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Bulgaria: Staff Report for the 2017 Article IV Consultation

Author(s):
International Monetary Fund. European Dept.
Published Date:
February 2018
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Context

1. Bulgaria has made major progress since joining the EU a decade ago but many challenges remain. Annual per capita GDP growth has averaged 3 percent since 2007 despite the hit from the global and euro-area crises. Health and education indicators have also improved. However, Bulgaria’s per capita income is still only half of the EU average, income inequality is higher than EU average and has risen, and the quality of institutions has seen only limited improvement. Furthermore, Bulgaria faces long-term growth and fiscal challenges due to unfavorable demographic prospects–working age population is projected to decline by 26 percent in 30 years.

Income Convergence Has Slowed Since the Global Financial Crisis

(GDP p.c in PPP in percent of EU average)

Sources: World Development Indicators; and IMF staff calculations

1/ EU new member states excluding Bulgaria are: Croatia, Czech Republic, Hungary, Poland, Rumania, Slovak Republic, Slovenia, Estonia, Latvia, and Lithuania.

2. A strong economic recovery has taken hold as Bulgaria has taken over the EU presidency. The challenge is to translate this recovery into durable and inclusive convergence of people’s incomes toward levels prevailing in the richer EU partners. This will require continued action on many fronts, notably increasing the efficiency of public institutions at all levels; remedying weaknesses in education, healthcare, and labor markets; improving the functioning of the judiciary; and further strengthening the financial stability framework. Progress on all these fronts will ultimately help deliver better, more rules-based governance. A short-run policy priority is to further strengthen the resiliency of the financial sector, which was shaken in 2014 by the collapse of the fourth largest bank.2 The government led by center-right GERB, in office since last May, has put boosting income and infrastructure building as its main priorities.

Recent Developments

3. The economy is performing well. Real GDP growth has been on an upward trend for five consecutive years, reaching 3.8–3.9 percent in 2016 and 2017Q1-Q3, driven by strong exports (in 2016) and a significant increase in tourism arrivals, easier financial conditions, and growing consumer and producer confidence. The unemployment rate has declined to 5.8 percent, the lowest level since the global financial crisis. The fiscal balance moved into a large surplus in 2016, owing to lower public investment, and maintained a surplus in 2017, reflecting revenue overperformance and capital underspending.

Private Consumption as the Main Growth Driver in 2017

(In percent)

Sources: Haver and IMF staff calcuations.

Strong Wage Growth amid Declining Unemployment and Rising Labor Shortage

(In percent)

Source: Haver.

4. There is rising underlying inflationary pressure. Headline inflation turned positive in 2017, reaching 1.8 percent in December buoyed by fuel and food prices and utility tariffs. Core inflation reached 0.5 percent, though still the lowest among the new member states (NMS),3 held back mostly by declining prices in vehicles and telecommunication services. Other indicators of inflationary pressure (HICP trimmed mean or median) also suggest that pressures are rising, consistent with increasingly rapid wage growth (now around 10 percent) and accelerating import prices. Inflation pressure seems consistent with indicators that signal a closing output gap: low unemployment, high capacity utilization and wage growth, and increasing reports of labor shortages.

Rising inflationary pressues

(Percent, y-o-y)

Sources: Haver and IMF staff calculations.

5. Despite rapid wage growth (including in the tradable sector), exports have remained competitive. The current account turned into a surplus of 5.3 of percent GDP in 2016, due to strong export growth and lower goods imports, the latter reflecting weak investment and declining import prices. Over January-October 2017, the current account remained at a surplus of 5.3 percent of GDP, helped by robust exports, despite a rebound in imports from the relatively low 2016 levels. Faster wage growth than peers has not yet impaired Bulgaria’s export performance—in fact, Bulgaria has continued to gain global goods market share—as local labor costs are still relatively low. But the unit labor cost (ULC)-based real effective exchange rate (REER) is now more than 20 percent higher than before the crisis. Staff judges Bulgaria’s external position to be moderately stronger than fundamentals and desirable policy settings (Annex I). External debt declined from a peak of 106 percent of GDP in 2009 to 66 percent of GDP in 2017. Reserves have reached 198 percent of the IMF metric in 2017.

Real Labor Productivity and Real Compensation Per Employee

(Index 2010 = 100)

Sources: Haver and IMF staff calculations.

Export Market Share (Goods)

(Index 2010 = 100)

Sources: Haver and IMF staff calculations.

6. The credit cycle continues to lag the economic cycle. Interest rates are still very low and credit standards have eased for households whose debt stands at 28 percent of GDP. Credit growth, which has also been supported by a government loan subsidy program aimed at improving energy efficiency of residential buildings, has risen from 1.0 percent y/y at end-2016 to 3.2 percent in November 2017.4 The share of foreign currency lending has declined from 64 percent in 2011 to 38 percent in November 2017. Most banks are very liquid and well capitalized and thus credit supply is not constrained. Credit demand is likely to pick up in line with economic activity, but high non-financial corporate indebtedness continues to stand in the way. While Bulgaria’s non-financial corporate debt has declined markedly from 106 percent of GDP in 2008 to 84 percent of GDP in 2016, it remains the highest among the NMS. Staff analysis shows that high corporate debt could be an important drag on investment in Bulgaria (see Selected Issues Paper).

Outlook and Risks

7. GDP growth is projected to remain strong in 2018 (around 3.8 percent) and moderate over the medium term. The main drivers of growth will be low funding costs; gradually easing credit conditions as banks and firms repair their balance sheets; elevated trading partner growth; and a large pickup in EU-funded capital expenditure. Over the medium term, staff expects growth to slow down to 2¾ percent (3½ percent in per capita terms), reflecting a modest investment recovery (due to elevated corporate debt) and declining working age population. The current account surplus is projected to fall over the medium term as private savings decline. Core inflation is projected to rise in 2018, but headline inflation would remain at around 2 percent, helped by expected lower energy and food price growth.

8. The risks around the projected, smooth gliding path for the economy are broadly balanced (Annex II). Too high a wage growth could trigger another boom-bust cycle by fueling higher consumption growth and undermining competitiveness to such an extent that the current account again falls into a deep deficit. Lack of progress in structural reforms to raise productivity and mitigate the impact of aging and emigration could be a drag on potential growth. External risks include a protracted period of slower European growth and rising policy and geopolitical uncertainties. Tightening global financial conditions could weigh on heavily-indebted corporates and banks with high NPLs. Upside risks include faster-than-expected growth in Europe and substantial progress in structural reforms resulting in faster growth.

Authorities’ Views

9. The authorities expect similar growth in the near term but higher growth over the medium term. In particular, they see stronger medium-term private investment and productivity growth than the staff. Some among the authorities view a rise in interest rates as a potential source of credit risk. They foresee a limited risk of losing competitiveness.

Policy Discussions

10. The short-term priority is to continue strengthening the resiliency of the financial system, despite a strong economy that helps reduce vulnerabilities. Staff sees fiscal policy, notwithstanding some procyclical impulse in the short run, as broadly consistent with a smooth macroeconomic glide path. Over the medium- to long-term, fiscal policy will need to do more to address growing aging-related spending (CR/16/345).

11. More efficient government and rules-based governance are key to support sustained and inclusive income convergence. This will require a better use of public expenditure, improved SOE management, including of the Bulgarian Development Bank, and an even stronger financial stability framework. The underlying supervisory policies and practices need to foster a market-based allocation of savings that contributes to stronger and sustained growth, while also serving as a line of defense against corrupt business practices.

A. Prudent Fiscal Policy

12. Fiscal outcomes have been stronger than budgeted in recent years, reflecting mainly revenue overperformance and under-execution of capital spending. Staff projects the large 2016 cash surplus (at balance on accrual basis) to decline in 2017 owing to lower EU tranfers. The fiscal outturn through November reached a surplus of 2.4 percent of GDP (compared with an originally projected budget deficit of 1.4 percent of GDP) despite the increases in teachers’ wages (Box 1) and in the minimum pension that were not in the original budget (0.2 percent of GDP). Revenues (excluding grants) have continued to overperform the budgeted level, reflecting higher growth, conservative revenue forecasting, and continued revenue collection efforts. Capital spending is lower than budgeted, mainly due to EU-funded projects in 2016, and both domestically-funded and EU-funded projects in 2017. A fiscal surplus of 0.8 percent of GDP is estimated for 2017.

2017 Fiscal Indicators(In percent of GDP, unless otherwise indicated)
Staff
Budget 1/Projection
Revenue excl. grants33.132.5
(in millions of leva)30,56032,146
Grants2.91.5
Expenditure37.433.2
Capital expenditures6.03.5
Fiscal balance−1.40.8
Sources: MoF and IMF staff calculations.

Excluding concession for the Sofia Airport which is delayed to 2018.

Sources: MoF and IMF staff calculations.

Excluding concession for the Sofia Airport which is delayed to 2018.

Box 1.Teachers’ Wages

Teachers in Bulgaria are among the lowest-paid in Europe and half of them are close to retirement. The average annual salary of a teacher in Bulgaria was 5,142 euros in academic year 2015/2016. This is the lowest among NMS. The ratio of teachers’ wage to the average wage is also lower than peers. Forty-eight percent of the teachers in Bulgaria are 50 years old or older (Eurostat), and will be retiring in the coming years.

Teachers’ wages are low in Bulgaria...

(Euro, 2015/16 academic year)

Source: Eurydice (2016).

... though less so in relative terms

Sources: Eurydice (2016) and Eurostat.

To attract new young teachers, the government plans to double the remuneration of pedagogical staffs in pre-, primary-, and secondary schools by the end of 2021. No increase in the number of teachers is envisaged. The wage increase will differ by categories. School principals will determine the wage rates of teachers in the school by negotiating with the teachers’ union.

The total cost for doubling the teachers’ wage over 2017-2021 is BGN 1.4 billion (1.4 percent of 2017 GDP). In September 2017, teachers’ wages were raised by 15 percent on average, which required BGN 80 million. The Ministry of Finance (MoF) will allocate the remaining BGN 1.32 billion, spread equally over 2018-2021.

13. The government’s fiscal strategy is broadly appropriate.

  • The 2018 budget envisages a deficit of 1 percent of GDP (0 percent on accrual basis), appropriately considering the need for more public investment. The largest spending increase is in capital expenditure, reflecting higher EU funds absorption. There are also sizable increases in wages for teachers and defense/security and medical personnel, as well as on public health spending. Revenue measures include further hikes in the social security contribution rate (part of the 2015 pension reforms) and excise duty on cigarettes (to align with the minimum EU levels).

  • The revised medium-term budget framework (MTBF) appropriately maintains the target of fiscal balance by 2020. The wage bill for teachers will be doubled between 2017 and 2021 (Box 1), and there will be large spending on military equipment. To offset these spending increases, the wage increase will be moderate for the rest of the public sector; and expenditure on goods and services, capital projects, and social payments will be reduced in percent of GDP. The MTBF also envisages strengthening public spending efficiency and tax collection by taking measures against tax fraud and evasion. Gross public debt would decrease further, to 22 percent of GDP in 2020 (Annex III). The objective of returning to a balanced budget by 2020 is adequate, both on account of cyclical considerations and the need to preserve buffers consistent with the currency board arrangement.

14. If revenues overperform, these could usefully be saved to build up fiscal buffers and avoid adding excessive fiscal stimulus. The authorities’ real GDP growth projections appear realistic for the near term and ambitious for the medium term. However, the revenue projections are suitably prudent throughout. There is also room to improve revenue. The authorities could consider designing targeted policies to reduce the value added tax (VAT) gap, and explore the scope to reduce undeclared work (notwithstanding increased labor inspections) and options to efficiently raise revenue, e.g., raising the property tax. If revenues exceed projections in 2018 as is likely, these could usefully be saved to avoid adding excessive fiscal stimulus. Over the medium term, the authorities could target a surplus if revenue overperforms, to strengthen fiscal buffers consistent with the currency board arrangement (CBA) and to address aging-related spending and unanticipated needs that could arise from contingent liabilities. Another reason for a surplus target could be a faster-than-projected acceleration in domestic demand that threatens to cause another boom-bust cycle.

There Is Scope to Reduce VAT Gap

(Percent, 2015)

Source: European Commission.

15. Population aging-related fiscal challenges deserve continued attention. Reforms in 2015 raised the social security contribution rate and statutory retirement age, and allowed unlimited transfers between the mandatory private Pillar II and the public Pillar I systems. Bulgaria’s statutory retirement ages are expected to remain below the EU medians after reaching 65 years by 2029 for men and by 2037 for women.5 Staff analysis suggests that further increases in the contribution rate and/or retirement age are eventually needed to ensure the sustainability of the public pension system and prevent an increase in old-age poverty. Staff also advises against unlimited shifts across pillars. While switches from Pillar II to Pillar I would initially lead to an increase in revenue, eventually they could cause an increase in pension expenditure. In addition, the possibility of large withdrawals could force Pillar II funds to hold more short-term and liquid assets with lower returns.

Bulgaria’s social security contribution rate is relatively low

(Percent, 2017)

Source: KPMG.

Pension Benefits in Bulgaria Are Relatively Low

Benefit Ratio 1/ (Percent, 2013)

Citation: 2018, 46; 10.5089/9781484342015.002.A001

Source: 2015 EU Ageing Report.

1/ Benefit ratio is the ratio of average public pension benefits to the economy-wide average wage.

Authorities’ views

16. The authorities reiterate their strong commitment to fiscal discipline and building buffers, but note the necessity of allowing transfer between Pillars I and II. On saving the revenue overperformance, the authorities point out that it could not be spent without amending the budget law. The authorities note that the 2015 social security reform has helped stabilize the pension system and no further action is envisaged at this stage. They understand the mission’s concerns about allowing unlimited transfers between Pillar I and Pillar II, but feel that it is necessary because of the mandatory nature of Pillar II and the possibility of Pillar II underperformance. They agree that this may entail a need for additional adjustments to Pillar I parameters but observe that transfers have been small so far (less than one percent of insured persons under Pillar II). The authorities also do not think that the potential for shifts is affecting pension funds’ behavior.

B. Improving Government and Enhancing Growth

17. Bulgaria’s public goods need improvement, which would also enhance potential growth. In particular, spending efficiency could be improved in general. The World Bank is conducting a public spending review focusing on internal order and security and waste management. The authorities could consider expanding the scope of these reviews.

EU Funds Absorption Rates

(Percent)

Sources: European Commission and IMF Staff calculation.

  • Public infrastructure is seen to be lagging in terms of quality. This calls for enhancing capital spending efficiency (see Selected Issues Paper). Staff analysis based on available data suggests that it would require more rigorous and transparent project appraisal and selection. The authorities could conduct a comprehensive public investment management assessment, to help formulate accurate diagnostics. While Bulgaria’s EU funds absorption rate in the previous cycle reached 95 percent, in line with peers, it can be further improved including by avoiding heavily back-loaded spending as in the previous round. Strengthening the cooperation between the central government and municipalities would help achieve these objectives.

    Index of Public Capital Coverage and Quality

    (Average 2012-2013)

    Source: World Economic Forum.

    Strength of Public Investment Management by Institution

    Sources: IMF (2016) and IMF staff calculations.

  • Education. Access to good education and training is essential to address Bulgaria’s complex structural challenges, including the deepening shortage of skilled labor. Better and more equal access to quality education are also the best way to enhance equality of opportunity and reduce risks of poverty. Government spending on education remains among the lowest in the EU, and the education system is characterized by outdated curricula and inequality of educational opportunities though there has been a good effort to improve inclusiveness and effectiveness. Staff welcomes recent measures, including performance-based funding for higher education and the pilot programs to improve vocational training in partnership with the business community. Also welcome are the plans to appreciably raise teachers’ low salaries to attract young, bright recruits and to better follow up on early school leavers. Pay increases should be linked to performance and reflect the findings of a functional review of public sector employment and wages. Additional efforts are needed to reach vulnerable groups.

    Government Education Spending and Outcome

    (Secondary, Latest Value Available)

    Source: World Bank.

    Bulgaria Has High Inactive Youth NEETs

    (In percent)

    Source: Eurostat.

  • Active labor market policies need to be more targeted to address skill mismatches and regional disparities in job opportunities, in order to raise the labor force participation rate, which is lower than the EU average, and reduce the high share of youth NEET (Not in Education, Employment, or Training) and long-term unemployment (Box 2).6 In this context, recent efforts to reach and activate NEETs and to raise employment in municipalities with high unemployment rate are welcome. To address labor shortages, the authorities are concluding agreements with some countries to allow seasonal workers (mostly in the tourism sector).

  • Healthcare is expensive for the outcomes. Significant efficiency gains could be achieved through better control of the distribution of pharmaceutical drugs and of the contracts between the National Health Insurance Fund and private providers. Public hospitals in a difficult financial situation need to be restructured to ensure service continuity. On a structural basis, the development of the national health map to identify medical needs should be used to alleviate the territorial imbalances in access to medical attention and the excessive reliance on hospitals as opposed to primary and preventive care. Measures will also be needed to address the lack of specialists and replace aging medical personnel.

Health Efficiency Frontier

(Latest Value Available)

Source; WHO.

18. Providing better public goods entails also improving the performance of SOEs.

  • Management and oversight of SOEs need strengthening. The policy and ownership functions could usefully be separated and the supervisory boards of SOEs be carefully staffed, while demanding greater accountability. Improving SOE governance and efficiency would also help improve infrastructure quality and raise potential growth, as SOEs are especially important in network industries.

  • Contingent liabilities from SOEs also pose medium-term fiscal risks. Nonfinancial SOE debt stands at 8.5 percent of GDP, but around 40 percent of SOEs are making loss. Several SOEs, notably in the energy and transport sectors, have significant debt. More transparency about SOE financial performance is the first step in improving their performance. Staff welcomes the amended Public Finance Act dictates the inclusion of SOE contingent liabilities into the MTBF. Full market liberalization in the energy sector as envisaged could improve the efficiency in the energy market and the financial viability of the National Electricity Company, while the authorities should also consider providing supports to vulnerable households.

Key FAD TA recommendations on SOE oversight and management

Fiscal risks

The authorities should consider establishing a fiscal risk management unit to identify and analyze SOE fiscal risks.

Legal framework

Most SOEs are exempted from insolvency procedures. Reducing fiscal risks will require amendments to existing insolvency legislation to remove exemptions for SOEs.

Oversight and management

It is important to separate the ownership and policy functions of SOEs. This could be done by transferring the management of all shares in state-level SOEs to a centralized ownership unit.

Corporate governance

The supervisory board should have relevant skills, independent authority and accountability necessary to guide the strategic direction of the company.

Box 2.Labor Market

Bulgaria is facing a decline in working age population due to aging and emigration. The latest population projections show that from 2015 to 2025 the working age population is expected to decline by 12 percent and the old age dependency ratio is expected to increase by about 7 percentage points. Bulgaria is among the EU countries facing the most severe demographic headwinds.

Working Age Population Growth and Old Age Dependency Ratio

(2015-2025)

Sources: Eurostat and IMF staff calculations.

Employment growth remained positive in recent years despite its demographic headwinds but challenges lie ahead. Positive employment growth in 2014 and 2015 reflected both the increase in the labor force participation rate and the sizable decline in unemployment rate against a backdrop of the strong economy. However, the unemployment rate is already at the lowest level since the global financial crisis, and labor shortages are becoming a more limiting factor across all sectors.

Employment Growth Decomposition

(In percent)

Sources: NSI, Haverand IMF staff calculations.

In the short term, unlocking inactive people, especially young NEETs, is critical to sustain employment growth. The labor force participation rate in Bulgaria was lower than in NMS and the share of NEETs in total population in Bulgaria was the highest among NMS in 2016. While the inactivity rate of middle-aged people has declined since 2012, that of the young changed little, indicating a structural nature of the NEET problem. Lack of qualification and regional disparities in job opportunity lie behind this structural problem. Also, it is important to retain school drop-outs who account for a large share in NEETs (UNICEF 2015), as their proportion is higher than the EU average and rising.

In the medium-term, it is important to address skill mismatches through improving the link between education and the labor market and enhancing the quality of education. The EC Education and Training Monitor 2017 points out mismatches in the labor market: the proportion of higher education graduates working in a position that do not normally require their education degrees is higher than the EU average; and a large part of the students in higher education choose a major in social science, business and law rather than in highly demanded areas such as health care or engineering.

19. A sound judiciary is the most important public good. Judicial reforms and the fight against corruption were already on major public policy agenda in the late 1990s. Progress was made during the EU accession process in improving legislative framework including introducing functional immunity for magistrates, improving efficiency in criminal proceedings, and mandating asset declaration of senior public officials. Nevertheless, the EC concluded that further progress was still needed to meet EU standards, and the Cooperation and Verification Mechanism (CVM) was established in 2007 to monitor progress. Following CVM recommendations, a constitutional amendment was made in 2007, which conferred on the Supreme Judicial Council (SJC) power to appoint, promote and discipline magistrates and created an independent judicial inspectorate to the SJC to monitor the integrity of the judiciary. The 2010 legal amendments gave the SJC the role of assessing workload, amending area of jurisdiction, and reallocating resources in the judiciary, and made integrity assessment a compulsory step in career development and promotion.

Governance Indicator: Rule of Law Rank, 2016

Source: Worldwide Governance Indicators, Daniel Kaufmann (Natural Resource Governance Institute and Brookings Institution) and Aart Kraay (World Bank).

1/ Croatia, Czech Republic, Hungary, Poland, Romania, Slovak Republic, Slovenia, Estonia, Latvia, and Lithuania.

20. More progress is still needed to improve the judiciary, notwithstanding recent reforms. Bulgaria ranks among the weakest performers in the EU on control of corruption and rule of law in the World Bank’s Worldwide Governance Indicators. Corruption is also considered the most problematic factor for doing business in Bulgaria by the Global Competitiveness Report. Staff welcomes the broad commitment to further improve the functioning of the judiciary. Important measures have been put in place in recent years, including to enhance the independence and operation of the SJC. The parliament recently passed the Anti-Corruption Act, which includes a provision to establish an anti-corruption body. Efforts are underway to improve the performance of the SJC, to strengthen the effectiveness and accountability of the Prosecutor’s Office, and to step up the fight against corruption. The experience of Eastern Europe suggests that the reform of the judiciary can be helped along with a more even distribution of opportunities and resources across society and with increased transparency and accountability.7 The efforts underway and the measures staff is recommending to improve the efficiency of government and strengthen the financial sector should support further progress in this critical area.

Most Problematic Factors for Doing Business in Bulgaria

Source: World Economic Forum 2017.

CESEE: Estimated Efficiency Gains from Institutional Reforms

(Percent; potential improvement in TFP)

Source: IMF 2016, Regional Economic Issues, Spring.

Notes: Central, Eastern, and Southeastern Europe (CESEE) refers to Albania, Belarus, Bosnia and Herzegovina, Bulgaria, Croatia, the Czech Republic, Estonia, Hunagary, Kosovo, Latvia, Lithuania, the former Yugoslav Republic of Macedonia, Moldova, Montene, Romania, Russia, Serbia, the Slovak Republic, Slovenia, Turkey, and Ukraine.

Authorities’ Views

21. The authorities concur that the main objective now is to increase the effectiveness and efficiency of spending, with a focus on improving education and health care. They agree that enhancing the effectiveness of EU funds is important and point to reforms such as introducing e-application and e-reporting. Regarding SOE reforms, the authorities disagree with the recommendation to transfer the ownership of all SOEs to the MoF. They argue that the line ministries should maintain the ownership to ensure fulfilling their policy goals, and that the MoF does not have the expertise to supervise all SOEs. The authorities note that publicly-owned banks are subject to the same supervision as private banks. The authorities agree that improving governance is a major task and critical for the economy and would appreciate specific recommendations in future consultations. While not denying the challenge posed by governance, some question the third-party indicators which show that Bulgaria performs poorly all the time regardless of the ebb and flow of reform.

C. A Stronger Financial Sector

22. The banking system has withstood shocks and the Bulgarian National Bank (BNB) has continued making progress in strengthening bank supervision since the 2014 bank failure. Prudent supervisory policies have resulted in high system capital ratios that are comfortably above the regulatory minimums, and earnings and liquidity are also strong. However, NPLs remain elevated at more than double the EU average. In line with FSAP recommendations, several legislative initiatives have been introduced, while other steps are in preparation, including implementation.

  • Governance of the BNB. The recent amendment of the Law on Credit Institutions (LCI) has accelerated governance reforms at the BNB by vesting decision making authority at the level of the Governing Council. This welcome broadening of the accountability to the Council, from the deputy governors overseeing banking and payments supervision, should strengthen the central bank’s institutional framework. The BNB needs to quickly put in place necessary operating procedures, and ensure that the new collective process does not hamper decision-making.

  • Addressing NPLs. NPLs have declined from 16.9 percent of total loans in 2013 to 11.4 percent in 2017Q3,8 but are still well above the EU average. The implementation of IFRS 9 in 2018 is likely to lead to a sizable increase in loan loss allowance. Renewed efforts are underway in Europe to tackle NPL problems. In this context, staff welcomes the BNB’s supervision department’s draft prudential guidance on NPLs that was recently circulated for industry comments, as it incorporates relevant supervisory metrics for credit loss provisioning, NPL accounting write-offs, and collateral valuation. The draft guidance appropriately addresses the legacy NPL stock as well as loans that fall into default in the future. This approach takes account of important local characteristics that include banks’ high capital and profitability, and credit conditions favorable for advancing the adjustments. Importantly, NPL reduction should also require incentivizing banks and debtors to engage in restructuring discussions, further developing the NPL market, and improving the judiciary procedures for debt resolution.

    NPLs are declining but remain high

    (Percent)

    Source: Financial Soundness Indicators (IMF).

  • Regulation and supervision. The amendments to the LCI also strengthened the definition of related-party exposures and tightened the control over related party exposures to align with EU legislation and country-specific circumstances. It is now important to complete the regulations and supervisory processes/guidance and enforce remedies to address concentration and related party risks on the basis of 2017 and forthcoming inspections. The BNB has also been making other progress in addressing regulation and supervision. It has recently issued a draft risk assessment manual, and is drafting new internal rules on anti-money laundering. The BNB also plans to finalize by 2018Q2 necessary amendments on regulation related to the internal governance rules, following the recently published EBA guidelines. The BNB needs to complete the multi-year action plan with detailed activities to continue strengthening banking supervision.

  • Financial safety net and crisis management arrangements. The authorities have introduced a resolution regime for credit institutions and investment firms in mid-2015, by implementing the EU Bank Recovery and Resolution Directive. The BNB is in the process of operationalizing the new regime. The recently amended Public Finance Act provides a legal framework to support lender of last resort liquidity assistance to a bank consistent with the currency board arrangement, though considerable efforts will still be required procedurally, including that the assistance complies with EU state aid rules.

23. Two of the banks identified by the asset quality review (AQR) and stress test still require larger capital buffers. The 2016 AQR and stress test showed that the banking system overall is resilient, reflecting significant capital and liquidity buffers and the presence of large foreign-owned institutions. However, three domestically-owned banks were identified with capital shortfalls. The smallest of them has raised capital through the conversion of debt into equity and has been put for sale. The other two banks, including a systemically important one, have also raised capital through retained earnings, but would still require larger capital buffers and credible new investment which should be finalized promptly. Sourcing equity from new bona fide investors would help improve credibility and address governance concerns. While the BNB continues to monitor developments and promote capital augmentation for these banks, it needs to adopt a comprehensive supervisory strategy to monitor and ensure their’ viability over the medium term.

24. The authorities have also made welcome legislative progress with regard to the nonbank financial sector, which is relatively small. The amended Financial Supervision Commission (FSC) Act enables the FSC to fund its budget through levies against supervised entities and improves its independence. The amended Social Insurance Code broadens the definition of related parties (to comply with EU regulation), requiring some pension funds to divest to comply with the new law, which could have a potentially large market impact. The FSC completed a balance sheet review and stress test for the insurance and pension sectors in early 2017, concluding that the investments of the pension funds were properly valued but that capital increases were needed for 13 insurance companies. Adequate capital was raised by all but two insurers, whose licenses were subsequently revoked.

Authorities’ Views

25. The authorities are satisfied with the FSAP and note that they have made good progress in the areas that are considered necessary. During the transition period to fully operationalizing the new governance model, the BNB Governing Council will conduct its new supervisory powers within the existing rules and procedures.

D. Integrating Further into the European Union

26. The authorities are contemplating joining ERM II as a first step towards joining the euro area. At least two years in ERM II are required for qualifying to adopt the euro. ERM II transition is likely to be smooth with no change in macro-policy framework, given the strong credibility of Bulgaria’s 20-year old CBA. While ERM II allows the currency to fluctuate up to 15 percent above and below the central exchange rate, Bulgaria can opt to unilaterally maintain its CBA with the fixed rate, as Estonia did in 2004. The current real exchange rate level has served Bulgaria well, recently allowing strong external performance.

27. Euro area membership will consummate the commitment of the EU membership which has already come with many benefits and catalyzed reforms. Euro area membership would come with a greater role in the EU’s decision making bodies, membership in banking union, and further economic benefits of integration (e.g. heightened confidence, reduced funding costs, and expanded trade). Once in the currency union, exit option is virtually forgone, and Bulgaria would be more exposed to spillover effects from any member’s decision on its membership, as well as generating such greater effects on others. This raises the premium of a strong and flexible economy.

Staff Appraisal

28. Bulgaria has achieved considerable progress in the first decade of EU membership. The economy has shown resilience to shocks, and attained comfortable levels of fiscal buffers and international reserves. However, the income gap relative to EU levels is still large and poverty remains high, with little progress in improving governance and reducing income inequality. Furthermore, Bulgaria faces long-term growth and fiscal challenges due to population aging and emigration.

29. The economy is in a strong position. GDP growth has picked up since 2015 and the output gap is closing. Unemployment is at its lowest level in ten years and consumer and business confidence are also near multi-year highs. At the same time, the current account has remained in surplus, as Bulgaria has been able to maintain its external competitiveness despite strong wage growth.

30. Fiscal policy has been appropriately conservative, but long-term fiscal challenges need continued attention. Fiscal outturns have been better than budgeted in recent years, reflecting both revenue overperformance and under-execution of capital spending. The 2018 Budget and the MTBF are broadly appropriate. Revenue overperformance should be saved to avoid adding excessive fiscal stimulus and to build up fiscal buffers. Public debt is low, whereas contingent pension liabilities pose risks over the long run. While much progress has already been achieved, the authorities need to, at some stage, revisit or address the consequences of the policy to allow for the unlimited transfers between Pillar I and Pillar II, and consider raising statutory retirement age and social security contribution rates.

31. Improving public goods provision and SOE performance would help raise potential growth. Enhancing spending efficiency and effectiveness including for EU funds is vital to provide better public goods and to improve Bulgaria’s growth prospects. Better education and training and more effective labor market policies could help raise employment and mitigate the adverse effects of population aging and emigration. Enhancing SOE oversight and performance would help raise productivity and contain fiscal risks.

32. Strengthening governance is critical in improving business environment and private investment. The recent reforms to improve the judiciary and the fight against corruption are welcome. Additional efforts are needed to establish a track record in demonstrating judicial independence and effectiveness, and to step up the fight against high-level corruption. More equal distribution of opportunities and resources across society and increased transparency and accountability will help improve institutional quality.

33. Recent efforts to further strengthen financial supervision are welcome and should continue. The authorities have legislated BNB governance changes and the new crisis management arrangements which are being operationalized. The BNB needs to complete ongoing work including on addressing concentration and related party risks and introducing a comprehensive strategy for NPL reduction. Two domestically-owned banks require larger capital buffers and credible new investment should be finalized promptly.

34. It is proposed that Bulgaria remain on the standard 12-month Article IV cycle.

Figure 1.Bulgaria: Real Sector Developments, 2012-17

Sources: Haver Analytics, National authorities, and IMF staff calculations.

1/ NMS-10: Estonia, Latvia, Lithuania, Croatia, Czech Republic, Hungary, Poland, Slovak Republic, Slovenia and Romania.

Figure 2.Bulgaria: External Sector Developments, 2008-17

Sources: Haver Analytics, National authorities, and IMF staff calculations.

Figure 3.Bulgaria: Fiscal Developments, 2008-20

Sources: Eurostat, National authorities, and IMF staff estimates.

Figure 4.Bulgaria: Monetary and Financial Sector Developments, 2008-17

Sources: BNB, IMF FSI, and IMF staff calculations.

1/ Due to the revocation of the banking license of KTB, the bank is excluded as a reporting agent from the monetary statistics data used in the panel charts staring in November 2014.

Table 1.Bulgaria: Selected Economic Indicators, 2013–22(Annual percentage change, unless noted otherwise)
2013201420152016201720182019202020212022
Est.Proj.
Real GDP0.91.33.63.93.83.83.12.82.82.8
Real domestic demand−1.92.63.51.74.64.64.13.63.23.2
Public consumption0.60.11.42.24.24.64.23.63.03.0
Private consumption−2.52.74.53.54.74.13.83.63.33.3
Gross capital formation−2.14.22.2−4.34.46.64.73.33.13.1
Private investment−2.60.3−3.7−1.64.13.33.33.33.33.3
Public investment11.414.021.4−18.4−8.918.29.53.83.13.1
Stock building 1/−0.50.2−0.10.50.70.00.00.00.00.0
Net exports 1/2.8−1.30.12.2−0.8−0.9−1.0−0.9−0.5−0.5
Exports of goods and services9.63.15.78.14.94.44.03.73.63.4
Imports of goods and services4.35.25.44.56.15.75.44.84.13.9
Resource utilization
Potential GDP2.12.22.53.03.02.92.92.92.92.9
Output gap (percent of potential GDP)−2.8−3.6−2.5−1.6−0.80.10.30.20.10.0
Unemployment rate (percent of labor force)13.011.59.27.76.36.05.85.65.55.5
Price
GDP deflator−0.70.52.22.21.22.02.12.12.12.1
Consumer price index (HICP, end of period)−0.9−2.0−0.9−0.51.82.12.12.12.12.1
Fiscal indicators (percent of GDP)
General government net lending/borrowing (cash basis)−1.8−3.6−2.81.60.8−1.0−0.50.00.00.0
General government primary balance−0.9−3.0−2.02.31.6−0.30.20.60.70.7
Structural overall balance−0.7−2.3−1.82.11.1−1.0−0.6−0.10.00.0
Structural primary balance0.1−1.6−1.12.91.9−0.30.10.60.70.7
General government gross debt 2/17.226.425.627.423.923.522.821.820.719.7
Monetary aggregates 3/
Broad money8.91.18.87.67.77.97.47.07.07.0
Domestic private credit0.3−7.7−1.61.84.65.86.16.26.76.7
Exchange rates regime
Leva per U.S. dollar (end of period)1.41.61.81.91.6
Nominal effective rate2.52.9−1.22.53.0
External sector (percent of GDP)
Current account balance1.30.10.05.33.82.92.11.30.60.3
o/w: Merchandise trade balance−7.0−6.5−5.8−2.0−2.4−2.8−3.0−3.3−3.4−3.5
Sources: Bulgarian authorities; World Development Indicators; and IMF staff estimates.

Contribution to GDP growth.

In projection period, largely reflects issuance and repayment of eurobonds.

Due to the revocation of the banking license of KTB, the bank is excluded as a reporting agent from the monetary statistics data starting in November 2014.

Sources: Bulgarian authorities; World Development Indicators; and IMF staff estimates.

Contribution to GDP growth.

In projection period, largely reflects issuance and repayment of eurobonds.

Due to the revocation of the banking license of KTB, the bank is excluded as a reporting agent from the monetary statistics data starting in November 2014.

Table 2.Bulgaria: Macroeconomic Framework, 2013–22(Annual percentage change, unless noted otherwise)
2013201420152016201720182019202020212022
Est.Proj.
GDP and prices
Real GDP0.91.33.63.93.83.83.12.82.82.8
Real GDP per working age population1.72.75.15.55.24.94.13.83.73.7
Real GDP per capita1.41.94.34.74.44.43.73.43.43.4
Real domestic demand−1.92.63.51.74.64.64.13.63.23.2
Of which: private−2.52.74.53.54.74.13.83.63.33.3
GDP deflator−0.70.52.22.21.22.02.12.12.12.1
Consumer price index (HICP, average)0.4−1.6−1.1−1.31.22.02.12.12.12.1
Nominal wages6.06.06.88.09.57.05.75.04.84.8
Real effective exchange rate, CPI based1.3−0.5−3.10.22.1
Monetary aggregates (percent change) 1/
Broad money8.91.18.87.67.77.97.47.07.07.0
Domestic private credit0.3−7.7−1.61.84.65.86.16.26.76.7
Saving and investment (percent of GDP)
Foreign saving−1.3−0.10.0−5.3−3.8−2.9−2.1−1.3−0.6−0.3
Gross national saving22.621.521.224.522.822.521.520.720.019.7
Government3.11.74.85.64.44.95.15.45.45.5
Private19.519.816.318.918.417.616.415.314.614.3
Gross domestic investment21.321.421.219.119.119.619.519.419.419.4
Government4.85.37.64.03.55.95.65.45.45.4
Private16.516.113.615.115.513.813.914.014.014.0
General government (percent of GDP)
Revenue33.833.735.034.734.034.934.834.834.935.0
Tax revenue (including social security contributions)25.726.026.727.228.028.028.128.128.128.1
Non-Tax revenue4.84.14.24.44.54.64.24.24.24.2
Grants3.23.54.13.11.52.32.52.52.62.6
Expenditure35.537.337.833.133.235.835.334.934.934.9
Balance (net lending/borrowing on cash basis)−1.8−3.6−2.81.60.8−1.0−0.50.00.00.0
Structural balance−0.7−2.3−1.82.11.1−1.0−0.6−0.10.00.0
Balance of payments (percent of GDP)
Current account1.30.10.05.33.82.92.11.30.60.3
Trade balance−7.0−6.5−5.8−2.0−2.4−2.8−3.0−3.3−3.4−3.5
Services balance6.35.96.66.46.25.85.65.35.14.9
Primary income balance−3.8−3.1−4.5−2.4−2.6−2.8−3.1−3.2−3.5−3.6
Secondary income balance5.73.83.63.32.52.62.62.52.52.5
Capital and financial account−2.37.14.80.5−0.6−0.5−0.6−0.3−0.10.2
Of which: Foreign direct investment−3.0−2.1−5.1−0.7−0.6−0.7−0.8−1.0−1.1−1.2
Memorandum items:
Gross international reserves (billions of euros)14.416.520.323.923.724.925.826.426.727.0
Short-term external debt (percent of GDP) 2/22.823.316.315.414.014.113.813.713.913.5
Export volume (goods, percent change)11.81.46.77.96.04.84.34.14.03.8
Import volume (goods, percent change)5.01.56.24.56.55.95.44.94.24.0
Terms of trade (percent change)−0.31.01.53.50.10.00.70.20.00.0
Output gap (percent of potential GDP)−2.8−3.6−2.5−1.6−0.80.10.30.20.10.0
Nominal GDP (millions of leva)82,16683,63488,57194,13098,868104,664110,175115,638121,372127,391
Nominal GDP (millions of euros)42,01142,76245,28648,12850,55053,51456,33159,12562,05765,134
Sources: Bulgarian authorities; and IMF staff estimates.

Due to the revocation of the banking license of KTB, the bank is excluded as a reporting agent from the monetary statistics data starting in November 2014.

At original maturity.

Sources: Bulgarian authorities; and IMF staff estimates.

Due to the revocation of the banking license of KTB, the bank is excluded as a reporting agent from the monetary statistics data starting in November 2014.

At original maturity.

Table 3.Bulgaria: Real GDP Components, 2013–22(Annual percentage change, unless noted otherwise)
2013201420152016201720182019202020212022
Est.Proj.
(Real growth rate, in percent)
GDP0.91.33.63.93.83.83.12.82.82.8
Domestic demand−1.92.63.51.74.64.64.13.63.23.2
Private demand−3.12.42.73.25.53.93.73.63.23.2
Public demand2.93.36.5−3.81.07.75.53.73.03.1
Final consumption−1.92.23.83.34.74.23.93.63.23.2
Private consumption−2.52.74.53.54.74.13.83.63.33.3
Public consumption0.60.11.42.24.24.64.23.63.03.0
Investment−2.14.22.2−4.34.46.64.73.33.13.1
Gross fixed investment0.33.42.7−6.60.76.94.93.43.23.2
Private investment−2.60.3−3.7−1.64.13.33.33.33.33.3
Public investment11.414.021.4−18.4−8.918.29.53.83.13.1
Inventories 1/−0.50.2−0.10.50.70.00.00.00.00.0
Net exports 1/2.8−1.30.12.2−0.8−0.9−1.0−0.9−0.5−0.5
Exports of goods and services9.63.15.78.14.94.44.03.73.63.4
Imports of goods and services4.35.25.44.56.15.75.44.84.13.9
(Contribution to real GDP growth, in percent)
Domestic demand−2.02.73.61.74.64.74.13.73.33.3
Private demand−2.62.02.22.54.43.23.02.92.62.6
Public demand0.60.71.4−0.80.21.51.10.80.60.6
Final consumption−1.51.83.12.63.73.43.23.02.62.6
Private consumption−1.61.72.92.33.12.62.52.42.22.2
Public consumption0.10.00.20.30.60.70.70.60.50.5
Investment−0.50.90.5−0.90.91.31.00.70.60.6
Gross fixed investment0.10.70.6−1.40.11.30.90.70.60.6
Private investment−0.40.0−0.6−0.20.60.50.50.50.50.5
Public investment0.50.71.2−1.2−0.40.80.50.20.20.2
Inventories−0.50.2−0.10.50.70.00.00.00.00.0
Net exports2.8−1.30.12.2−0.8−0.9−1.0−0.9−0.5−0.5
Exports of goods and services5.51.93.65.23.23.02.72.52.52.4
Imports of goods and services2.63.23.52.94.13.83.73.43.02.9
Sources: Bulgaria National Statistical Institute; and IMF staff estimates.

Contributions to GDP growth.

Sources: Bulgaria National Statistical Institute; and IMF staff estimates.

Contributions to GDP growth.

Table 4.Bulgaria: Balance of Payments, 2013–22(Millions of euros, unless noted otherwise)
2013201420152016201720182019202020212022
Est.Proj.
Current account balance53635−172,5611,9031,5401,156791390223
Trade balance−2,933−2,777−2,622−984−1,192−1,517−1,712−1,950−2,127−2,288
Exports (f.o.b.)21,21821,02621,92023,10425,64026,32727,65628,90130,41431,835
Imports (f.o.b.)24,15123,80324,54224,08826,83227,84429,36830,85132,54134,122
Services balance2,6532,5143,0043,0923,1473,1263,1623,1543,1723,178
Exports of non-factor services5,8886,7386,9677,5918,0668,1458,4288,6618,9579,221
Imports of non-factor services3,2354,2243,9634,4984,9195,0195,2675,5075,7856,043
Primary Income balance−1,581−1,319−2,039−1,131−1,318−1,486−1,748−1,892−2,186−2,318
Receipts8749299731,1121,0381,1331,1741,2651,3311,386
Payments2,4552,2483,0122,2432,3562,6192,9223,1583,5173,704
Secondary income balance2,3961,6161,6401,5851,2661,4171,4541,4791,5311,650
Capital account balance4699601,4221,0705879051,0621,2041,3131,456
Financial account balance1,419−2,090−7398419101,1891,3821,3771,3661,355
Foreign direct investment balance−1,243−882−2,329−340−287−369−468−571−679−793
Portfolio investment balance132−1,212−582−630−388−10886909599
Other investment balance2,424222,1561,8271,6021,6821,7811,8751,9672,065
Errors and omissions−118−1,2771,586676000000
Overall balance−5321,8073,7303,4671,5801,256836618336324
Financing532−1,807−3,730−3,467−1,580−1,256−836−618−336−324
Gross international reserves (increase: -)532−1,807−3,730−3,467−1,580−1,256−836−618−336−324
(Percent of GDP, unless otherwise indicated)
Memorandum items:
Current account balance1.30.10.05.33.82.92.11.30.60.3
Merchandise trade balance−7.0−6.5−5.8−2.0−2.4−2.8−3.0−3.3−3.4−3.5
Exports50.549.248.448.050.749.249.148.949.048.9
Imports57.555.754.250.053.152.052.152.252.452.4
Foreign direct investment balance−3.0−2.1−5.1−0.7−0.6−0.7−0.8−1.0−1.1−1.2
Terms of trade (merchandise, percent change)−0.31.01.53.50.10.00.70.20.00.0
Exports of goods (volume, growth rate)11.81.46.77.96.04.84.34.14.03.8
Imports of goods (volume, growth rate)5.01.56.24.56.55.95.44.94.24.0
Exports of goods (prices, growth rate)−3.6−2.2−2.3−2.44.7−2.00.70.31.20.8
Imports of goods (prices, growth rate)−2.8−2.9−2.9−6.04.6−2.00.00.11.20.9
GDP (millions of euro)42,01142,76245,28648,12850,55053,51456,33159,12562,05765,134
Sources: Bulgarian authorities; and IMF staff estimates.
Sources: Bulgarian authorities; and IMF staff estimates.
Table 5.Bulgaria: External Financial Assets and Liabilities, 2013–22(Millions of euros, unless noted otherwise)
2013201420152016201720182019202020212022
Est.Proj.
International investment position−30,657−32,184−27,760−22,675−21,887−19,425−17,190−15,178−13,459−11,764
Financial assets31,26536,11138,81646,23849,66354,77259,68264,58669,42074,465
Foreign direct investment3,5754,0114,1274,8825,7196,6067,5408,5209,54810,627
Portfolio investment4,9395,5995,0506,2807,1448,0529,01310,02511,08612,201
Other investments8,3269,9669,35311,17813,13815,19617,37519,66922,07724,603
Gross international reserves14,42616,53420,28523,89923,66224,91825,75426,37326,70927,033
Financial liabilities61,92368,29566,57668,91371,55074,19776,87279,76482,87986,228
Foreign direct investment37,50041,12341,57642,50743,63144,88746,28847,83949,54751,420
Portfolio investment2,3893,9484,4486,1057,3588,3739,24910,17011,13712,152
Other liabilities22,02323,14920,47620,20320,56120,93721,33621,75522,19522,657
(Percent of GDP, unless otherwise indicated)
International investment position−72.8−75.2−61.2−47.0−43.3−36.3−30.5−25.7−21.7−18.1
Financial assets74.484.485.796.198.2102.4105.9109.2111.9114.3
Foreign direct investment8.59.49.110.111.312.313.414.415.416.3
Portfolio investment11.813.111.213.014.115.016.017.017.918.7
Other investments19.823.320.723.226.028.430.833.335.637.8
Gross international reserves34.338.744.849.746.846.645.744.643.041.5
Financial liabilities147.4159.7147.0143.2141.5138.7136.5134.9133.6132.4
Foreign direct investment89.396.291.888.386.383.982.280.979.878.9
Portfolio investment5.79.29.812.714.615.616.417.217.918.7
Other liabilities52.454.145.242.040.739.137.936.835.834.8
Memorandum items:
Gross external debt87.992.073.670.763.061.358.956.555.953.2
Public 1/8.114.112.314.111.210.810.39.710.810.4
Private79.877.961.356.651.850.548.746.745.142.7
Short-term22.821.016.315.414.014.113.813.713.913.5
Long-term57.056.944.941.237.836.534.933.131.129.2
Net external debt 2/53.653.328.821.116.214.713.211.912.911.7
Sources: BNB; NSI; and IMF staff estimates.

General government, excluding publicly-guaranteed private debt.

Gross debt minus gross international reserves.

Sources: BNB; NSI; and IMF staff estimates.

General government, excluding publicly-guaranteed private debt.

Gross debt minus gross international reserves.

Table 6a.Bulgaria: General Government Operations, 2013–22 1/(Millions of leva, unless noted otherwise)
2013201420152016201720182019202020212022
Est.Proj.
Revenue27,73528,14530,96432,67133,65836,48938,37540,28442,37644,560
Taxes16,31016,57917,90919,58520,99022,07523,29524,51825,72726,993
Taxes on profits1,5531,6791,8602,0762,2812,3322,4622,5882,7162,851
Taxes on income2,3482,5962,7312,9613,2093,4183,6163,7983,9844,180
Value-added taxes7,3667,2647,7408,5539,2199,77110,33910,91311,44912,010
Excises4,0564,0394,5254,8055,0325,2315,4855,7576,0436,342
Customs duties146149159173182192203213223234
Other taxes8408518931,0171,0681,1301,1901,2491,3111,376
Social contributions4,8185,1875,6996,0296,7257,2037,6198,0068,3988,809
Grants2,6562,9223,6482,9071,5132,3682,7842,8523,1003,350
Other revenue 2/3,9513,4573,7094,1504,4304,8434,6774,9095,1525,408
Expenditure29,17531,19333,43631,20332,84237,48438,89940,33242,34444,497
Expense24,55125,54525,91826,99628,90131,14732,49833,85035,50937,297
Compensation of employees 3/4,5605,6225,6445,7776,1456,4866,8217,1417,5137,925
Wages and salaries4,4544,5534,6164,8475,1465,6445,9726,2916,6206,987
Other compensation1061,0691,028929999843848850893938
Use of goods and services 4/4,6033,5353,3183,7284,0764,6204,6444,6554,8865,128
Interest689580698734799722760798838879
External484337431447546465490514539566
Domestic204243267288253257271284298313
Subsidies1,3071,4521,6341,6451,9452,1462,2592,3712,4892,612
Grants 5/9349559468598881,1341,2111,3011,3651,433
Social benefits12,33213,26813,54314,10914,89815,93216,69617,47618,31119,212
Pensions7,7628,1368,4338,7349,0979,4949,94910,41910,90311,437
Social assistance2,1602,3172,4242,5432,7012,7772,8082,8272,9683,115
Health Insurance Fund2,4102,8152,6872,8323,1013,6623,9384,2304,4404,660
Other expense127133134144151107106108108108
Contingency6441,186767401431205223232262274
Net acquisition of nonfinancial assets 6/3,9814,4626,7513,8063,5106,1326,1776,2496,5736,925
Net lending/borrowing−1,441−3,048−2,4721,468816−995−524−483363
Primary balance−752−2,468−1,7742,2021,615−273237750871942
Financing1440.73048.02471.9−1468.1−815.8995.3523.847.8−33.0−62.8
Privatization proceeds15.618.04.26.213.711.043.92.10.00.0
Net external financing−690.05784.31449.13518.6−2156.1177.728.3−49.91898.0146.5
Disbursements1,1196,0916,4383,876395223032932,1702,830
Amortization−1,809−307−4,988−357−2,195−344−275−343−272−2,684
Net domestic financing2151.1−1279.2−937.4−557.91341.6821.6466.6110.6−1915.9−194.3
Bank credit / Securities issuance1,7575,654−194,8127902,0651,3861,123−1,117110
Amortization−1,006−3,497−2,234−1,051−785−1,243−920−1,013−799−304
Fiscal Reserve Account1400.4−3436.61316.0−4319.21337.30.00.00.00.00.0
Net lending and other items−37.6−1587.01951.8−4441.2−15.0−15.0−15.0−15.0−15.0−15.0
Memorandum items:
Fiscal reserve account4,6818,1176,80111,1209,7839,7839,7839,7839,7839,783
Gross public debt14,11922,10222,71425,75123,59924,59925,09425,15425,13625,088
Nominal GDP (percent change)0.21.85.96.35.05.95.35.05.05.0
Real GDP (percent change)0.91.33.63.93.83.83.12.82.82.8
HICP inflation (percent change)0.4−1.6−1.1−1.31.22.02.12.12.12.1
Nominal private consumption (percent change)−5.02.75.73.56.06.16.05.85.45.4
Nominal imports (percent change)1.82.31.70.311.13.55.45.05.44.8
Sources: Ministry of Finance; and IMF staff estimates.

On cash basis.

Includes dividends. For 2018, includes concession revenue BGN 400 million for the Sofia Airport.

Includes Other remuneration, which were previously integrated in use of goods and services, from 2014.

From 2014, with the adoption of the Public Finance Act, other remunerations are re-classified to the compensation of employees.

Contribution to EU budget.

Includes only acquisitions of nonfinancial assets, i.e., capital expenditure. For 2018, includes concession revenue BGN 400 million for the Sofia Airport.

Sources: Ministry of Finance; and IMF staff estimates.

On cash basis.

Includes dividends. For 2018, includes concession revenue BGN 400 million for the Sofia Airport.

Includes Other remuneration, which were previously integrated in use of goods and services, from 2014.

From 2014, with the adoption of the Public Finance Act, other remunerations are re-classified to the compensation of employees.

Contribution to EU budget.

Includes only acquisitions of nonfinancial assets, i.e., capital expenditure. For 2018, includes concession revenue BGN 400 million for the Sofia Airport.

Table 6b.Bulgaria: General Government Operations, 2013–22 1/(Percent of GDP, unless noted otherwise)
2013201420152016201720182019202020212022
Est.Proj.
Revenue33.833.735.034.734.034.934.834.834.935.0
Taxes19.919.820.220.821.221.121.121.221.221.2
Taxes on profits1.92.02.12.22.32.22.22.22.22.2
Taxes on income2.93.13.13.13.23.33.33.33.33.3
Value-added taxes9.08.78.79.19.39.39.49.49.49.4
Excises4.94.85.15.15.15.05.05.05.05.0
Customs duties0.20.20.20.20.20.20.20.20.20.2
Other taxes1.01.01.01.11.11.11.11.11.11.1
Social contributions5.96.26.46.46.86.96.96.96.96.9
Grants3.23.54.13.11.52.32.52.52.62.6
Other revenue 2/4.84.14.24.44.54.64.24.24.24.2
Expenditure35.537.337.833.133.235.835.334.934.934.9
Expense29.930.529.328.729.229.829.529.329.329.3
Compensation of employees 3/5.56.76.46.16.26.26.26.26.26.2
Wages and salaries5.45.45.25.15.25.45.45.45.55.5
Other compensation0.11.31.21.01.00.80.80.70.70.7
Use of goods and services 4/5.64.23.74.04.14.44.24.04.04.0
Interest0.80.70.80.80.80.70.70.70.70.7
External0.60.40.50.50.60.40.40.40.40.4
Domestic0.20.30.30.30.30.20.20.20.20.2
Subsidies1.61.71.81.72.02.12.12.12.12.1
Grants 5/1.11.11.10.90.91.11.11.11.11.1
Social benefits15.015.915.315.015.115.215.215.115.115.1
Pensions9.49.79.59.39.29.19.09.09.09.0
Social assistance2.62.82.72.72.72.72.52.42.42.4
Health Insurance Fund2.93.43.03.03.13.53.63.73.73.7
Other expense0.20.20.20.20.20.10.10.10.10.1
Contingency0.81.40.90.40.40.20.20.20.20.2
Net acquisition of nonfinancial assets 6/4.85.37.64.03.55.95.65.45.45.4
Net lending/borrowing−1.8−3.6−2.81.60.8−1.0−0.50.00.00.0
Primary balance−0.9−3.0−2.02.31.6−0.30.20.60.70.7
Financing1.83.62.8−1.6−0.81.00.50.00.00.0
Privatization proceeds0.00.00.00.00.00.00.00.00.00.0
Net external financing−0.86.91.63.7−2.20.20.00.01.60.1
Disbursements1.47.37.34.10.00.50.30.31.82.2
Amortization−2.2−0.4−5.6−0.4−2.2−0.3−0.2−0.3−0.2−2.1
Net domestic financing2.6−1.5−1.1−0.61.40.80.40.1−1.6−0.2
Bank credit / Securities issuance2.16.80.05.10.82.01.31.0−0.90.1
Amortization−1.2−4.2−2.5−1.1−0.8−1.2−0.8−0.9−0.7−0.2
Fiscal Reserve Account1.7−4.11.5−4.61.40.00.00.00.00.0
Net lending and other items0.0−1.92.2−4.70.00.00.00.00.00.0
Memorandum items:
Gross public debt17.226.425.627.423.923.522.821.820.719.7
Structural fiscal balance−0.7−2.3−1.82.11.1−1.0−0.6−0.10.00.0
Output gap (percent of potential GDP)−2.8−3.6−2.5−1.6−0.80.10.30.20.10.0
Nominal GDP (millions of leva)82,16683,63488,57194,13098,868104,664110,175115,638121,372127,391
Sources: Ministry of Finance; and IMF staff estimates.

On cash basis.

Includes dividends. For 2018, includes concession revenue BGN 400 million for the Sofia Airport.

Includes Other remuneration, which were previously integrated in use of goods and services, from 2014.

From 2014, with the adoption of the Public Finance Act, other remunerations are re-classified to the compensation of employees.

Contribution to EU budget.

Includes only acquisitions of nonfinancial assets, i.e., capital expenditure. For 2018, includes concession revenue BGN 400 million for the Sofia Airport.

Sources: Ministry of Finance; and IMF staff estimates.

On cash basis.

Includes dividends. For 2018, includes concession revenue BGN 400 million for the Sofia Airport.

Includes Other remuneration, which were previously integrated in use of goods and services, from 2014.

From 2014, with the adoption of the Public Finance Act, other remunerations are re-classified to the compensation of employees.

Contribution to EU budget.

Includes only acquisitions of nonfinancial assets, i.e., capital expenditure. For 2018, includes concession revenue BGN 400 million for the Sofia Airport.

Table 7.Bulgaria: General Government Stock Position, 2008–2016(Percent of GDP, unless noted otherwise)
200820092010201120122013201420152016
Net financial worth9.75.73.01.42.21.1−4.0−5.6−5.8
Financial assets30.629.426.824.227.226.431.527.532.5
Monetary gold and SDRs
Currency and deposits14.012.39.88.111.09.611.18.513.9
Debt securities0.00.00.00.00.00.00.00.00.0
Loans1.81.71.51.31.21.12.11.52.1
Equity and investment funds shares9.310.711.210.410.18.710.19.49.2
Insurance, pensions, and standardized guarantee schemes0.00.00.00.00.00.00.00.00.0
Financial derivatives and employee stock options
Other accounts receivable5.54.64.34.34.97.08.18.07.4
Liabilities20.923.623.822.825.025.335.533.138.3
Special Drawing Rights (SDRs)0.00.00.00.00.00.00.00.00.0
Currency and deposits0.00.00.00.00.00.00.00.00.0
Debt securities8.38.69.79.512.011.217.420.323.9
Loans4.85.76.26.15.86.710.66.66.9
Equity and investment funds shares0.00.00.00.00.00.00.00.00.0
Insurance, pensions, and standardized guarantee schemes0.00.00.00.00.00.00.00.00.0
Financial derivatives and employee stock options0.30.10.10.20.20.20.20.30.2
Other accounts receivable7.69.37.87.16.97.27.35.97.4
Memorandum items
Gross debt (at market value)20.623.523.722.724.825.135.232.838.1
Gross debt (at face value)20.623.023.122.324.525.234.132.2
Gross debt (Maastricht definition)13.013.715.315.217.517.927.026.0
Nominal GDP (billions of leva)72.873.074.880.882.082.283.688.694.1
Sources: Eurostat; and IMF staff calculations.
Sources: Eurostat; and IMF staff calculations.
Table 8.Bulgaria: Monetary Accounts, 2013–22 1/(Billions of leva, unless noted otherwise)
2013201420152016201720182019202020212022
Est.Proj.
Monetary Survey
Net foreign assets28.435.040.749.751.747.750.453.256.359.8
Net domestic assets55.850.551.749.753.858.062.467.368.370.1
Domestic credit57.152.153.250.954.458.662.967.868.970.6
General government1.20.42.4−0.70.41.52.33.50.2−2.7
Non-government55.951.650.851.754.057.160.664.468.773.3
Broad money (M3)67.268.074.079.685.792.599.3106.3113.7121.7
Currency outside banks9.110.211.412.814.115.516.617.718.920.3
Reserve money17.319.227.528.629.631.533.435.437.439.6
Deposits 2/58.257.862.666.871.677.082.788.694.8101.4
Accounts of the Bulgarian National Bank
Net foreign assets26.830.838.144.944.745.045.151.852.459.6
Net foreign reserves (billions of euro)13.715.719.523.022.923.023.126.526.830.5
Net domestic assets−5.7−7.3−6.4−11.8−10.8−10.0−9.6−9.6−11.5−11.8
Net claims on government−4.3−6.7−6.0−11.0−10.1−9.3−8.8−8.7−10.6−10.8
Base money17.319.227.528.629.631.533.435.437.439.6
Currency in circulation9.110.211.412.814.115.516.617.718.920.3
Banks reserves8.29.116.115.815.416.016.817.718.519.3
Deposit money banks
Net foreign assets1.64.22.64.97.04.23.73.02.31.7
Gross foreign assets13.615.310.612.414.515.615.114.413.713.1
Gross foreign liabilities12.111.18.17.67.511.411.411.411.411.4
Net domestic assets59.956.957.460.763.867.271.175.978.980.8
Domestic credit61.358.659.161.964.467.871.676.479.481.3
Memorandum items:(Annual percentage change, unless otherwise indicated)
Base money−0.411.143.04.03.56.55.95.95.85.8
Broad money8.91.18.87.67.77.97.47.07.07.0
Domestic non-government credit0.3−7.7−1.61.84.65.86.16.26.76.7
Domestic deposits9.3−0.68.26.87.17.67.47.17.07.0
Domestic currency8.60.19.210.110.88.07.77.47.37.3
Foreign currency10.3−1.56.81.91.37.06.96.56.56.5
Money multiplier (ratio)3.93.52.72.82.92.93.03.03.03.1
Velocity (M3) (ratio)1.21.21.21.21.21.11.11.11.11.0
GDP (millions of leva)82,16683,63488,57194,13098,868104,664110,175115,638121,372127,391
Sources: Bulgarian National Bank, National Statistics Institute, and Fund staff estimates and projections.

Due to the revocation of the banking license of KTB, the bank is excluded as a reporting agent from the monetary statistics data starting in November 2014.

Includes deposits at central bank.

Sources: Bulgarian National Bank, National Statistics Institute, and Fund staff estimates and projections.

Due to the revocation of the banking license of KTB, the bank is excluded as a reporting agent from the monetary statistics data starting in November 2014.

Includes deposits at central bank.

Table 9.Bulgaria: Financial Soundness Indicators, 2010–17(Percent)
20102011201220132014201520162017Q2
Core indicators
Capital adequacy
Capital to risk-weighted assets17.417.616.617.021.922.222.222.5
Tier 1 capital to risk-weighted assets15.215.715.116.020.020.520.921.3
Asset quality
Nonperforming loans to total gross loans11.915.016.616.916.714.613.212.4
Nonperforming loans net of provisions to capital28.036.938.936.243.549.844.740.5
Large exposures to capital90.6111.6115.1119.764.351.458.256.4
Earnings and profitability
Return on assets0.80.60.70.60.81.11.41.5
Return on equity 1/7.85.76.35.77.27.910.411.1
Net interest income to gross income74.173.268.868.567.466.269.272.8
Noninterest expense to gross income49.150.652.154.049.947.344.047.3
Personnel expense to total income17.818.519.119.818.517.218.421.1
Liquidity
Liquid assets to total assets20.922.022.423.426.131.132.431.2
Liquid assets to short-term liabilities30.029.130.030.633.740.241.039.5
Liquid assets to total liabilities24.225.425.726.929.939.240.339.1
Encouraged indicators
Deposit-taking institutions
Capital to assets 2/10.510.810.110.411.612.011.612.1
Trading income to total income5.45.07.45.87.07.910.3−0.1
Personnel expenses to noninterest expenses36.436.536.736.737.136.341.744.5
Customer deposits to total (non-interbank) loans87.895.4100.2107.4115.5127.7134.7132.7
Foreign currency denominated loans to total loans61.363.764.061.257.050.045.141.8
Foreign currency denominated liabilities to total liabilities58.654.851.850.249.042.641.740.5
Source: Bulgarian National Bank.

Return on equity is calculated with Tier I capital as denominator.

Capital to assets is based on Tier I capital.

Source: Bulgarian National Bank.

Return on equity is calculated with Tier I capital as denominator.

Capital to assets is based on Tier I capital.

Annex I. Competitiveness and External Sector Assessment

Staff’s overall assessment is that Bulgaria’s external position in 2017 was moderately stronger than implied by fundamentals and desirable policies. Nonetheless, the continued labor shortage and labor cost increases in excess of productivity growth could weaken competitiveness going forward.

1. The current account has corrected sharply since the financial crisis and posted large surpluses in 2016 and 2017. After reaching a deficit of about 24 percent of GDP in 2007, the current account adjusted rapidly. The correction was precipitated by the collapse of external financing and manifested in moderate import growth coupled with strong export growth. While the current account was broadly balanced during 2011–15, it recorded a surplus of 5.3 percent in 2016, and is estimated to have recorded a surplus of 3.8 percent of GDP in 2017.

Current Account

(Percent of GDP)

Sources: Haver Analytics; IMF staff calculations.

2. Bulgaria’s export performance has been strong since 2010 but the market share expansion slowed down in recent years Bulgaria’s goods export volume is estimated to have grown by about 75 percent between 2010 and 2017, exceeding export growth of other EU new member states. Over the same period, services volume is estimated to have grown by about 24 percent. The world market share of Bulgarian exports of goods and services increased steadily to rise above the NMS median. However, the market share has stayed broadly constant since 2013 unlike regional peers, probably reflecting a sharp appreciation in the ULC-based real exchange rate around the same year.

Export Volume Growth, 2010-2017

(Percent)

Sources: Eurostat; and IMF staff calculations.

Market Share of Exports

(Index 2010 = 100)

Sources: European Commission.

Current Account

3. The CA model of the EBA-lite framework adjusted for Bulgaria specific-factors points to a moderately stronger current account than fundamentals and desirable policies. While the unadjusted model points to a sizable undervaluation (18.7 percent) with an estimated CA gap of 8.4 percent of GDP, it does not capture country-specific factors underpinning Bulgaria’s CA developments. Specifically, in staff’s view, the CA is boosted by temporary factors, notably a drop in public investment and stronger exports growth largely owing to the recent buoyancy of tourism driven by political uncertainties in some traditional tourism destinations. Owing to these reasons, staff estimates the cyclically adjusted CA, removing all temporary factors, to be about 0.8 percent of GDP. The estimated current account norm is -4.6 percent of GDP. However, based on historical experience and in staff’s judgement, external financing a deficit of that size may not be sustainable. Staff assesses that a smaller CA deficit of about 2½ percent of GDP is a more appropriate norm. The CA gap is estimated at 3.5 percent of GDP after the adjustments, and the REER would be undervalued by 7.8 percent.

EBA-Lite CA Approach Results, 2017(percent of GDP)
Standard versionAdjusted CA norm
Actual CA3.8Actual CA3.8
Cyclically-adjusted CA (removing all
Cyclically-adjusted CA3.7temporary factors)0.8
CA norm−4.6Adjusted CA norm−2.6
CA gap8.4CA gap3.5
o/w policy gap1.3o/w policy gap1.3
Elasticity−0.5Elasticity−0.5
REER gap−18.7REER gap−7.8

Exchange Rate Indicators

4. Rapid wage growth poses risks to external competitiveness. In Bulgaria, labor costs have outpaced productivity growth since 2012, while in regional peer countries, wage growth developed more in line with productivity. Manufacturing labor costs hit the bottom in 2011 and have since been on an upward trend. Bulgaria’s adjusted wage share in total factor cost decoupled from regional peers in 2011, reached the EU level in 2014, and has since slightly surpassed that level. At present, increasing wages do not appear to have seriously impaired Bulgaria’s export performance as labor cost remains at comparatively low levels. However, its market share growth has broadly stalled since 2013, and going forward, export competitiveness could weaken should the current trend of divergence between wage growth and productivity growth continue.

5. Bulgaria’s real effective exchange rates developments suggests that its real exchange rates are broadly in line with or somewhat weaker than fundamentals. Bulgaria’s REER based on ULC has strongly appreciated well beyond the financial crisis level on the back of rising labor costs, while the consumption-based REER, was broadly stable during the post-crisis low-inflation environment and has depreciated recently in view of imported deflation—which lasted up to 2016—largely owing to falling metal and textile product prices. Per the REER model of the extended External Balance Assessment (“EBA-lite”), the CPI-based REER is estimated to be above the REER norm by 1.2 percent, suggesting a slight overvaluation. A comparable analysis of ULC-based REER would likely indicate a larger overvaluation, judging from the divergence of Bulgaria’s ULC-based REER from regional peers. While a formal assessment of ULC-based REER is not available, a comparison with the crisis period indicates as much. The ULC-based REER appreciated by 44 percent between 2007 and 2017 while CPI-based REER appreciated by 7 percent over the same period.

EBA-Lite REER Approach(percent of GDP)
REER gap1.2

Wages and Salaries Labor Cost Index, Manufacturing

(Percent change, y-o-y)

Source: National Statistical Institute.

Adjusted Wage Share

(Compensation per employee in percent of factor cost per person employed)

Sources: Eurostat; and IMF staff calculations.

Real Labor Productivity and Real Compensation Per Employee

(Index 2010 = 100)

Sources: Haver Analytics and IMF staff calculations.

Real Effective Exchange Rates

(Index 2010 = 100)

Sources: European Commission; and IMF staff calculations.

6. Considering current account and exchange rate indicators, staff assesses the external position of Bulgaria to be moderately stronger than fundamentals and desirable policy settings, albeit subject to substantial statistical and model uncertainty. The adjusted current account model—which better captures the Bulgaria specificities—point to a real exchange rate gap of -7.8 percent. The CPI-based real effective exchange rate model yields an REER gap of 1.2 percent. In addition, the ULC-based REER has appreciated by about 20 percent since 2011, while the CPI-based REER remains broadly stable. The range of the estimated REER gaps reflects the unusually high uncertainties. Besides the abovementioned factors, there is potential for large revisions to the 2016 and 2017 CA estimates, judging by past experience,1 and reflecting Bulgaria’s large volatility in the balance of payments with a CA standard deviation of 8 percent. Bulgaria also has the need to rapidly reduce external debt (paragraph 8).

Foreign Asset and Liability Position

7. Bulgaria’s international investment position has improved in recent years, but the country could benefit from further external debt decline. The IIP increased from about 92 percent of GDP net liabilities in 2010 to 47 percent of GDP net liabilities in 2016 and estimated to improve further to about 40 percent in 2017. The improvement has mainly been driven by an increase in reserve assets and a reduction in other liabilities, the latter reflecting private-sector deleveraging, in particular by banks. External debt has been declining in recent years, from 106 percent of GDP in 2009 to about 66 percent in 2017.2 While the IIP position is not vulnerable, a further reduction in the external debt possibly at a faster pace would strengthen the country’s external position and bring the external debt within the range of 35—40 percent of GDP beyond which the country is considered vulnerable to external shocks.3

Net International Investment Position

(Percent of GDP)

Sources: IMF; and IMF staff calculations.

External Debt

(Percent of GDP)

Source: Word Economic Outlook.

Capital and Financial Account Flows

8. Direct investment has increased and net portfolio investment inflows have resumed recently. Net FDI inflows have been stable at around an average of 2½ percent of GDP over 2010–14 and increased to 5.1 percent of GDP in 2015. However, net FDI inflows slowed down in 2016 to 0.7 percent of GDP and are estimated at 0.6 percent in 2017. Portfolio debt inflows have resumed in 2014, reflecting renewed investor confidence in Bulgaria, although their pace has moderated over 2015–17. Private-sector bank-led deleveraging is ongoing, as other investment positions abroad have been reduced. Reserve accumulation has picked up (with some signs of stabilization in 2016) mainly on the back of current and capital account surpluses.

Capital Flows

(In percent of GDP)

Sources: IMF; and IMF staff calculations.

9. Bulgaria’s international reserves are estimated to be adequate to support the CBA. Reserves stood at 47 percent of GDP at end-2017, well above the standard rules of thumb (three months’ coverage of prospective imports and 20 percent of broad money). Bulgaria’s reserves exceeded 100 percent of short-term debt, and are estimated at 198 percent of the standard IMF metric in 2017, well above the 100–150 percent range considered appropriate. The standard metric, however, needs to be interpreted with caution, as the ratio of reserves over CBA liabilities stood at 114 percent at end-2017, while 100 percent coverage is required under the CBA.

ARA Metric Decomposition

(USD billion)

Sources: IMF, WEO; and IMF staff calculations.

Reserves Over Reserve Money and Broad Money

(Percent)

Sources: IMF, WEO; and IMF staff calculations.

Gross International Reserves vs. Traditional Metrics

(Percent of GDP)

Sources: IMF WEO, IFS, and IMF staff calculations.

Reserves and Reserve Adequacy Metrics

(Percent of risk-weighted metric)

Sources:IMF, WEO; and IMF staff calculations.

Annex II. Risk Assessment Matrix1
Source of RiskRelative LikelihoodImpact if Realized
1. High wage growth (medium term).High

Negative impact through undermining competitiveness.
High/Medium

Higher consumption growth.

Competitiveness and the current account weaken. Possible boom-bust cycle.
2. Weak progress in structural reforms to raise productivity and mitigate the impact of aging and emigration (short/medium term).High/Medium

Lack of political support delays the structural reform agenda, including reforms that would reduce medium-term fiscal risks.
High

Lower potential growth, high structural Unemployment, and increased fiscal risks.
3. Inadequate actions to address weaknesses in the banking system, as identified by the AQR/stress test and the FSAP (short term).Medium

Banks identified by AQR/stress test are unable to raise high quality private capital and/or inadequate progress in implementing a comprehensive supervisory strategy for them.
High/Medium

Increased vulnerability to unanticipated shocks. Financial sector stability weakened.
4. Structurally weak growth in the Euro area (medium term).High/Medium

Bulgaria’s exports are highly dependent on Euro-area markets. There would be direct negative influence through trade and investment channels.
High

Low potential growth, high structural unemployment and low FDI, continued fiscal pressures.
5. Significant slowdown in large EMs (short/medium term).Medium

Negative impact through trade and investment channels.
Medium

Lower exports, employment, and growth
6. Policy and geopolitical uncertainties, including uncertainty associated with negotiating post-Brexit arrangements (short/medium term).High

Increased investor uncertainty. Negative impact through trade channel.
High/Medium

Exacerbating low investment. Lower exports, employment, and growth.
7. Tighter global financial conditions (Fed normalization and tapering by ECB) (short term)High

Negative impact through increase in funding costs for banks, corporates, and households.
Medium

Lower investment and growth.
8. European bank distress (short term)Medium

Foreign bank subsidies are primarily funded by local deposits, with limited funding from parent banks.
Medium/Low

Lower bank lending and growth.
Annex III. Debt Sustainability

Bulgaria debt outlook has improved. External debt is steadily declining and public debt is sustainable within the medium-term projection horizon. Under the baseline scenario, public debt will fall from around 27 percent of GDP at end-2016 to 20 percent of GDP by end-2022, which is low by international standards. Standardized macro-fiscal stress tests indicate that lower growth and a combined macro-fiscal shock could shift the debt-to-GDP ratio upwards, but debt would remain on a downward trajectory.

External Debt

1. The external debt’s downward trend continues and is accelerating. After reaching a peak of 106.4 percent of GDP at end-2009, gross external debt has been steadily declining since then and stood at about 66 percent at end-2016, mainly on account of private sector deleveraging in the banking sector. Since 2014 declining inter-company lending has also been contributing to the downward trend. Excluding inter-company lending, external debt declined to about 38 percent by end-2017, largely covered by international reserves. Rollover risks related to external exposure in the non-bank private sector are contained given moderate short-term exposure; these risks also did not materialize during the global financial crisis. External debt could be brought down faster to further reduce the country’s external vulnerabilities.1

2. Under staff’s baseline projection scenario, gross external debt is expected to decline further over the medium term. External debt is set to decline to around 53 percent of GDP by 2022. The medium-term decline in gross external debt is largely driven by nominal GDP growth whereas nominal external debt is expected to remain broadly stable as the authorities issued no external debt in 2017, the pace of private sector deleveraging moderates and phases out while the authorities have no plan for new external borrowing in 2018-2020. The historical scenario, projecting external debt on the basis of 10-year averages of key determinants, generates a very similar trajectory.

3. External debt dynamics appear broadly resilient to shocks. Shocks to the interest rate, the growth rate, and the current account deficit would shift the trajectory of external debt relative to GDP upwards. The external debt to GDP ratio is projected to eventually resume its downward-sloping path over the medium-term under each of these scenarios except for the current account shock where external debt is projected to reach 76 percent over the medium-term.

Public Debt

4. General government gross debt increased temporarily in 2016, but is projected to decline over the medium term. Under the IMF’s standard DSA methodology, Bulgaria is considered a “lower scrutiny” country given its relatively moderate level of debt and gross financing needs. In 2016, public debt rose to 27.4 percent of GDP due to the sizable Eurobonds issuance (EUR 2 billion or 4.6 percent of GDP). However, in 2017, mainly due to the repayment of the Eurobonds, it is estimated to decline by 3.5 percentage points of GDP. The authorities issued no new external bonds in 2017 and have no plan to do so in 2018. In the medium term, the authorities plan to achieve the balanced budget in 2020. Fiscal consolidation and a favorable growth-interest rate differential will help reduce general government debt over the medium term.

5. Public debt remains at manageable levels. In the baseline projections, assuming Fiscal Reserve Account (FRA) balances remain unchanged from the projected 2017 level (BGN 8.9 billion, 9.1 percent of GDP) for 2017-2022, the general government debt is projected to decline to 19.7 percent of GDP, which is low by international standards.2 If the government were to draw down FRA for financing, the pace of debt reduction could be faster.3 Alternative scenarios indicate that public debt would likely remain below 30 percent of GDP under various shock scenarios. Gross financing needs are also projected to remain well below 6 percent of GDP under shocks.

Figure 1.Bulgaria: External Debt Sustainability: Bound Tests 1/2/

(External debt in percent of GDP)

Sources: International Monetary Fund, Country desk data, and staff estimates.

1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks, except in case of the interest rate shock where a 200 bp shock is assumed. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.

2/ For historical scenarios, the historical averages are calculated over the ten -year period, and the information is used to project debt dynamics five years ahead.

3/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance.

4/ One-time real depreciation of 30 percent occurs in 2018.

Figure 2.Bulgaria: Public Sector Debt Sustainability Analysis (DSA) – Baseline Scenario

(in percent of GDP, unless otherwise indicated)

Source: IMF staff.

1/ Public sector is defined as general government.

2/ Based on available data.

3/ Long-term bond spread over German bonds.

4/ Defined as interest payments divided by debt stock (excluding guarantees) at the end of previous year.

5/ Derived as [(r - π(1 + g) - g - ae(1 + r]]/[1+g+π+gπ)) times previous period debt ratio, with r = interest rate; π = growth rate of GDP deflator; g = real GDP growth rate; a = share of foreign-currency denominated debt; and e = nominal exchange rate depredation (measured by increase in local currency value of U.S. dollar).

6/ The real interest rate contribution is derived from the numerator in footnote 5 as r - π (1 + g) and the real growth contribution as -g.

7/ The exchange rate contribution is derived from the numerator in footnote 5 as ae(1 + r).

8/ Indudes asset changes and interest revenues (if any). For projections, indudes exchange rate changes during the projection period.

9/ Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.

Figure 3.Bulgaria: Public DSA – Composition of Public Debt and Alternative Scenarios

Source: IMF staff.

Figure 4.Bulgaria: Public DSA – Stress Tests

Source: IMF staff.

1/ Real GDP growth shock scenario assumes (i) real GDP growth for 2018-19 to be below the baseline projections by a 10-year historical standard deviation; (ii) the primary balance deteriorates; (iii) additional borrowing leads to increases in interest rate of 25 bbp per 1 percent of GDP worsening of the primary balance; and (iv) inflation declines by 0.25 percentage point per 1 percentage point decrease in GDP growth.

2/ Primary balance shock scenario assumes (i) the primary balance for 2018-19 to be below the baseline projections by 50 percent of the 10-year historical standard deviation; and (ii) additional borrowing leads to increase in interest rate of 25 bbp per 1 percent of GDP worsening of the primary balance.

3/ Real interest rate shock scenario assumes nominal interest rate increases by the difference between the maximum real interest rate over history (last 10 years) and the average real interest rate level over projection.

Appendix I. Main Recommendations of the 2016 Article IV Consultation and Authorities’ Actions
IMF 2016 Article IV RecommendationsPolicy Actions
Financial Sector Policies
Follow-up on the recently completed AQR and stress test to restore capital buffers of identified banks.The three identified banks have raised capital, but two of them would still require larger capital buffers.
Use the information acquired during the banking assessment to pursue a more risk-based supervisory review and evaluation process, and devote adequate resources to more inspections.The BNB has issued a draft risk assessment manual. It is developing a multi-year action plan with detailed activities to continue strengthening banking supervision.
Improve bank governance by strengthening the regulatory requirements for transparency of groups’ operational and ownership structures and upgrading the Boards’ governance.Amendments to the LCI strengthened the definition and tightened the control of related-party exposures in line with EU legislation and country-specific circumstances.
Take proactive measures to promote effective write-offs within a reasonable time frame to reduce NPLs.NPLs have declined from 16.9 percent of total loans in 2013 to 11.4 percent in 2017Q3, but are still well above the EU average. Draft guidance by the BNB’s supervision department incorporates relevant supervisory metrics for credit loss provisioning, NPL accounting write-offs, and collateral valuation.
Fiscal Policy
Save the revenue overperformance in 2016 to strengthen fiscal buffers.The fiscal balance (1.6 percent of GDP) substantially exceeded the original budget target.
Improve public spending efficiency, particularly in the areas of education, health, and public investment.The authorities are undertaking selective public spending reviews in cooperation with the World Bank. Efforts to improve public goods including public infrastructure, education, and healthcare are continuing.
Need further pension reforms to address long-term spending pressures.No reform of pension system is planned at this stage.
Structural Reforms
Labor market
Make active labor market policies more effective by better targeting training and education to reduce skill mismatch and improve institutional environment and career opportunities for reintegration.The authorities have implemented multiple measures to address skill mismatches including the pilot programs to improve vocational training in partnership with the business community.
SOEs
Enhance the governance and performance of state-owned enterprises to reduce contingent liabilities and improve productivity. Monitor fiscal contingent liabilities closely and reflect in fiscal planning.The authorities received a technical assistance on oversight and management of SOEs from the IMF. The Public Finance Act was amended to include contingent liabilities from SOEs in the MTBF.
Governance
Adopt a comprehensive anti-corruption law and establish a single agency with adequate powers and independence, consolidate the anti-corruption work, and establish a track record of successful investigations and prosecutions of alleged high-level corruption.Parliament passed the Anti-Corruption Act, which includes the establishment of an anti-corruption body. Efforts are continuing to strengthen the effectiveness and accountability of the Prosecutor’s Office and to step up the fight against corruption.
Appendix II. Key FSAP Recommendations
RecommendationTime1
Banking Sector Stability
Analyze and stress test largest exposures separately, also considering potential cash flows from collateral in case of default (BNB).NT
Financial Sector Oversight and Regulation
Ensure adequate staffing and resources of all financial oversight authorities and arrange significant training and capacity building for staff (MoF, BNB, BDIF).NT
Strengthen the legal and operational framework for legal protection for current and former staff of all financial oversight authorities. (MoF, BNB, FSC, BDIF).NT
Banking Sector Supervision and Regulation
Adopt a multi-year Action Plan with detailed activities to continue strengthening BSD (BNB).NT
Implement a comprehensive supervisory strategy for the target banks under the AQR (BNB).I
Introduce regulation (based on Article 45) on related parties setting criteria to typify circumvention (e.g., including the inability to identify ultimate beneficial owner, inter-alia) (BNB).I
Based on 2017 inspections, enforce remedies to concentration and related party risks (BNB).NT
Implement a risk-based approach to AML/CFT supervision in line with the FATF standards.NT
Macroprudential Policy Framework
Strengthen public disclosure of macroprudential policy, including the objectives and reasoning for policies and how they are supposed to work, and ex-post assessment of effectiveness (BNB).NT
Nonperforming Loans Strategy for Banks
Implement a comprehensive strategy for NPL reduction, including the use of supervisory review tools. The strategy should enforce (i) robust provisioning in 2017 (under IAS 39) and in 2018 (under IFRS 9), building on BCBS efforts and related supervisory guidance; (ii) oblige write-offs of NPLs where collection is unlikely; (iii) issue supervisory guidance setting out minimum collateral valuation practices; and (iv) enhance supervisory reporting and disclosure BNB.I
Financial Safety Net
Prioritize RRP for (1) the banks for which the 2016 AQR and stress test indicated capital shortfalls, and (2) the majority domestically owned D-SIBs. (BNB).I
Ensure a smooth and decisive transition from early intervention into resolution. (BNB).NT
Consistent with the currency board arrangement, define joint BNB-MoF strategies for liquidity assistance to banks, supported by a comprehensive toolkit. (BNB, MoF).I
Under the oversight of the FSAC with an expanded mandate and membership, strengthen the crisis management framework. (FSAC, MoF, BNB, FSC, BDIF).NT
1 Immediately (I) is within one year, near term (NT) is 1–3 years.

Bulgaria, Financial System Stability Assessment, IMF, 2017.

The liquidation process for the Corporate Commercial Bank (domestically-owned) is still ongoing.

NMS includes Bulgaria, Croatia, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovakia, Slovenia.

These loans will be eventually paid by the budget, and represent 40 percent of the growth of loans to households from October 2016 to October 2017.

The 2015 reforms introduced an automatic link between the retirement ages and life expectancy once the retirement ages reach 65 years.

The share of the long-term unemployed in percent of the labor force is low, reflecting the low unemployment rate. However, the share of the long-term unemployed among the unemployed is high at 59.5 percent.

“Reforming the Judiciary: Learning from the Experience of Central, Eastern and Southeastern Europe” in Regional Economic Outlook: Europe Hitting Its Stride, IMF, November 2017.

Based on the EBA definition. The BNB has traditionally employed a more conservative NPL measure.

For example, 2015 CA estimate has been revised from 1.4 percent of GDP to 0. The 2016 CA estimate will be revised in March 2018, and the 2017 estimate will be revised in September 2018 for the trade data and in March 2019 for FDI data. Moreover, the BNB has discontinued the international transactions reporting system (ITRS), which provides timely, comprehensive data for compiling items in the services and income accounts. The non-availability of data from the ITRS is likely to undermine the timeliness, accuracy, and reliability of the estimates until adequate data sources are developed.

Excluding inter-company lending, external debt declined to about 38 percent in 2017

World Economic Outlook, 2003 September

The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relatively likelihoods of risks listed is the staff’s subjective assessment of the risks surrounding the baseline. The RAM reflects staff’s views on the sources of risk and overall level of concern as of the time of discussions with the authorities.

Beyond the range of 35–40 percent of GDP, external debt is found to start having a negative impact of growth (World Economic Outlook, 2003 September).

The minimum requirement of FRA is set with the annual budget law. For 2017, it is set at BGN 4.5 billion.

There have been years when the deficit has been at least partially financed out of the fiscal reserve, but recently such practices are avoided.

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