projections (as % of GDP unless indicated otherwise) 5.4.Hungary - Balance of payments 5.5.Hungary - Market integration 6.1.Poland - Components of inflation 6.2.Poland - Other inflation and cost indicators 6.3.Poland - Budgetary developments and projections (as % of GDP unless indicated otherwise) 6.4.Poland - Balance of payments 6.5.Poland - Market integration 7.1.Romania - Components of inflation 7.2.Romania - Other inflation and cost indicators 7.3.Romania - Budgetary developments and projections (as % of GDP unless indicated otherwise) 7.4.Romania - Balance of payments

7.5.Romania - Market integration 8.1.Sweden - Components of inflation 8.2.Sweden - Other inflation and cost indicators 8.3.Sweden - Budgetary developments and projections (as % of GDP unless indicated otherwise) 8.4.Sweden - Balance of payments 8.5.Sweden - Market integration LIST OF Graphs 2.1. Bulgaria - Inflation criterion 2.2. Bulgaria - HICP inflation 2.3. Bulgaria - Inflation, productivity and wage trends 2.4. Bulgaria - BGN/EUR exchange rate 2.5. Bulgaria - 3-M Sofibor(1) spread to 3-M Euribor 2.6. Bulgaria - Long-term interest rate criterion 2.7. Bulgaria - Long-term interest rates 2.8. Bulgaria - Saving and investment 2.9. Bulgaria - Effective exchange rates 2.10. Bulgaria - Foreign ownership and concentration in the banking sector 2.11. Bulgaria - Selected banking sector soundness indicators 2.12. Bulgaria - Recent development of the financial system relative to the euro area

3.1.Czechia - Inflation criterion 3.2.Czechia - HICP inflation 3.3.Czechia - Inflation, productivity and wage trends 3.4.Czechia - CZK/EUR exchange rate 3.5.Czechia - 3-M Pribor spread to 3-M Euribor 3.6.Czechia - Long-term interest rate criterion 3.7.Czechia- Long-term interest rates 3.8.Czechia - Saving and investment 3.9.Czechia - Effective exchange rates 3.10.Czechia - Foreign ownership and concentration in the banking sector 3.11.Czechia - Selected banking sector soundness indicators 3.12.Czechia - Recent development of the financial system relative to the euro area 4.1. Croatia - Inflation criterion 4.2. Croatia - HICP inflation 4.3. Croatia - Inflation, productivity and wage trends 4.4. Croatia - HRK/EUR exchange rate 4.5. Croatia - 3-M Zibor(1) spread to 3-M Euribor 4.6. Croatia - Long-term interest rate criterion 4.7. Croatia - Long-term interest rates 4.8. Croatia - Effective exchange rates

4.9. Croatia - Foreign ownership and concentration in the banking sector 4.10. Croatia - Selected banking sector soundness indicators 4.11. Croatia - Recent development of the financial system relative to the euro area 5.1.Hungary - Inflation criterion 5.2.Hungary - HICP inflation 5.3.Hungary - Inflation, productivity and wage trends 5.4.Hungary - HUF/EUR exchange rate 5.5.Hungary - 3-M Bubor spread to 3-M Euribor 5.6.Hungary - Long-term interest rate criterion 5.7.Hungary - Long-term interest rates 5.8.Hungary - Saving and investment 5.9.Hungary - Effective exchange rates 5.10.Hungary - Foreign ownership and concentration in the banking sector 5.11.Hungary - Selected banking sector soundness indicators 5.12.Hungary - Recent development of the financial system relative to the euro area 6.1.Poland - Inflation criterion 6.2.Poland - HICP inflation 6.3.Poland - Inflation, productivity and wage trends 6.4.Poland - PLN/EUR exchange rate 6.5.Poland - 3-M Wibor spread to 3-M Euribor

6.6.Poland - Long-term interest rate criterion 6.7.Poland - Long-term interest rates 6.8.Poland - Saving and investment 6.9.Poland - Effective exchange rates 6.10.Poland - Foreign ownership and concentration in the banking sector 6.11.Poland - Selected banking sector soundness indicators 6.12.Poland - Recent development of the financial system relative to the euro area 7.1.Romania - Inflation criterion 7.2.Romania - HICP inflation 7.3.Romania - Inflation, productivity and wage trends 7.4.Romania - RON/EUR exchange rate 7.5.Romania - 3-M Robor spread to 3-M Euribor 7.6.Romania - Long-term interest rate criterion 7.7.Romania - Long-term interest ratescent 7.8.Romania - Saving and investment 7.9.Romania - Effective exchange rates 7.10.Romania - Foreign ownership and concentration in the banking sector 7.11.Romania - Selected banking sector soundness indicators 7.12.Romania - Recent development of the financial system relative to the euro area 8.1.Sweden - Inflation criterion

8.2.Sweden - HICP inflation 8.3.Sweden - Inflation, productivity and wage trends 8.4.Sweden - SEK/EUR exchange rate 8.5.Sweden - 3-M Stibor spread to 3-M Euribor 8.6.Sweden - Long-term interest rate criterion 8.7.Sweden - Long-term interest rates 8.8.Sweden - Saving and investment 8.9.Sweden - Effective exchange rates 8.10.Sweden - Foreign ownership and concentration in the banking sector 8.11.Sweden - Selected banking sector soundness indicators 8.12.Sweden - Recent development of the financial system relative to the euro area LIST OF Boxes 1.1.Article 140 of the Treaty 1.2.Assessment of price stability and the reference value 1.3.Excessive deficit procedure 1.4.A reinforced approach to ERM II participation by means of upfront policy commitments by the applicant Member States 1.6.The Macroeconomic Imbalance Procedure (MIP) 1.5.Data for the interest rate convergence

LIST OF Maps No table of contents entries found. 1.report PROPER 1.1.Role of the report The euro was introduced on 1 January 1999 by eleven Member States. Since then, Greece (2001), Slovenia (2007), Cyprus and Malta (2008), Slovakia (2009), Estonia (2011), Latvia (2014) and Lithuania (2015) have also adopted the euro. Member States for which the Council has not yet decided that they fulfil the necessary conditions for the adoption of the euro are referred to as "Member States with a derogation". Article 140 of the Treaty lays down provisions and procedures for examining the convergence situation of Member States with a derogation (Box 1.1). At least once every two years, or at the request of a Member State with a derogation, the Commission and the European Central Bank (ECB) prepare Convergence Reports for such Member States. Denmark negotiated an opt-out arrangement before the adoption of the Maastricht Treaty () and does not participate in the third stage of EMU. Until Denmark indicates that it wishes to participate in the third stage and adopt the euro, it is not the subject of an assessment as to whether it fulfils the necessary conditions for such a participation. In 2018, the Commission and the ECB adopted their latest regular Convergence Reports (). None of the Member States assessed in those reports was deemed to meet the necessary conditions for adopting the euro. In 2020, two years will have elapsed since the last regular reports were prepared. Denmark has not expressed a wish to enter the third stage of EMU (). Therefore, this convergence assessment covers Bulgaria, Czechia, Croatia, Hungary, Poland, Romania and Sweden. This Commission Staff Working Document is a Technical Annex to the Convergence Report 2020 and includes a detailed assessment of the progress with convergence, as required by Article 140(1) of the Treaty.

The 2008-2009 financial and economic crisis, along with the euro-area sovereign debt crisis, had revealed certain gaps in the economic governance system of the Economic and Monetary Union (EMU) and showed that its instruments need to be strengthened and used more comprehensively. With the aim of ensuring a sustainable functioning of EMU, an overall strengthening of economic governance in the Union has been undertaken. Accordingly, this Commission Staff Working Document makes references where appropriate to procedures that help to strengthen the assessment of each Member States' convergence process and its sustainability. In particular, it incorporates references to the strengthened surveillance of macroeconomic imbalances (see sub-section 1.2.6.). The COVID-19 pandemic represents a severe shock that fundamentally disrupts the economy of the EU and of its Member States. Accordingly, it could have a significant impact on economic convergence indicators going forward, making it more difficult to assess the sustainability of convergence. However, the impact of the COVID-19 pandemic on the historical data used in the 2020 Convergence Report is limited. This is mainly due to the constraints imposed by its cut-off date, which together with the Treaty-defined calculation methods of the price stability and long-term interest rate criteria (i.e. one year averages have to be used), mean that the corresponding data still largely reflect the situation prior to the COVID-19 pandemic. Furthermore, the latest Commission assessment of macroeconomic imbalances has also taken place before the pandemic (see Box 1.6). The implications of the COVID-19 pandemic for the forward-looking elements of this Report are taken into account through inputs from the Commission services’ Spring 2020 Forecast, i.e. using the latest available Commission forecast. This forecast is the first comprehensive assessment from the Commission of the likely economic effects of the COVID-19 crisis in 2020 and 2021, and as such, it is surrounded by higher than usual uncertainty. The remainder of the first chapter presents the methodology used for the application of the assessment criteria. Chapters 2 to 8 examine, on a country-by-country basis, the fulfilment of the convergence criteria and other requirements in the order in which they appear in Article 140(1) (see Box 1.1). The cut-off date for the statistical data included in this Convergence Report was 23 April 2020. 1.2.Application of the criteria In accordance with Article 140(1) of the Treaty, the Convergence Reports shall examine the compatibility of national legislation with Articles 130 and 131 of the Treaty and the Statute of the European System of Central Banks (ESCB) and of the European Central Bank. The reports shall also examine the achievement of a high degree of sustainable convergence by reference to the fulfilment of the four convergence criteria dealing with price stability, public finances, exchange rate stability and long term interest rates as well as some additional factors. The four convergence criteria are developed further in a Protocol annexed to the Treaty (Protocol No 13 on the convergence criteria). 1.2.1.Compatibility of legislation In accordance with Article 140(1) of the Treaty, the legal examination includes an assessment of compatibility between a Member State’s legislation, including the statute of its national central bank, and Article 130 and 131 of the Treaty. This assessment mainly covers three areas. ·First, the independence of the national central bank and of the members of its decision-making bodies, as laid down in Article 130, must be assessed. This assessment covers all issues linked to a national central bank's institutional, financial independence and to the personal independence of the members of its decision-making bodies. ·Second, in accordance with Articles 123 and 124 of the Treaty, the compliance of the national legislation is verified against the prohibition of monetary financing and privileged access. The prohibition of monetary financing is laid down in Article 123(1) of the Treaty, which prohibits overdraft facilities or any other type of credit facility with the ECB or the central banks of Member States in favour of Union institutions, bodies, offices or agencies, central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of Member States; and the purchase directly from these public sector entities by the ECB or central banks of debt instruments. As regards the prohibition on privileged access, the central banks, as public authorities, may not take measures granting privileged access by the public sector to financial institutions if such measures are not based on prudential considerations. ·Third, the integration of the national central bank into the ESCB has to be examined, in order to ensure that at the latest by the moment of euro adoption, the objectives of the national central bank are compatible with the objectives of the ESCB as formulated in Article 127 of the Treaty. The national provisions on the tasks of the national central bank are assessed against the relevant rules of the Treaty and the ESCB/ECB Statute. 1.2.2.Price stability The price stability criterion is defined in the first indent of Article 140(1) of the Treaty: “the achievement of a high degree of price stability; this will be apparent from a rate of inflation which is close to that of, at most, the three best performing Member States in terms of price stability”. Article 1 of the Protocol on the convergence criteria further stipulates that “the criterion on price stability […] shall mean that a Member State has a price performance that is sustainable and an average rate of inflation, observed over a period of one year before the examination, that does not exceed by more than 1.5 percentage points that of, at most, the three best performing Member States in terms of price stability. Inflation shall be measured by means of the consumer price index on a comparable basis, taking into account differences in national definitions”. Since national consumer price indices (CPIs) diverge substantially in terms of concepts, methods and practices, they do not constitute the appropriate means to meet the Treaty requirement that inflation must be measured on a comparable basis. To this end, the Council adopted on 23 October 1995 a framework regulation () setting the legal basis for the establishment of a harmonised methodology for compiling consumer price indices in the Member States. This process resulted in the production of the Harmonised Indices of Consumer Prices (HICPs), which are used for assessing the fulfilment of the price stability criterion. As has been the case in past convergence reports, a Member State’s average rate of inflation is measured by the percentage change in the arithmetic average of the last 12 monthly indices relative to the arithmetic average of the 12 monthly indices of the previous period. The reference value is calculated as the arithmetic average of the average rate of inflation of the three 'best-performing EU Member States in terms of price stability' plus 1.5 percentage points (see Box 1.2). (Continued on the next page)

Box (continued) Accordingly, the reference value is currently 1.8%, based on the data of Portugal (0.2%), Cyprus (0.4%), and Italy (0.4%) over the 12-month period covering April 2019-March 2020. The Protocol on the convergence criteria not only requires Member States to have achieved a high degree of price stability but also calls for a price performance that is sustainable. The requirement of sustainability aims at ensuring that the degree of price stability and inflation convergence achieved in previous years will be maintained after adoption of the euro. This deserves particular attention as the Global Financial Crisis exposed unsustainable price developments in many EU Member States, including euro area countries, in the pre-crisis period. Inflation sustainability implies that the satisfactory inflation performance must essentially be due to the adequate behaviour of input costs and other factors influencing price developments in a structural manner, rather than reflecting the influence of cyclical or temporary factors. Therefore, this Technical Annex also takes account of the role of the macroeconomic situation and cyclical position in the inflation performance, of developments in unit labour costs as a result of trends in labour productivity and nominal compensation per head, and of developments in import prices to assess how external price developments have impacted on domestic inflation. Similarly, the impact of administered prices and indirect taxes on headline inflation is also considered. From a forward-looking perspective, the report includes an assessment of medium-term prospects for price developments. The analysis of factors that have an impact on the inflation outlook – cyclical conditions, labour market developments and credit growth – is complemented by a reference to the most recent Commission services’ forecast of inflation. That forecast can subsequently be used to assess whether the Member State is likely to meet the reference value also in the months ahead (). Medium-term inflation prospects are also assessed by reference to the economies' key structural characteristics, including the functioning of the labour and product markets. (Continued on the next page) Box (continued) 1.2.3.Public finances The convergence criterion dealing with the government budgetary position is defined in the second indent of Article 140(1) of the Treaty as “the sustainability of the government financial position; this will be apparent from having achieved a government budgetary position without a deficit that is excessive as determined in accordance with Article 126(6)”. Furthermore, Article 2 of the Protocol on the convergence criteria states that this criterion means that “at the time of the examination the Member State is not the subject of a Council decision under Article 126(6) of the said Treaty that an excessive deficit exists”. The convergence assessment in the budgetary area is thus directly linked to the excessive deficit procedure which is specified in Article 126 of the Treaty and further clarified in the Stability and Growth Pact (see Box 1.3 for further information on the excessive deficit procedure as strengthened by the 2011 reform of the Stability and Growth Pact). The details of the excessive deficit procedure are defined in Regulation 1467/97 as amended in 2005 and 2011 which sets out the way in which government deficit and debt levels are assessed to determine whether an excessive deficit exists, under article 126 of TFEU. The convergence assessment in the budgetary area is therefore judged by whether the Member State is subject to a Council decision under 126(6) on the existence of an excessive deficit (). 1.2.4.Exchange rate stability The Treaty refers to the exchange rate criterion in the third indent of Article 140(1) as “the observance of the normal fluctuation margins provided for by the exchange-rate mechanism of the European Monetary System, for at least two years, without devaluing against the euro”. Article 3 of the Protocol on the convergence criteria stipulates: “The criterion on participation in the exchange rate mechanism of the European Monetary System […] shall mean that a Member State has respected the normal fluctuation margins provided for by the exchange-rate mechanism of the European Monetary System without severe tensions for at least the last two years before the examination. In particular, the Member State shall not have devalued its currency’s bilateral central rate against the euro on its own initiative for the same period” (). Based on the Council Resolution on the establishment of the ERM II (), the European Monetary System has been replaced by the Exchange Rate Mechanism II upon the introduction of the euro, and the euro has become the centre of the mechanism. In its assessment of the exchange rate stability criterion, the Commission takes into account developments in auxiliary indicators such as foreign reserve developments and short-term interest rates, as well as the role of policy measures, including foreign exchange interventions, and international financial assistance wherever relevant, in maintaining exchange rate stability. In principle, the assessment of this criterion verifies the participation in ERM II and examines exchange rate behaviour within the mechanism. As currently none of the Member States assessed in this Convergence Report participates in ERM II, de facto exchange rate stability is reviewed for analytical purposes (see Box 1.4 for further information on ERM II participation). The relevant period for assessing exchange rate stability in this Technical Annex is 24 April 2018 to 23 April 2020. 1.2.5.Long-term interest rates The fourth indent of Article 140(1) of the Treaty requires that “the durability of convergence achieved by the Member State with a derogation and of its participation in the exchange rate mechanism” is “reflected in the long-term interest rate levels”. Article 4 of the Protocol on the convergence criteria further stipulates that “the criterion on the convergence of interest rates […] shall mean that, observed over a period of one year before the examination, a Member State has had an average nominal long-term interest rate that does not exceed by more than two percentage points that of, at most, the three best performing Member States in terms of price stability. Interest rates shall be measured on the basis of long-term government bonds or comparable securities, taking into account differences in national definitions” (see Box 1.5). (Continued on the next page)

Box (continued) For the assessment of the criterion on the convergence of interest rates, yields on benchmark long-term bonds have been taken, using an average rate over the latest 12 months. The reference value for March 2020 is calculated as the simple average of the average long-term interest rates in Portugal (0.5%), Cyprus (0.8%) and Italy (1.6%), plus 2 percentage points, yielding a reference value of 2.9%. 1.2.6.Additional factors Article 140(1) TFEU also requires that the reports take into account other factors relevant to economic integration and convergence. These additional factors include financial, product and labour market integration and the development of the balance of payments. The analysis of the development of unit labour costs and other price indices, which is also prescribed by Article 140 of the Treaty, is covered in the price stability section. The assessment of additional factors gives an important indication of a Member State's ability to integrate into the euro area without difficulties. As regards the balance of payments, the focus is on the situation and development of the external balance (). Market integration is assessed through trade, foreign direct investment and a smooth functioning of the internal market. Moreover, progress in financial integration is examined, together with the main characteristics, structures and trends of the financial sector. Given that Member States which adopt the euro also participate in the banking union, developments in national banking sectors are specifically looked at as well. Starting with the 2012 Convergence Report, the convergence assessment is aligned with the broader European Semester approach which takes an integrated look at the economic policy challenges facing EMU in ensuring fiscal sustainability, competitiveness, financial market stability and economic growth (). The section on additional factors makes reference to the surveillance of macroeconomic imbalances under the Macroeconomic Imbalance Procedure, which was adopted in December 2011 as one of the key elements of the legislative package (the "Six-Pack") to enhance the governance structures in EMU, and integrates its results into the assessment (see Box 1.6). 2.1.LEGAL COMPATIBILITY 2.1.1.Introduction The legal basis for the Bulgarska Narodna Banka (BNB – central bank of Bulgaria), the Law on the Bulgarian National Bank (the BNB Law) of 1997, has been amended since the 2018 Convergence Report. Bulgarian authorities have amended the BNB Law to remedy certain incompatibilities highlighted in the Commission's 2018 Convergence Report(). In particular, it concerns issues flagged in previous convergence reports in the section on central bank independence. Other issues remain unresolved. Therefore, certain comments provided in the 2018report are repeated also in this year's assessment. 2.1.2.Central Bank independence Regarding the rules on a possible removal of the Governor from office, Article 14(1) of the BNB Law has been amended. It now provides that the competent authority may only remove a member of the Governing Council from office if he no longer fulfils the conditions required for the performance of his duties or if he has been found guilty of serious misconduct. This provision is compatible with Article 14.2 of the ESCB/ECB Statute. The Conflict of Interest Prevention and Ascertainment Act of 2008, which regarding the possibility to dismiss the Governor of the BNB had to be brought in line with Article 14.2 of the ESCB/ECB Statute, was fully repealed and replaced by the Act on Corruption Counteraction and Eviction of Illegally Acquired Property of 2018 (). However, similar to the repealed Act, Article 80(1) in conjunction with Article 6(1)(12) of the new Act provides that the ascertainment of a conflict of interest is a ground for dismissal of the Governor of the BNB. Thus, an incompatibility remains. It should be specified that a dismissal of the Governor is only admissible if, as set out in Article 14.2 of the ESCB/ECB Statute, the ascertainment of a conflict of interest corresponds to a lack of fulfilment of the conditions required for the performance of the Governor's duties or a serious misconduct of which the Governor has been guilty within the meaning of Article 14 (1) of the BNB Law. Pursuant to Article 12(1) of the BNB Law, the Governor shall be elected by the National Assembly. The National Assembly has taken the view that it has the power to annul or amend its decisions, including decisions under Article 12(1) of the BNB Law. The National Assembly has substantiated this assertion by stating that pursuant to a Constitutional Court decision of 26 February 1993, the Bulgarian Constitution does not explicitly prohibit the National Assembly from amending or annulling its decisions. Such understanding would allow the dismissal of the Governor under conditions other than those mentioned in Article 14.2 of the ESCB/ECB Statute. It should be ensured that the Governor, when properly elected or appointed, may not be dismissed under conditions other than those mentioned in Article 14.2 of the ESCB/ECB Statute. Article 13(2) of the BNB Law foresees that the Governor of the BNB shall swear an oath before the Parliament. The content of the oath laid down in paragraph one of the same provision refers inter alia to abiding by law and to contribute to the performance of the functions of the BNB. The Governor of the BNB acts in dual capacity as a member of BNB’s decision-making bodies and of the relevant decision-making bodies of the ECB. Article 13 of the BNB Law needs to be adapted to reflect the status and the obligations and duties of the Governor of the BNB as member of the relevant decision-making bodies of the ECB. Moreover, the oath does not contain a reference to central bank independence as enshrined in Article 130 of the TFEU. The oath as it stands now is an imperfection and should be remedied.

Article 44 of the BNB Law has been amended since the 2018 Convergence Report with a view to achieving compatibility with Article 130 of the TFEU and Article 7 of the ESCB/ECB Statute. The amended Article 44 of the BNB Law now also encompasses a reference, as suggested in the previous report, that the BNB and members of the Governing Council, in the performance of their tasks, shall be independent and shall not seek or take any instructions from foreign and EU institutions or bodies. However, an imperfection remains in the second sentence of Article 44 of the BNB Law where it refers to the public institutions and bodies not having the right to influence the BNB, the Governor and the members of the Governing Council. The wording should be further improved by referring to the wording of Article 130 of the TFEU, which states that public authorities may not seek to influence the members of national central banks’ decision-making bodies. In this context, it is also noted that Article 3 of the BNB Law provides that "in the formulation of the general outlines of the monetary policy, the BNB and the Council of Ministers shall inform each other". This procedure provides for the opportunity for the government to exert ex ante influence on the monetary policy of the BNB. As from the date of the formal adoption of the euro in Bulgaria or after the currency board has been suspended this might constitute an incompatibility in the area of independence, with Article 130 of the TFEU and Article 7 of the ESCB/ECB. 2.1.3.Prohibition of monetary financing and privileged access Since the 2018 Convergence Report, Article 45(1) and (2) of the BNB Law, which were not fully consistent with Article 123 of the TFEU and Article 21.1 of the ESCB/ECB Statute have been amended with a view to including all European and other national public entities mentioned in Article 123(1) of the TFEU and Article 21.1 of the ESCB/ECB Statute. However, an imperfection remains given the original list of national entities referred to in Article 45(1) was maintained. The imperfection in the latter provision referred to in the 2018 Convergence Report regarding the scope of public sector debt that can be purchased by a national central bank has been solved. In addition, Article 45(3) of the BNB Law was amended since the 2018 Convergence Report. It provides that the BNB shall not purchase in the primary and secondary markets public debt instruments. This paragraph is inconsistent with the amended Article 45(1) of the BNB Law and with Article 123 of the TFEU given the word ‘direct’ refers to the prohibition to purchase debt instruments on the primary market only. Purchases on the secondary market are not prohibited unless they qualify as a circumvention of the objective of Article 123 of the TFEU. For this reason, the wording ‘and secondary” in Article 45(3) should be removed. In addition, since the first paragraph of Article 45 of the BNB Law already covers the prohibition to buy directly debt instruments, i.e. on the primary market, the third paragraph’s content becomes redundant after adjustment. Pursuant to Article 45(2) in conjunction with Article 33(2) of the BNB Law, Article 45(1) of the BNB Law does not apply to the extension of credits to state-owned and municipal banks in emergency cases of liquidity risk that may affect the stability of the banking system. The scope of this exemption should be amended to be fully consistent with the wording of Article 123(2) of the TFEU and Article 21.3 of the ESCB/ECB Statute. 2.1.4.Integration in the ESCB Objectives The secondary objective of the BNB (Article 2(2) of the BNB Law) is compatible with the Treaty on the Functioning of the European Union. Article 2(1) of the BNB Law correctly reflects that the primary objective of the BNB is to maintain price stability. However, as from the day that Bulgaria adopts the euro, the latter will replace the national currency (lev) in accordance with Article 140 (3) of the TFEU. The reference to the wording ‘through ensuring the stability of the national currency’ will become obsolete as from that day. The incompatibilities in the BNB Law are linked to the following ESCB/ECB tasks: ·absence of a general reference to the BNB as an integral part of the ESCB (Article 1(1) of the BNB Law) and to its subordination to the ECB’s legal acts (Articles 16 (1) and (2) and 60 of the BNB Law); ·definition of monetary policy and monetary functions, operations and instruments of the ESCB (Articles 2(1) and (3), 16(4) and (5), 28, 29, 30, 31, 32, 33, 35, 38, 41 and 61 of the BNB Law); ·conduct of foreign exchange operations and the definition of foreign exchange rate policy (Articles 20(1), 28, 29, 30, 31, 32 of the BNB Law); ·right to authorise the issue of banknotes and the volume of coins (Articles 2(5), 16(9), 24 to 27 of the BNB Law); · non-recognition of the role of the ECB in the field of international cooperation (Articles 5, 16(12) and 37(4) of the BNB Law); ·ECB's right to impose sanctions (Article 61, 62 of the BNB Law). There are also numerous imperfections regarding: ·non-recognition of the role of the ECB in the functioning of the payment systems (Articles 2(4) and 40(1) of the BNB Law); ·non-recognition of the role of the ECB and the EU in the collection of statistics (Article 4(1) and 42 of the BNB Law);

·non-recognition of the role of the ECB and of the Council in the appointment of the external auditor (Article 49(4) of the BNB Law); ·absence of an obligation to comply with the Eurosystem's regime for the financial reporting of NCB operations (Article 16(11), 46 and 49 of the BNB Law). 2.1.5.Assessment of compatibility The Commission welcomes the efforts of Bulgarian authorities to remedy the incompatibilities and imperfections in comparison to its previous 2018 Convergence Report. However, the BNB Law and the Conflict of Interest Prevention and Ascertainment Act are not yet fully compatible with Article 131 of the TFEU as regards central bank independence, the prohibition of monetary financing and the integration in the ESCB at the time of euro adoption. 2.2.Price stability 2.2.1.Respect of the reference value The 12-month average inflation rate, which is used for the convergence assessment, was below the reference value at the time of the last convergence assessment of Bulgaria in 2018. It then increased to 3.0% by April 2019, before decreasing to 2.4% by November 2019. In March 2020, the reference value was 1.8%, calculated as the average of the 12-month average inflation rates in Portugal, Cyprus and Italy plus 1.5 percentage points. The corresponding inflation rate in Bulgaria was 2.6%, i.e. 0.8 percentage points above the reference value. The 12-month average inflation rate is projected to approach the reference value in the months ahead. 2.2.2.Recent inflation developments The annual HICP inflation rose from 1.7% in April 2018 to 3.7% by August and returned to 2.3% by end-2018. It then increased to 3.1% by April 2019, before falling back to 1.6% by September. Inflation then started to rise again, reaching 3.4% in January 2020 and then fell to 2.4% in March. The fluctuation of inflation was mainly driven by energy and unprocessed food prices. Fuel price increases propped up inflation between May and November 2018, in the first five months of 2019 and then again in the end of 2019 and the two months of 2020. Their contribution turned negative, following the depressed oil prices in the second half of 2019 and again in March 2020. Unprocessed food prices spiked in 2018 due to a bad harvest and higher international grain prices. High unprocessed food inflation continued in 2019, following the outbreak of the African swine fever in April and higher import prices of meat. Inflation rates in Bulgaria have exceeded those of the euro area over the past two years. Core inflation (measured as HICP inflation excluding energy and unprocessed food) hovered around 2.5% over the last two years. It remained below headline inflation in most of 2018. In 2019, core inflation was close to the headline figure and remained below overall inflation between December 2019 and February 2020. Inflation in processed food gathered pace over the last two years, reflecting both higher international food prices and domestic factors, such as higher prices of unprocessed food. Inflation in services also picked up in 2018 and 2019, reaching 6.1% in August 2018 and 4.3% in July 2019. The cyclical upturn and the convergence process sustained the dynamics in prices of services over those two years. Specific factors have also contributed to services inflation. Higher food prices fed into higher prices for catering services. Statistical effects and a more pronounced seasonality pushed up prices of accommodation services during the summer months of 2018 and 2019. Sharp increases in car insurance premiums in mid-2018 also added to annual inflation in 2018 and early 2019. Prices of non-energy industrial goods had a negligible effect on overall price movements. 2.2.3.Underlying factors and sustainability of inflation Macroeconomic policy mix and cyclical stance Real GDP growth accelerated from 3.1% in 2018 to 3.4% in 2019, despite relatively weaker external demand and higher uncertainty abroad. Private consumption was the main driving force of economic growth on the back of rapid wage growth and high employment. Overall investment growth was moderate, although favourable financing conditions and high capacity utilisation were in place. Export growth slowed in 2018, mainly in relation with the external trade slowdown with major trading partners and temporary one-off factors (i.e. closure of oil refinery) and became volatile in the course of 2019. Net exports had a sizable negative contribution to GDP growth in 2018, while in 2019 the contribution was less negative at -0.3%. According to the Commission services’ Spring 2020 Forecast, real GDP is expected to contract sharply by 7.2% in 2020 due to the coronavirus pandemic and then to recover by 6% in 2021 on the back of a relatively swift rebound in private consumption and exports. Output gap is projected to turn deeply negative in 2020 and then recover only partially, remaining below zero in 2021. The fiscal stance, as measured by the change in the structural balance, was tightened in 2018 and loosened in 2019, but was overall broadly neutral over the two years. According to the Commission services' Spring 2020 Forecast, the fiscal stance is set to be expansionary in the current and next year. The BNB pursues its primary objective of price stability through an exchange rate anchor in the context of a currency board arrangement (CBA) with the lev pegged to the euro. The CBA serves as a key macroeconomic policy anchor. Wages and labour costs Employment rates continued to increase in 2018 and 2019. The improved prospects for employment and higher wages attracted more working age population to the labour market, thus increasing the activity rates. The unemployment rate continued its downward trend, reaching historically low levels of 5.2% in 2018 and 4.2% in 2019. However, the imposition of containment measures against the COVID-19 pandemic already caused job losses in the first months of 2020. Job losses are set to be most pronounced in the services sector (which accounts for more than 60% of employment), where the disruption is likely to last longest. According to the Commission services' Spring 2020 Forecast, the unemployment rate is expected to jump to 7% in 2020, after having declined to historic lows of around 4% in 2019. Government measures to support employment in hard-hit sectors are expected to cushion the impact of the crisis on the labour market. The government has taken measures to protect employment, notably a new short-time work scheme according to which the State will cover 60% of the wages of employees in companies with a proven impact from the crisis. Nominal compensation per employee increased by 9.7% in 2018 and 7.8% in 2019, owing to the tight labour market and wage convergence pressures.

Labour productivity growth hovered around 3% in 2018 and 2019. It is projected to decrease by 4.8% in 2020 due to partial labour hoarding and recover in 2021. Nominal unit labour cost (ULC) growth remained high at 6.3% in 2018 and then decelerated to 3.0% in 2019 while labour market tightness and skill shortages persisted. According to the Commission services' Spring 2020 Forecast, ULC growth is expected to strongly increase in 2020 as labour hoarding would cause a sharp drop in productivity. ULC dynamics are projected to slow down somewhat in 2021 alongside the recovery. External factors Given the high openness of the Bulgarian economy, developments in import prices play an important role in domestic price formation. Import prices of mineral fuels, food and other manufactured articles, including clothing and footwear, are particularly relevant for inflation in Bulgaria, due to the high energy intensity of the Bulgarian economy and the relatively large share of manufactured goods in the consumer basket. In 2018, growth in the import deflator stood at 2.2%, pushed up by higher oil and gas prices as well as prices of some non-durable consumer products. In 2019, growth in the import deflator was close to zero, as prices of mineral fuels dropped sharply and inflation in imported consumer goods decelerated. Over the last two years, the appreciating nominal effective exchange rate (NEER) decreased import price dynamics. The lev’s NEER (measured against a group of 36 trading partners), which is determined by the price of the lev (and therefore the euro) vis-à-vis the currencies of major trade partners, appreciated by 3.4% in 2018 and by 0.6% in 2019. The appreciation in 2018 was strongly influenced by the depreciation of the Turkish lira against the euro. Turkey is the most important trading partner for Bulgaria outside the EU, with 8% of total exports and 6% of total imports. Administered prices and taxes The growth rate of administered prices accelerated in 2019, reaching 2.6% on the back of increases in utilities prices and (tertiary) education fees. Administered prices inflation remained below overall HICP in 2018 and slightly surpassed headline consumer price inflation in 2019. The share of administered prices in the HICP basket is relatively high at around 16%, compared to 12% in the euro area. Regulated prices of electricity, heat and water follow a seasonal pattern, as they are usually updated at the beginning of the year or in the summer months. Indirect tax changes had only a small positive effect on inflation over the last two years. Annual constant-tax HICP was thus slightly below headline inflation during the assessment period. Medium-term prospects Annual HICP inflation is expected to decline significantly in 2020 before stabilizing at a low level in 2021. Following the oil price collapse at the beginning of 2020, energy prices are set to push inflation downwards substantially in 2020 and the beginning of 2021. In 2020, services inflation is projected to decline given the demand reduction in sectors that are affected by the imposed lockdown due to the COVID-19 outbreak as well as by the negative cyclical position of the economy. Inflation of processed and unprocessed food prices is forecast to gradually decelerate, as price pressures in the beginning of 2020 are expected to abate. Average annual inflation is projected at 1.1% for both 2020 and 2021. Risks to the inflation outlook appear broadly balanced. However, the interplay between supply and demand constraints related to the COVID-19 pandemic presents additional uncertainty to the inflation forecast. The level of consumer prices in Bulgaria stood at about 49% of the euro area average in 2018. This suggests that there is a significant potential for price level convergence in the long term, as GDP per capita in PPS (about 48% of the euro-area average in 2018) increases towards the euro-area average. Medium-term inflation prospects will depend on wage and productivity developments as well as on the functioning of product and services markets. These developments may be substantially affected by the COVID-19 crisis. Given the openness of the Bulgarian economy and its limited resource base, commodity prices and other external price shocks will continue to exercise significant influence on domestic inflation. 2.3.Public finances 2.3.1.Recent fiscal developments The general government budget registered surpluses of 2% of GDP in 2018 and 2019. The overall improvement in budget surpluses relative to the previous years was mostly driven by higher revenue. Total public revenue increased by more than 2 percentage points of GDP between 2017 and 2019, to 38.4%. This increase reflects improvements in tax collection and higher transfers from the EU. Moreover, a large part of the increase in the level of total revenue (by around 1 percentage point of GDP) was due to the introduction of a fee on electricity supply in favour of the national energy security fund in 2018. This change, however, does not affect the government balance as it is matched with an equal increase in expenditure through subsidies. In this context, the expenditure-to-GDP ratio increase by 1.4 percentage points between 2017 and 2019 to 36.3%, mainly due to wage increases in education and a recovery in public investment from a very low level in 2017. The main driving forces of public investment were the picking up in EU funded projects and some investment in road infrastructure and defence. The general government balance was 2.1% of GDP in 2019, overshooting the target of -0.3% of GDP in the 2019 Convergence Programme. The better outcome is mainly due to better than projected revenue and lower than planned public investment. In structural terms, after the peak of 2018 at around 1.3% of GDP the surplus returned to 1% of GDP in 2019. The general government debt declined from around 25% of GDP in 2017 to close to 20% of GDP in in 2019. 2.3.2.Medium-term prospects

The 2020 budget was originally adopted by Parliament in December 2019 and aimed at a balanced general government budget in cash terms, corresponding to a close to balanced budget in ESA terms. The budget envisaged an increase in all public wages by 10% and for some categories of teaching staff by 17% and no new measures on the revenue side. The medium term plan of the government up to 2022 was to maintain a balanced budget and to continue decreasing debt. In April 2020, the Parliament amended the budget law to take into account a deteriorated economic outlook and the new budgetary plans of the government in response to the COVID-19 pandemic. The updated 2020 budget envisages a deficit slightly over 3% of GDP in cash terms, as the overall impact of the pandemic on the budget is estimated to be close to 5 percentage points of GDP relative to the previous year. This is mainly due to the deteriorated macroeconomic outlook, which is expected to lead to lower revenues from taxes and social security contributions and a higher spending on unemployment and social benefits. Moreover, as part of the package of measures to contain the pandemic and its impact, the government announced a higher spending on medical equipment and wage bonuses and increases for the medical and security staff, as well as subsidies, tax deferrals, state guarantees and a reallocation of investment funds to support the economy. According to the Commission services’ Spring 2020 Forecast, the deficit of the general government balance in ESA terms is set to reach 2.8% of GDP in 2020 and to slightly diminish to 1.8% of GDP in 2021 (assuming unchanged policies), mainly due to the positive impact of higher economic growth on revenues and the fading impact of some expenditure measures. Taking into account the estimated positive output gap, the structural deficit is projected to be in the neighbourhood of -1.5% of GDP in both 2020 and 2021. The public-debt-to-GDP ratio is forecast to increase to 25.5% of GDP in 2020 and remain at that level in 2021. The rise in general government debt is mainly driven by a return to primary deficits, the contraction in GDP and certain measures to support liquidity in the economy (e.g. the capital strengthening of the Bulgarian Development Bank to provide state guaranteed loans) that do not affect the deficit but do weigh on debt. The Bulgarian fiscal framework has been strengthened over the recent years. It should be recalled that Bulgaria is bound (based on its own declaration of intention) by the Fiscal Compact provisions of the intergovernmental Treaty on Stability, Coordination and Governance in the Economic and Monetary Union (TSCG)() and has transposed those requirements in the national legal order. Based on the Commission’s Fiscal Governance Database, Bulgaria has in place no less than nine domestic numerical rules (highest number in the EU), with a recently improving trend of compliance. Based on its broad remit, the Fiscal Council has gradually established its system for releasing its mandatory monitoring reports on the annual and medium-term fiscal plans and compliance with all the numerical rules laid down in the Public Finance Act. The mandate of the Council was further extended in 2019 to include regular and comprehensive ex post evaluations of the government’s macroeconomic and budgetary forecasts (the first evaluation is yet to be released). 2.4.Exchange rate stability The Bulgarian lev does not participate in ERM II. In July 2018, Bulgaria announced its intention to put in place the necessary elements for a successful entry into ERM II. In order to ensure a smooth transition to, and participation in, ERM II, Bulgaria committed to implement before joining the ERM II a number of measures (i.e. prior-commitments) in the following six policy areas: banking supervision, macro-prudential framework, supervision of non-banking financial sector, insolvency framework, anti-money laundering framework, governance of state-owned enterprises. Bulgaria is currently working towards the completion of these prior-commitments, in close liaison with the Commission and the ECB who monitor their progress. Bulgaria introduced its CBA on 1 July 1997, pegging the Bulgarian lev to the German mark and subsequently to the euro (at an exchange rate of 1.95583 BGN/EUR). Under the CBA, the BNB’s monetary liabilities have to be fully covered by its foreign reserves. The BNB is obliged to exchange monetary liabilities and euro at the official exchange rate without any limit. Bulgaria's international reserves hovered around EUR 25 billion in 2019, after having increased from EUR 22.6 billion at the beginning of 2018 to around EUR 25 billion at the end of the same year. International reserves increased in the course of 2018 on account of inflows of EU funds and the related net purchases of euros by the BNB. As international reserves were broadly stable in 2019 compared to 2018, their share as a percentage of GDP declined slightly to below 41% from around 45% at the end of 2017. The BNB does not set monetary policy interest rates. The domestic interest rate environment is directly affected by the monetary policy of the euro area through the operation of Bulgaria's CBA. The BNB discontinued the production of short-term reference rates (e.g. SOFIBOR) as of 1 July 2018.() 2.5.Long-term interest rates Long-term interest rates used for the convergence examination reflect the secondary market yield on a single benchmark Bulgarian government bond with a residual maturity of around 10 years. The Bulgarian 12-month moving average long-term interest rate relevant for the assessment of the Treaty criterion was below the reference value in the 2018 convergence assessment of Bulgaria. It further declined to below 1% at the end of 2018 and to below 0.50% by the end-2019. In March 2019, the reference value, given by the average of long-term interest rates in Portugal, Cyprus, and Italy plus 2 percentage points, stood at 2.9%. In that month, the 12-month moving average of the yield on the Bulgarian benchmark bond stood at 0.3%, i.e. 2.6 percentage points below the reference value. The long-term interest rate of Bulgaria has been on a downward path since the beginning of 2018, declining from close to 1% to below 0.20% in the first three months of 2020. Bulgarian benchmark bond yields fell throughout 2018-19, supported by local market conditions and continuing strong demand for government securities while their supply remained subdued. Falling long-term interest rates were supported also by external forces, i.e. expectations of loose monetary policy in the euro area for an extended period of time. After falling sharply to below 50 basis points at the beginning of 2018, the spread to German long-term benchmark bond increased somewhat, while remaining below 100 basis points, between mid-2018 and mid-2019, reflecting a sharp drop in the German long-term interest rates. The spread declined again to close to 50 basis points by end 2019, before widening only moderately to close to 70 basis points in March 2020, mainly reflecting developments in German long-term government bond yields. 2.6.Additional factors The Treaty (Article 140 TFEU) calls for an examination of other factors relevant to economic integration and convergence to be taken into account in the assessment. The assessment of the additional factors – including balance of payments developments, as well as product, labour and financial market integration – gives an important indication of a Member State's ability to integrate into the euro area without difficulties. In December 2019, the Commission published its ninth Alert Mechanism Report (AMR 2020) under the Macroeconomic Imbalance Procedure (MIP - see also Box 1.6), which concluded that an In-Depth Review (IDR) was warranted for Bulgaria. In February 2020, the Commission published its annual country report on Bulgaria, including an In-Depth Review (IDR). The report concluded that Bulgaria is experiencing no imbalances. In the past years, vulnerabilities in the financial sector were coupled with high indebtedness and non-performing loans in the corporate sector. Consistent policy action and a favourable macroeconomic environment have reduced risk and vulnerabilities further. Progress has been made in strengthening financial sector governance and addressing outstanding regulatory issues. The insolvency framework reform has been advancing. Robust economic growth has supported the reduction of corporate debt and non-performing loan ratios.

2.6.1.Developments of the balance of payments Bulgaria’s external balance (i.e. the combined current and capital accounts) continued to record surpluses in both 2018 and 2019, with the surplus rising from 2.5% of GDP in 2018 to 5.5% of GDP in 2019. This improvement was mostly driven by a substantial increase in the current account surplus, which rose to 4% in 2019 from 1.4% in 2018, on account of declining deficits of goods and primary income balances while the surplus of the balance of trade services continued to increase for the third consecutive year. The balance of goods strengthened in 2019, as nominal exports expanded faster than nominal imports. The terms of trade have also improved, supporting Bulgaria’s external position. The balance of services remained positive and strengthened further in 2019 due to lower imports of other services. Declining profits from FDI in 2019 led to improved balance of primary income. Given the high share of FDI revenues in income outflow and their volatility, they determine to a large extent the evolution of primary income balance. The surplus in secondary income increased in 2019, as the income outflow returned to normal levels following an increase in 2018. Capital account also improved on the back of higher inflows from EU funds transfers. The saving-investment gap of the Bulgarian economy increased in 2019 compared to 2018, reaching 5.5% of GDP. The higher surplus was driven by higher net savings in the private sector. The somewhat depressed investment rate in 2019, influenced by the increased uncertainty abroad, accounted for the widening of the saving-investment gap. Aggregate savings rate remained roughly constant. The financial account continued to show net outflow of capital. Increasing net deposits of commercial banks abroad, coupled with more foreign currency held domestically, account for the largest part of the financial account balance. Correspondingly, the negative Net International Investment Position (NIIP), continued to decrease rapidly. The net external liabilities consist mostly of FDI equity, which have been rather stable as a share of GDP after the crisis of 2009. The measures of price and cost competitiveness worsened somewhat in 2018 and were kept broadly unchanged in 2019. In 2018, the pace of appreciation of the real effective exchange rate (REER), deflated by ULC, slowed to 3.2% and in 2019 its level stayed roughly constant. The REER deflated by HICP appreciated moderately in 2018. By the end of 2018, it was 1.6% higher than a year earlier. It then remained at that level in 2019. The long-term trend of growing export market share continued in 2018 and 2019, suggesting that Bulgaria’s external competitiveness has been preserved so far. Productivity gains, expansion in production capacity and improvement in product sophistication indicate that non-price competitiveness factors compensated for price and cost increases. According to the Commission services’ Spring 2020 Forecast, the current account surplus is expected to deteriorate as an external demand slump is set to drive exports down in 2020. Nevertheless, the current account is projected to remain in surplus in 2020, and to improve further in 2021 on the back of a rebound in exports. 2.6.2.Market integration The economy is well integrated with the euro area through trade and investment linkages. Although the ratio of trade openness declined to close to 64% in 2019 from above 68% in 2017, Bulgaria remained a relatively open economy. Trade with the euro area was about 29% of total trade in 2019. Outside the EU, Bulgaria's main trading partners are Turkey and Russia (especially for imports). FDI inflows remained low at about 1% of GDP in 2018 and 2019. The stock of FDI amounted to some 78% of GDP in 2018 and 76% in 2019, with FDI mainly coming from the Netherlands, Austria, Germany and Italy. 27% of all FDI stock is directed to industry (excluding construction), 23% are invested in real estate, while the trade sector attracted 14% of total FDI stock. Concerning the business environment, Bulgaria performs relatively worse than many euro-area Member States in international rankings (WEF's Global Competitiveness Index, the World Bank's Ease of Doing Business). The slow pace of improvement and the lack of substantial reforms dragged Bulgaria down from the 50th place in 2017 to 61st place in the 2019 ‘Ease of Doing Business’ ranking. The major challenges relate to the institutional framework, including fighting corruption, improving the functioning of the judicial system, reducing the administrative burden on corporations, and improving the quality of public services. Shortcomings in the functioning of institutions are a significant obstacle to the economic and social potential of the country. However, action is being taken to improve the business environment, in particular regarding the insolvency framework and governance of state-owned enterprises. Bulgaria ranks low in the World Bank’s Worldwide Governance Indicators and the European Quality of Government Index. Bulgaria's transposition deficit of EU Directives has decreased by 0.6 percentage points since December 2017 (the second highest decrease amongst all Member States) to 0.7%, according to the 2019 Internal Market Scoreboard. Bulgaria now equals the EU average, but it is still above the target (0.5%) proposed by the European Commission in the Single Market Act (2011). The 4th Anti-Money Laundering Directive imposed transposition by 26 June 2017. Bulgaria communicated to the Commission several measures adopted to transpose the directive between April 2018 and November 2019. The Commission is analysing the communicated measures to assess their completeness and conformity with the directive and also in light of the prior ERM II commitments. As regards the 5th Anti-Money Laundering Directive, whose transposition deadline elapsed on 10 January 2020, Bulgaria has notified national transposition measures and declared a complete transposition. The Commission is analysing the communicated measures to assess their completeness and conformity with the directive. Beyond the transposition of the latest anti-money laundering directives, the recently completed National Risk Assessment shows weaknesses that need urgent mitigation to prevent money laundering and terrorist financing. Actions need to be designed and implemented to deliver an effective application of the anti-money laundering framework by obliged entities. The employment rate increased steadily in the past 5 years, reaching 75% in 2019 and the unemployment rate reached 3.8 % in the last quarter of 2019. However, Bulgaria’s labour market suffers from a number of vulnerabilities, such as regional disparities, skills mismatches and still high levels of inactivity in some population groups (e.g. NEETs, Roma). In a context of worsening demographics, the supply of labour has been negatively affected by high emigration and brain drain. Demographic developments strongly affect the labour market, and may constrain future economic growth. The population decreased by 50,000 in 2018, to reach nearly 7 million in January 2019. Bulgaria’s labour force is expected to decrease by 10% by 2030. The age cohort 25-49 (with a labour market participation rate of 86% on average) is expected to decline the most. Such a reduction in the available labour force might jeopardise sustainable future growth. Bulgaria's financial sector is well integrated into the EU financial sector, in particular through a high level of foreign ownership in its banking system. The share of foreign-owned institutions in total bank assets stood at 77% in 2018. Bank concentration, as measured by the market share of the five largest credit institutions in total assets, reached almost 60%, some 10 percentage points above the euro area average in 2018.

Based on the available data, the capital adequacy of the banking sector is somewhat higher than in the euro area. The average capital adequacy ratio stood at 19.5% in the third quarter of 2019, which was some 1.4 percentage points higher than in the euro area. However, according to the results of the ECB comprehensive assessment of six Bulgarian banks published on 26 July 2019 and which included an asset quality review (AQR) and a stress test, two banks faced capital shortfalls, as their capital adequacy ratios fell below some of the relevant thresholds used in the AQR and the stress test.() The ratio of NPLs to the loan portfolio held by the banking sector has fallen substantially over the last two years, but at 7.2% in the third quarter of 2019, was still more the double of the euro-area average of 3.4%. The profitability of the domestic banking sector remained well above the euro-area level, with an average return on equity (RoE) close to 13% in the third quarter of 2019. The COVID-19 pandemic could have a significant impact on the indicators analysed in this paragraph over the coming months. House prices continued to grow at a rather rapid pace of about 5% yearly in real terms, reaching 121.9% of its 2015 level in 2019. Residential investment grew at much more moderated rates of around 2.5% both in 2018 and 2109. The stock of loans for house purchases increased annually by 12.5% at the end of 2018 and by 15.1% at the end of 2019. Although growth in household debt increased due to intensified mortgage lending, it still remains among the lowest in the EU.() Relative to GDP, the financial system is much smaller in Bulgaria than in the euro area. Domestic bank credit stood at below 50% of GDP in 2019 compared to almost 90% of GDP in the euro area. The capitalization of the stock market increased to around 23% of GDP in 2019, but remained well below the euro-area average of over 70%. The debt securities market remained small in comparison with the euro area average (just over 19% vs. 148% of GDP). According to available data, the consolidated stock of private sector debt stood at 95% of GDP in 2018 and was below the euro-area average of 135%. 3.1.LEGAL COMPATIBILITY 3.1.1.Introduction The Česká národní banka (ČNB – Czech national bank, hereafter ČNB) was established on January 1, 1993. Its main legal basis is the Czech National Council Act No. 6/1993 Coll. on the Czech National Bank, adopted on 17 December 1992 (the ČNB Law). Following the Commission’s 2018 Convergence Report, the ČNB Law was only slightly amended (). However, since there have been no amendments as regards the incompatibilities highlighted in the Commission's 2018 Convergence Report, the comments made in the latter report are largely repeated in this year's assessment. 3.1.2.Central Bank independence Article 9(1) of the ČNB Law prohibits the ČNB and its Board from taking instructions from the President of Czechia, Parliament, the Government, administrative authorities, European Union institutions, any government of a Member State of the European Union or any other body. Article 9(1) of the ČNB Law needs to be adapted to fully reflect the provisions of Article 130 of the TFEU and Article 7 of the Statute and consequently expressly prohibit third parties from giving instructions to the ČNB and its Board members who are involved in the performance of ESCB-related tasks. The power for the Chamber of Deputies of the Parliament to impose modifications to the annual financial report, which was previously submitted and rejected (Article 47(5) of the ČNB Law) could hamper the ČNB’s institutional independence. Moreover, it is formulated in a very general manner, which could create situations where the Parliament requests changes affecting the financial independence of the ČNB. Thus, the current wording of Article 47(5) of the ČNB Law constitutes an incompatibility, which should be removed from the Act. Article 6(10) of the ČNB Law provides that members of the Bank Board, which also includes the Governor of the ČNB, may be relieved from office only if they no longer fulfil the conditions required for the performance of their duties or if they have been guilty of serious misconduct. Although Article 6(10) of the ČNB Law extends the protection offered by Article 14.2 of the ESCB/ECB Statute to Governors against arbitrary dismissal to all Bank Board members of the ČNB, it remains silent on the Governor’s right in case of dismissal to seek a remedy before the Court of Justice of the European Union. However, pursuant to footnote 22, the Commission understands that the possibility to seek legal redress by the Governor before the Court of Justice of the European Union, as enshrined in Article 14.2 of the ESCB/ECB Statute, would apply. However, the ČNB Law would benefit from a more explicit clarification. Pursuant to Article 11(1) of the ČNB Law, the Minister of Finance or another nominated member of the Government may attend the meetings of the Bank Board in an advisory capacity and may submit motions for discussion. Article 11(2) entitles the Governor of the ČNB, or a Vice-Governor nominated by him, to attend the meetings of the Government in an advisory capacity. With regard to Article 11(1) of the ČNB Law, although a dialogue between a central bank and third parties is not prohibited as such, it should be ensured that this dialogue is constructed in such a way that the Government should not be in a position to influence the central bank when the latter is adopting decisions for which its independence is protected by the TFEU. The active participation of the Minister, even without voting right, in discussions where monetary policy is set would structurally give to the Government the opportunity to influence the central bank when taking its key decisions. Therefore, Article 11(1) of the ČNB Law is incompatible with Article 130 of the TFEU, as Member States have to undertake not to seek to influence the members of the decision-making bodies of the national central bank. 3.1.3.Prohibition of monetary financing and privileged access Article 34a(1) first half-sentence of the ČNB Law prohibits the ČNB from providing overdraft facilities or any other type of credit facility to the bodies, institutions or other entities of the European Union, central governments, regional or local authorities or other bodies governed by public law, other entities governed by public law or public undertakings of the Member States of the European Union. The list of entities does not fully mirror the one in Article 123(1) of the TFEU and, therefore, has to be amended. Moreover, the footnote in Article 34a(2) of the ČNB Law should refer to Article 123(2) of the TFEU instead of globally to Article 123 of the TFEU. 3.1.4.Integration in the ESCB

Objectives Pursuant to Article 2(1) of the ČNB Law, "in addition" to the ČNB's primary objective of maintaining price stability, the ČNB shall work to ensure financial stability and the safety and sound operation of the financial system and – without prejudice to its primary objective – support the general economic policies of the Government and the European Union. Article 2(1) of the ČNB Law needs to be amended with a view to achieving compatibility with Article 127 TFEU and Article 2 of the ESCB/ECB Statute. Compatibility with the ESCB's objectives requires a clear supremacy of the primary objective over any other objective. Tasks The incompatibilities in this area, following the TFEU provisions and ESCB/ECB Statute, include: ·definition of monetary policy and monetary functions, operations and instruments of the ECB/ESCB (Articles 2(2)(a), 5(1) and 23 to 26, 28, 29, 32, 33 of the ČNB Law); ·conduct of exchange rate operations and the definition of exchange rate policy (Articles 35 and 36 of the ČNB Law); ·holding and management of foreign reserves (Articles 35(c), 36 and 47a of the ČNB Law); ·non-recognition of the competences of the ECB and of the Council on the banknotes and coins (Article 2(2)(b), Articles 12 to 22 of the ČNB Law); ·ECB's right to impose sanctions (Article 46a of the ČNB Law); ·the possibility for Parliament to demand amendments to the report of the ČNB on monetary policy developments and to determine the content/scope of the extraordinary report in view of the absence of a specification regarding the non-forward looking nature of the reports (Article 3 of the ČNB Law). ·There are also some imperfections regarding: ·the partial absence of reference to the role of the ECB and of the EU in the collection of statistics (Article 41); ·non-recognition of the role of the ECB in the functioning of the payment systems (Articles 2.2 c), 38 and 38a of the ČNB Law); ·non-recognition of the role of the ECB and of the Council in the appointment of the external audit of the ČNB (Article 48(2) of the ČNB Law); ·absence of an obligation to comply with the Eurosystem's regime for the financial reporting of NCB operations (Article 48 of the ČNB Law); ·non-recognition of the role of the ECB in the field of international cooperation (Article 2(3) of the ČNB Law). 3.1.5.Assessment of compatibility As regards the independence of the central bank, the prohibition of monetary financing and the integration of the central bank in the ESCB at the time of euro adoption, the ČNB Law is not fully compatible with the compliance duty under Article 131 of the TFEU. The Czech authorities are invited to remedy the abovementioned incompatibilities.

3.2.Price stability 3.2.1.Respect of the reference value The 12-month average inflation rate, which is used for the convergence assessment, was above (2.2%) the reference value (1.8%) at the time of the last convergence assessment of Czechia in 2018. It declined gradually to 2% in November 2018 and then steadily increased up to 2.6% by end-2019. In March 2020, the reference value was 1.8%, calculated as the average of the 12-month average inflation rates in Portugal, Cyprus and Italy plus 1.5 percentage points. The corresponding inflation rate in Czechia was 2.9%, i.e. 1.4 percentage points above the reference value. According to the Commission Service’s 2020 Spring Forecast, the 12-month average inflation rate is projected to remain well above the reference value in the months ahead. 3.2.2.Recent inflation developments The annual HICP inflation rate was broadly on an upward path during the last two years. In 2018, it fluctuated between 1.6% and 2.4%. After dropping at the end of 2018, mainly due to declining food prices, HICP inflation increased steadily from 2.0% to 3.2% in 2019, exceeding the central bank’s tolerance band of 3.0% in both November and December (). This resulted mainly from a rapid hike in food prices, as well as a sustained rise in services and energy prices throughout 2019. In annual terms, the inflation rate dropped to 2.0% in 2018 (vs. 2.4% in 2017), before rising again to 2.6% in 2019. The acceleration is explained by a combination of high wage growth and strong domestic demand in an economy working at full capacity. Since end 2018, annual HICP inflation in Czechia has been higher than in the euro area with a fast increasing gap. Core inflation (measured as HICP inflation excluding energy and unprocessed food prices) remained below headline inflation in 2018 and 2019. This was mainly due to high energy inflation. Core inflation oscillated between 1.3% and 2.1% in 2018. It decreased markedly in September 2018 as a result of a drop in service prices and rose steadily up to 2.4% in March 2019. After decreasing again in April 2019 to 1.8% due to food prices, it grew strongly to 3.6% in March 2020, driven by a sustained increase in service prices and prices of processed food. Domestic producer prices increased steadily in 2018 and 2019, in line with rising prices for manufactured products and electricity. 3.2.3.Underlying factors and sustainability of inflation Macroeconomic policy mix and cyclical stance After a significant economic upswing up to 2017, the Czech economy decelerated in 2018 and 2019, mostly due to a more subdued external environment. Real GDP expanded by 2.8% in 2018, considerably less than in 2017 (4.4%). The economy continued its deceleration in 2019, when it grew by 2.6%. Private consumption was the main driver of GDP growth, supported by low unemployment and strong wage growth. Yet, private consumption growth moderated gradually throughout the period, falling from 3.2% in 2018 to 3% in 2019. Gross fixed capital formation increased strongly in 2018 by 7.6%, mainly driven by an influx of EU funds, investment in automation and robotisation in manufacturing, and a revival of investment in construction. As the external environment deteriorated, growth in investment in 2019 fell significantly to 2.8%. According to the Commission services’ Spring 2020 Forecast, due to the COVID-19 pandemic real GDP is expected to decrease by around 6.2% in 2020, before recovering by 5% in 2021. As a result, although the Czech economy is estimated to have been operating above its potential since 2016 the output gap will become sharply negative in 2020 due to the strong fall in the GDP. The fiscal stance, as measured by the change in the structural balance, eased considerably in 2018 and in 2019. In particular, the structural balance decreased by 0.8 percentage points to 0.0% of GDP in 2018, and went into negative territory at

-0.7% of GDP in 2019. According to the Commission services’ Spring 2020 Forecast, it is expected to decrease significantly in 2020 to -5% of GDP, due to a large decline of the balance in light of the fiscal measures taken against the pandemic. It is then projected to recover partially to -3.5% of GDP in 2021. The ČNB conducts monetary policy within an inflation targeting framework. The use of the exchange rate as an additional monetary policy instrument was discontinued in April 2017. The decision was supported by macroeconomic data and forecasting scenarios indicating a sustainable fulfilment of the 2% inflation target over the forecast horizon. Subsequently, the ČNB started in August 2017 to gradually raise its main policy rate (the 2-week repo rate) as annual inflation remained above its 2% inflation target. The rate increased from 0.75% in February 2018 to 2.0% in May 2019. Due to increasing domestic inflation pressure at end of the year 2019 and beginning 2020, the CNB Board raised the policy rate by 25 basis points to 2.25% during the February CNB Board meeting. After observing and assessing the measures taken by governments in trading partner countries, the Bank Board debased interest rates first by 50 basis point, followed by a 75 reduction rate to 1% during two monetary policy meetings in March 2020. Growth in loans to domestic sectors slowed down during last two years. According to the Bank Lending Survey, credit standards were tightened after the ČNB tightened its macroprudential policies in June 2018 and June 2019 (). This specifically led to a decline in loans for house purchase in 2019. After credit volumes to non-financial corporations expanded in 2018, firms, especially in industry and wholesale and retail trade, reduced their demand for loans in 2019. According to the latest Bank Lending Survey, this was mainly due to the increased use of internal financing and lower need to finance inventories and working capital. Wages and labour costs The labour market continued to perform well in 2018 and 2019. The unemployment rate dropped further in both years, to 2.9% in 2018 and 2% in 2019, making Czechia the best performer in the EU for the fourth year in a row. Nevertheless, the labour market is set to be impacted by the COVID-19 pandemic, with the unemployment rate hiking to 5% in 2020, despite temporary measures supporting self-employed and companies. The employment rate of those aged between 20 and 64 reached 80.4% in the second half of 2019, 6 percentage points above the EU average. Overall nominal wage growth accelerated sharply in 2018 and 2019, reaching 9.5% and 7.0% respectively. Although wage growth moderated slightly in end of 2019 and beginning of 2020, the still high growth rate is mainly attributable to persisting labour shortages, due to e.g. demographic factors, and an increase in the minimum wage (). Wages in both the public and private sector showed similar growth dynamics during 2018 and 2019. Labour productivity increased moderately in 2018 and 2019, mainly driven by manufacturing. As compensation per employee kept growing at a faster pace than productivity, nominal unit labour costs grew markedly in 2018 and 2019 (6.5% and 4.3%, respectively). According to the Commission services’ Spring 2020 Forecast wage growth is expected to moderate in 2020 as the labour market eases, but growth in unit labour costs is set to increase to 5.4% due to a likely drop in labour productivity. In 2021, unit labour costs are projected to remain broadly unchanged as both labour productivity and wage growth are likely to rebound. Unit labour cost growth will also notably depend on the way labour shortages are adressed. External factors

Given the size and openness of the Czech economy, import prices have a sizeable effect on domestic price formation. The imports of goods deflator fell by -0.6% in 2018, mainly due to lower industrial producer price inflation of trading partners in the euro area and declining oil prices. In 2019, goods’ import prices increased by 0.6%, driven by prices for machinery and transport equipment. The nominal effective exchange rate (measured against the main 36 trading partners) remained relatively stable throughout 2018 and 2019. It then appreciated end of 2019 and beginning of 2020, bringing import prices down during that period. Import prices are set to remain broadly stable in 2020 and 2021, as the expected depreciation of the koruna in 2020 and 2021 should be offset by emerging anti-inflationary pressures stemming from the COVID-19 crisis and by falling oil prices. Administered prices and taxes The share of administered prices in the HICP basket increased markedly in 2019 to 15.8%, which is significantly above the euro area average (12.2%). This came after a gradual decline in the share since 2011, from 11.2% to 9.8% in 2018. Changes in administered prices were a significant driver of inflation in 2019, as they increased by 3.8%, i.e. almost double that of headline HICP. This was not the case in 2018, where the growth in administered prices was just 1.6%, compared to 2.0% for the overall HICP. Increases in heat energy and pharmaceutical products were the main contributors to the increase in administered prices in 2019. Administered transport prices decreased considerably by roughly 6.5% on average that year. HICP at constant tax rates was somewhat below headline inflation in 2018 (1.9%) and at the same level in 2019 (2.6%). Medium-term prospects Annual HICP inflation remained relatively elevated in early 2020, driven by a hike in food prices, increasing administered prices, and changes to indirect taxes. It is expected to moderate substantially in the second half of 2020, as declining oil prices, falling demand, and lower wage growth bring inflation down. According to the Commission services’ Spring 2020 Forecast, annual HICP inflation is projected to average 2.3% in 2020 and 1.9% in 2021. Risks to the inflation outlook mainly stem from external developments. The main downside risk comes from a potential slower recovery in trading partners’ demand. On the upside, domestic inflation pressures stemming from higher than expected wage growth could push prices up. The level of uncertainty of this inflation forecast is unusually high. The level of consumer prices in Czechia increased to about 69% of the euro-area average in 2018, suggesting that there is still potential for further price level convergence in the long term. Since 2012, Czechia has steadily converged to the euro area average in GDP per capital in PPS, to about 86% in 2018. 3.3.Public Finances 3.3.1.Recent fiscal developments Since 2016, the general government balance has been constantly in surplus, supported by a constant increase in tax revenues. In 2019, the total expenditure-to-GDP and revenue-to-GDP ratios reached 41.9% and 42.1% respectively. While the growth in revenues was marginal compared to 2018, the growth of expenditure increased more significantly. Public investment levels also grew by 4.4.% in 2019, the highest since 2016, as the current EU funds cycle is starting to close. The 2019 general government surplus of 0.3% of GDP was in line with the target in the 2019 Convergence Programme. Similar to previous years, the surplus was supported by high growth in tax revenue on the back of a strong labour market and domestic consumption. On the back of a shrinking general balance and a positive output gap, the structural balance turned slightly negative in 2019 at -0.5% of GDP. The general government debt further declined from 32.6% of GDP in 2018 to 30.8% of GDP in 2019, the lowest figure in the past 10 years, remaining well below the 60% threshold. 3.3.2.Medium-term prospects The initial 2020 state budget was adopted by the Parliament in December 2019 with an envisaged headline deficit of 0.75% of GDP, similar to previous years. The budget proposed increased social expenditures, such as higher pension indexation, increased salaries for teachers and higher parental allowances, but also additional discretionary revenues such as an increase in excise duties. In order to adopt measures to contain the COVID-19 pandemic, the state budget was revised twice in March and in April 2020 and now envisages a headline deficit of 5.5% of GDP. The new measures adopted by the government to contain the crisis amount to around 4% of GDP. The most important measures foresee financial support and deferral of health and social contributions for the self-employed and a short-time subsidy working scheme for firms. According to the Commission services’ Spring 2020 Forecast, in 2020, the headline general government balance is projected to decline significantly to -6.7% of GDP, while the structural balance will reach -4.6% of GDP. The debt-to-GDP ratio is expected to increase significantly to 38.7%. This fiscal weakening is, in addition to a denominator effect, due to the combined loss in tax revenues, on the back of the economic drop, and the adopted policy measures to contain the pandemic. According to the Commission services’ Spring 2020 Forecast and based on a no-policy change scenario, the government balance is expected to improve only slightly in 2021, to -4% of GDP, while the structural balance is forecast to reach

-2.9% of GDP. The debt-to-GDP ratio is expected to stabilise, reaching 39.9%. The Czech national fiscal framework is well developed, after the adoption of several legal acts in recent years. Since the appointment of its members in 2018, the Czech Fiscal Council has fulfilled its mandated tasks to assess the long-term sustainability of public finances and compliance with the national rules on budgetary responsibility. The assessment of compliance with the local government debt rule at end-2018 triggered administrative proceedings for three municipalities, which eventually took the corrective measures specified by the law on the budgetary responsibility rules within the specified timeframe. Furthermore, in all its 2019 assessments, the Committee on Budgetary Forecast confirmed the realism of the macroeconomic and budgetary forecasts. However, the assessment of budgetary forecasts only covers the revenue parameters and provides a partial picture of the underlying budgetary developments. The law on financial control in public administration amended in April 2019 entered into force on 1 January 2020, adding to the set of acts defining the Czech fiscal framework. Against the backdrop to the COVID-19 pandemic, the Parliament recently fast-tracked a legislative amendment to widen the structural deficit ceiling in 2021 from 1% to 4% of GDP and alter the adjustment path between 2022 and 2027 with an annual consolidation of at least 0.5 percentage points of GDP . 3.4.Exchange rate stability

The Czech koruna does not participate in ERM II. Since the late 1990s, the ČNB has been operating an explicit inflation targeting () framework combined with a floating exchange rate regime, allowing for foreign exchange market interventions by the central bank. Following the expiry of the ČNB's exchange rate commitment in April 2017, the koruna followed a gradual appreciation trend against the euro, strengthening from above 27 CZK/EUR in early April 2017 to 25.5 CZK/EUR in May 2018. It appreciated only temporarily after the CNB increased policy rates four times in the second half of 2018. Beginning 2019, it fluctuated in a relative narrow band around 25.7 CZK/EUR before slightly depreciating to 25.9 CZK/EUR in September 2019. Thereafter, the koruna appreciated steadily and reached 25.1 CZK/EUR in February. Following the lock-down measures, the koruna depreciated significantly and stood above 27 CZK/EUR at the end of March 2020. The 3-month interest rate differential vis-à-vis the euro area increased by around 120 basis points between August 2017 and May 2019, following regular policy rate hikes by 25 basis points from 0.05% in 2017 to 2% in May 2019. Afterwards, the ČNB kept its policy rates unchanged and the three-month interest rate spread relative to the euro fluctuated around 255 up to January 2020. In March 2020, the Czech 3-month rate fell in response to easing measures implemented by the ČNB, and the spread vis-à-vis the euro area reached around 240 basis points. International reserves held by the ČNB were relatively stable and increased from EUR 121 billion beginning of 2018 (60% of GDP) to above EUR 133 billion (61% of GDP) in 2019. The level of reserve assets was mainly influenced by a rise in returns on the CNB’s securities and inflows of EU funds. 3.5.Long-term interest rates Long-term interest rates in Czechia used for the convergence examination reflect secondary market yields on a basket of government bonds with the average residual maturity of close to, but below, 10 years. The Czech 12-month average long-term interest rate relevant for the assessment of the Treaty criterion was well below the reference value at the time of the last convergence assessment in 2018. It followed a gradual upward trend up to December 2018 and oscillated around 2% during the first half of 2019. From June 2019, it gradually decreased to 1.5% in January. In March 2020, the reference value, given by the average of long-term interest rates in Portugal, Cyprus and Italy plus 2 percentage points, stood at 2.9%. In that month, the 12-month moving average of the yield on the Czech benchmark bond stood at 1.5%, i.e. 1.4 percentage points below the reference value. The long-term interest rate of Czechia slowly increased to about 2.0% by end-2018 as the ČNB gradually tightened its monetary policy stance. Consequently, the spread against the German long-term benchmark bond () widened from 130 basis points in March 2018 to some 180 basis points. In 2019, the long-term interest rate stabilised around 1.8% during the first half of the year and then declined rapidly to 1% in August driven by developments abroad when the prospect of monetary easing by major central banks suppressed long-term yields. Czechia’s long-term interest rate increased again and stood at 2.0% in March 2020, with a spread against the German long-term benchmark bond of around 180 basis points. 3.6.Additional factors The Treaty (Article 140 TFEU) calls for an examination of other factors relevant to economic integration and convergence to be taken into account in the assessment. The assessment of the additional factors – including balance of payments developments, product, labour and financial market integration – gives an important indication of a Member State's ability to integrate into the euro area without difficulties. In December 2019, the Commission published its ninth Alert Mechanism Report (AMR 2020) under the Macroeconomic Imbalance Procedure (MIP - see also Box 1.6), which highlighted issues relating to competitiveness and pressures in the housing market. However, since overall risks remained limited, no In-Depth Review (IDR) was warranted. The end of the exchange rate commitment in April 2017 led to an appreciation of the real effective exchange rate. Nominal unit labour costs have increased significantly, on the back of strong wage rises and acute labour market shortages although a deceleration is expected. At the same time, the country is exposed to risks relating to the trade policy environment and the disruption of global value chains. Real house price growth has remained high but with a deceleration in 2018 compared to 2017. 3.6.1.Developments of the balance of payments According to balance of payments data, Czechia’s external balance (i.e. the combine