The Bulgarian authorities thank the Article IV mission team for the constructive discussions in Sofia, well-balanced appraisals, and for the elaborations in the Selected Issues Papers. Encouraged by staff’s acknowledgement of the country’s solid performance and resilience, they remain committed to prudent macroeconomic and financial policies. The authorities broadly concur with the staff’s recommendations which will be carefully considered to address the challenges to the Bulgarian economy.
The new coalition government, which took office last May, is dedicated to boost competitiveness and growth potential by strengthening the public finance management, accelerating the EU funds utilization, and improving the business environment. In line with the recent FSAP recommendations, the concerted efforts of the Bulgarian National Bank (BNB), Financial Supervisory Commission (FSC) and government have resulted in substantial progress with strengthening the financial stability framework. Several legislative initiatives have been introduced, while other steps are being prepared, including implementation. We will focus our remarks on (1) financial stability, (2) fiscal sustainability, and (3) structural reforms and growth.
Without complacency, the authorities continue to address the remaining financial stability risks. In line with the recent FSAP recommendations, they have made substantial progress with strengthening the institutional framework for the financial system oversight and operationalizing systemic banks resolution and crisis management. As pointed out in the staff report, several legislative initiatives have been introduced, while other steps are in preparation, including implementation. The recent changes in the BNB legislation transferred the supervisory powers from Deputy Governors to the BNB Governing Council, and the BNB is working to quickly put in place decision making rules and procedures adequate to the new governance model. It is envisaged to become fully operational in the course of this year. The FSC Act was also amended to make the regulator fully financially independent and more accountable. The FSC is the competent authority for the recently transposed EU Directive on Markets in Financial Instruments (MIFID II) into the Bulgarian legislation. New rules for admission to trading of government securities were adopted, and an electronic platform was introduced to increase transparency and limit the clearing and settlement risks.
In line with recent FSAP recommendations, the BNB has already implemented a number of policies to strengthen financial stability and increase confidence in the financial system. The plan to promote risk-based supervision, including the risk-based AML/CTF approaches, has been evaluated and regularly been updated by the governing council to accommodate important developments in the financial sector reform at the European level. The banking supervision has completed a comprehensive assessment of the banks’ credit rules and procedures and their ability to implement the IFRS 9. The new standard should strengthen the individual banks’ capacity for risk assessment and asset classification, and reinforce the collateral evaluation and provisioning in line with the best recommended international practices. Now, the BNB remains focused on making the bank resolution framework fully operational. The BNB continues to proactively develop the macroprudential framework and has enhanced its capacity to analyze and address the systemic risk. With regards to the non-banking financial system, the FSC has made the next steps to implement the European Solvency II Directive in the insurance sector, and strengthen portfolio quality and capital buffers of the insurers and pension funds in line with the outcomes of the 2017 comprehensive asset quality reviews (AQRs) and stress-tests of insurers.
The Bulgarian banking sector remains profitable, well capitalized, and highly liquid, since credit growth has steadily recovered and the NPLs declined from 17.2% at the end of 2014 to 10.2% at December 2017. Since 2016 bank profits have returned to pre-crisis levels, and all banks have firmly observed the regulatory standards for accumulating various capital buffers. Following the results of the 2016 AQRs and stress tests, some banks have successfully implemented recovery plans to achieve the supervisory targets above the minimum regulatory capital. Potential spillover risks from the Bulgarian banking system remain well contained thanks to the stable domestic deposit funding and low reliance on both the domestic and international wholesale financial markets. Supported by the BNB, market-driven changes in the ownership structure of the Bulgarian financial sector continue to take place, and at the beginning of this year the “Municipal Bank PLC” has been privatized to European investors.
Bulgaria has implemented conservative fiscal strategies since the adoption of the Currency Board Arrangement (CBA). Like in the previous year, the 2017 fiscal consolidation appeared to be faster than initially anticipated due to higher economic growth, further strengthening of the revenue collection framework, and under-execution of the capital spending. The government saved the revenue’s overperformance to strengthen fiscal buffers and contain cyclicality of the private demand. They accordingly adjusted the medium-term fiscal target, and will return to a structurally balanced budget by 2020, which enables the automatic stabilizers to work while the government builds up liquidity buffers in good times and contains further debt accumulation. The 2018 budget projects a cash deficit at 1 percent of GDP, and the structural budget deficit will remain at about 0.5 percent to GDP. The 2018 tax policy remained broadly unchanged in line with the long-standing authorities’ commitment to maintain a predictable low-tax environment. Given the long-term challenges to the pension system, however, from the beginning of 2018 the social security contribution rate was increased by one percentage point.
The authorities remain vigilant to the potential medium- and long-term fiscal pressures. Last year, supported by IMF Technical Assistance (TA), they started developing a framework to better identify and manage fiscal risks stemming from the state-owned enterprises. Corresponding amendments to the Public Finance Act were made to include their contingent liabilities into the medium-term budgetary framework. The national energy and water regulator also implemented series of measures to bring the utility prices firmly on the cost recovery path and ensure better quality of the services. In 2018, the IMF TA will support the Bulgarian national revenue agency to improve the tax gap assessment process. Together with the World Bank, the authorities are conducting a public spending review in several areas. Depending on the success in the following years, the scope of the project will be extended to other areas. As described in the staff report, the next steps in the public education reform will be implemented to achieve a more targeted and efficient public expenditure and to further enhance the productivity of public investment.
Structural Reforms and Growth
The Bulgarian macroeconomic fundamentals grew significantly stronger after the global crisis thanks to the firm national consensus to the CBA and the government’s strong underlying fiscal position. These remain the anchors for all other macroeconomic policies in the long run to make a steadfast progress with the EU income convergence. In addition, the new coalition in power since May has made decisive efforts to increase public awareness in the needed structural and institutional reforms, and to consolidate public confidence and reinvigorate the reform process. In January 2018 the Bulgarian parliament adopted the new Counter-Corruption and Unlawfully Acquired Asset Forfeiture Act to better coordinate the fight against corruption. They consider this key to enhance the business environment and facilitate a smooth transition toward a sustainable investment- and export-driven growth model.
The cyclical economic recovery accelerated further in 2017 given the improved domestic business confidence after the elections, robust growth of the European economy, and surge in the global trade. Inflation has steadily recovered, and the unemployment rate has reached its lowest level since the global financial crisis. Initial estimates indicate that the 2017 GDP growth may approach 4 percent, higher than initially anticipated by staff and the authorities. It was primarily driven by private consumption, which also contributed to an increase in imports. Government consumption had a broadly neutral contribution to growth, and its dynamics were determined by the rate of increase in compensation-per-employee in budget organizations, operating expenditure and health insurance payments. The improved external demand led to a significant increase in exports and tourism receipts, which resulted in a close to nil contribution of net exports to real GDP growth. To sustain growth momentum, the government adopted the 2018 National Employment Action Plan with a series of measures to strengthen the labor participation and re-inclusion in the labor market of the long-term unemployed.
The authorities broadly share staff’s view on outlook and risks, but they believe the upside risks can be better tailored in the medium-term baseline scenario. In line with expectations of improving global economic activity, the external demand for Bulgarian export is likely to continue growing. If market expectations materialize, the terms of trade will remain favorable. Investors’ interest in Bulgaria and the region has also recovered on the back of the favorable global economic outlook and the recent substantial infrastructure investments. The Bulgarian business climate index rose by another 2.6 points m/m in January on the back of improving confidence in all the economic sectors. The business surveys suggest that 2018 will be stronger in terms of demand for industrial plots and the upcoming investments are planned in a broad spectrum of sectors – from food and textile, to high tech, car parts and machinery industries. Steady improvement of the EU funds absorption and the credit expansion gaining momentum will help investment growth in Bulgaria too. Going forward, positive effects on both domestic demand and potential output stem from the second-round effects of gradual fiscal consolidation in recent years. It is encouraging that now the investors’ radar includes regions with high unemployment. There have also been initial signs that Bulgarians started gradually returning from abroad, but the income convergence will be key to intensify this process.
The new government has demonstrated high determination to make up for delayed structural reforms. Priority has been given to various legislative initiatives under the Cooperation and Verification Mechanism (CVM) with the EU to give impetus of the juridical reforms. The most important development in 2017 were the election of a new Supreme Judicial Council to boost independence and efficiency of decision-making in the judicial system, and the adoption of amendments in the Judicial Systems Act and Criminal Procedure Code to improve the legal framework for prosecution of high-level corruption and serious organized crime. In line with the most recent recommendations under the CVM, the remaining legislative initiatives will be brought forward in a spirit of a broad public debate and consultation with affected stakeholders. By the end of March 2018, the government will also introduce a roadmap for transformation towards an e-government with clear funding, dates and strategy. A new model for the registration, operation, management and funding of medical care is developed to increase cost efficiency and improve the service quality. After the public debate, the authorities will prepare the relevant legislative changes, and the system would be ready to start operating under the new model from January 1, 2019. They also forcefully consider measures to tackle air pollution in the big cities, and make public transportation more efficient and environment-friendly.