Bulgaria: Staff Report for the 2000 Article IV Consultation and Fifth Review Under the Extended Arrangement

Bulgaria’s currency board arrangement continues to have broad political and public support and shows no signs of strain, as interest rates are low and stable, fiscal reserves ample, and banks liquid. A structural reform agenda has also been implemented. The authorities have improved banking supervision, started the overhaul of the pension and health care systems, and liberalized trade and prices. Executive Directors stressed the need to strengthen the bank supervision and corporate governance to reduce the perceived risks of lending to the private sector.


Bulgaria’s currency board arrangement continues to have broad political and public support and shows no signs of strain, as interest rates are low and stable, fiscal reserves ample, and banks liquid. A structural reform agenda has also been implemented. The authorities have improved banking supervision, started the overhaul of the pension and health care systems, and liberalized trade and prices. Executive Directors stressed the need to strengthen the bank supervision and corporate governance to reduce the perceived risks of lending to the private sector.

I. Introduction

1. A staff team visited Sofia during January 15–29, 2001 to hold discussions for the 2000 Article IV consultation and the fifth (final) review under the extended arrangement.1 The mission also followed up on the Report on the Observance of Standards and Codes (ROSC) originally issued in September 1999 (an update will be issued to the Executive Board separately). The three-year arrangement for SDR 627.62 million (98 percent of quota) was approved in September 1998, and so far ten purchases of SDR 52.3 million each have been made (Appendix I). Bulgaria’s economic program is supported by the World Bank (Appendix II), the EU, and other donors.

2. In discussing Bulgaria during 2000, Executive Directors commended the authorities for their sound macroeconomic policies, and urged them to persevere with structural reform. In concluding the third review and the last Article IV consultation (in March) and the fourth review (in September), Directors observed that prudent fiscal and incomes policies and the acceleration of structural reforms had helped Bulgaria to weather adverse shocks and initiate a rebound in economic activity and exports. Looking forward, Directors stressed the need to continue strong and comprehensive policies, including vigorous structural reform in the enterprise and energy sectors, and measures to improve governance and the business climate.

3. In the attached letter to the Managing Director and the accompanying Memorandum on Economic Policies, the authorities report on progress made, describe their policies for 2001, and request completion of the fifth review. Bulgaria’s eleventh purchase of SDR 52.3 million under the arrangement is contingent on completion of the review. The final purchase, of the same amount, is contingent on observance of the performance criteria for end-March 2001 set in the Memorandum.

4. General elections will be held in June 2001. Since mid-1997, the center-right Union of Democratic Forces has ruled as the dominant coalition partner in a government enjoying a parliamentary majority. Opinion polls suggest that neither this coalition, nor the opposition Socialist Party and its allies, is likely to obtain a majority in the new parliament, necessitating the formation of a broader coalition government. Most observers believe that a coalition led by either main party would remain committed to policies leading to EU accession. The EU invited Bulgaria to start membership negotiations in December 1999.

5. The quality and timeliness of statistical reporting by Bulgaria are generally sufficient for program monitoring and surveillance (Appendix III). Nevertheless, important deficiencies remain in real sector and balance of payments statistics. These are being addressed with Fund technical assistance. The lack of comprehensive labor statistics hampers the assessment of developments in private sector wages and employment. Since May 2000, Bulgaria has participated in the General Data Dissemination System. The authorities are making progress toward subscribing to the Special Data Dissemination Standard.

II. Background

6. After a disappointing performance during the early years of transition, Bulgaria has come a long way in three years (Table 1 and Figure 1). Having fallen by more than a third between 1989 and 1997, real GDP has since increased by 11 percent, despite severe shocks, including the global financial crises and the war in Kosovo. Inflation, which reached near-hyperinflationary levels during a banking and foreign exchange crisis in 1996–97, has been brought under control. External debt has declined from nearly 100 percent of GDP in 1997 to about 80 percent now. Starting from almost scratch, in three years over one half of enterprise assets and four fifths of bank assets have been privatized.

Table 1.

Bulgaria: Selected Economic Indicators, 1996-2000

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Sources: Bulgarian authorities; and staff estimates.

Industry: average of public and private sectors. A number above zero indicates a positive average assessment of current business conditions.

Average monthly wage in the public (including nonbudgetary) sector.

Includes the republican budget, municipalities, and extrabudgelary funds. The coverage became more comprehensive from 1998 onward, resulting in a structural break.

Domestic debt increased by 2.5 percent of GDP in June 1997 due to a restructuring of central bank claims on government.

Starting 1998, a new methodology was adopted for the calculation of BOP data. Data for Q2 2000 are: April and May for current account and trade; June for reserves; and May for external debt.

End-of-period, in redenominated leva.

Figure 1.
Figure 1.

Bulgaria: Indicators of Progress, 1991–2000

Citation: IMF Staff Country Reports 2001, 053; 10.5089/9781451804355.002.A001

Sources: Bulgarian authorities; and Fund staff estimates.

7. This turnaround owes much to a sound policy framework centered on a currency board arrangement (CBA). Bulgaria’s early transition was characterized by stop-and-go policies and lack of structural reform. Since the introduction of the CBA in mid-1997, the authorities have followed prudent stabilization policies. The general government fiscal position has been in approximate balance, and under a strict incomes policy for state enterprises, the worst-performing firms have been subject to wage bill freezes. The CBA continues to have broad political and public support, and shows no signs of strain, as interest rates are low and stable, fiscal reserves ample, and banks liquid. An ambitious structural reform agenda has also been implemented quite successfully. Besides the rapid privatization, the authorities have improved banking supervision, started the overhaul of the pension and health care systems, and liberalized trade and prices. Less progress has been made in reducing inefficiencies in the enterprise sector, restructuring the energy sector, and improving the business climate. Indeed, while exports have begun to grow rapidly, they have yet to return to levels reached in the mid-1990s, and productivity outside manufacturing has been stagnant.

8. Recent policy performance has remained generally good, with some slowdown in structural reform. All performance criteria for September and December 2000 were observed (Tables 2 and 3). State enterprises have maintained wage discipline, and fiscal policy has remained prudent, with the general government deficit contained to 1 percent of GDP in 2000. Following intensive efforts in 1999, the authorities also generally maintained the momentum of reform in 2000, with major advances in most areas (Box 1). However, toward the end of the year signs emerged of some slowdown in sensitive areas, stemming in large part from the approach of the elections. A key structural benchmark for September 2000, the submission to parliament of amendments to the Energy Law, was still outstanding in February 2001, holding back the creation of an efficient and competitive energy sector and the restructuring of the ailing district heating sector. Also, parliamentary approval of amendments to the Labor Code (aimed at making wages and employment more flexible) was delayed by nine months, to March 2001, as social partners continued to debate the details. Moreover, while an amended Privatization Law aimed at increasing transparency was approved expeditiously in November 2000, new strategies to sell the telecommunications and tobacco monopolies are yet to be put in place. The first attempts to sell these companies, initiated in 1998, were suspended last summer.

Table 2.

Bulgaria: Performance Criteria and Indicative Targets for September 2000 - December 2001 1/

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Sources: Program projections; and data provided by the Bulgarian authorities.

2000 figures are cumulative from January 1, 2000, and 2001 figures are cumulative from January 1, 2001, except the floor on the level of deposits of Banking Department. Also, 2000 figures use EFF Third Review definitions and exchange rates, with 1.94687 leva/U.S. dollar; and 2001 figures use EFF Fifth Review definitions and exchange rates, with 2.10191 leva/U.S. dollar.

Excluding normal import-related credits.

Table 3.

Bulgaria: Structural Performance Criteria and Benchmarks for September 30 and December 31, 2000

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Progress in Structural Reform During 2000

Fiscal reforms. Four major reforms were implemented to help ensure long-term fiscal sustainability.

  • In June, the Council of Ministers approved a plan to create a Unified Revenue Agency aimed at enhancing the capacity to collect taxes and social contributions. Good progress has been made in implementing the plan.

  • The implementation of the Single Treasury Account (STA) in the central bank, a key step in further improving treasury operations, started in January. All leva accounts in the BNB were consolidated in the STA by July. Good progress was made toward consolidating the government’s accounts in commercial banks into the STA.

  • A strengthened pay-as-you-go pension scheme was introduced from the beginning of 2000, voluntary private pension funds were licensed, and preparations were made to launch a fully funded mandatory private pension scheme in 2002.

  • The first stage of the health care reform involving outpatient care was launched from the beginning of July.

Financial sector. Further progress was made in enabling sound private sector credit growth, promoting competition, and modernizing the financial sector.

  • In October, parliament approved amendments to the Commercial Code designed to simplify and accelerate bankruptcy procedures, and judges were trained on bankruptcy issues.

  • A central credit registry accessible to all banks was made fully operational in March.

  • Bulbank, the largest bank in Bulgaria, was sold to a strategic foreign investor in July, and a new tender for the sale of another large bank, Biochim, was issued in September.

  • Important measures to modernize the payments system, including steps to legalize electronic signatures, were taken.

  • A modern bank bankruptcy law was submitted to parliament in September, and passed first reading in November.

Incomes policy. Wages in state enterprises were kept under control through the continued application of a strict incomes policy (defined in the incomes policy ordinance for 2000, adopted in February).

  • In 2000 Q3, the total wage bill in the 97 most closely monitored enterprises (including the worst-performing ones) was 8½ percent below that in 1999 Q3.

Labor markets. Besides promoting private sector growth, the government tackled the unemployment problem through a combination of measures to increase labor market flexibility and active labor market policies.

  • In June, draft amendments to the Labor Code easing restrictions on hiring and firing were submitted to parliament.

  • A comprehensive assessment of active labor market policies was carried out with World Bank assistance.

Privatization. Progress was made in selling residual shares and leveling the playing field for bidders.

  • The share of privatized long-term fixed assets rose from 47 percent at end-1999 to 51 percent at end-2000, and that of assets excluding infrastructure increased from 71 to 78 percent during the same period.

  • Residual government shares in most nonstrategic enterprises were sold or otherwise disposed of.

  • Amendments to the Privatization Act aimed at increasing the efficiency and transparency of the privatization process were approved by parliament in November.

Energy sector. A number of programs to overhaul this critical sector were adopted, but implementation was uneven.

  • The break-up of the electricity monopoly NEK into its generation, transmission, and distribution components was completed in June. Business plans aimed at improving financial performance were implemented in the separated companies.

  • A comprehensive action plan to restructure district heating companies (DIICs) was adopted by the Council of Ministers in June. In line with the plan, the Council of Ministers decided in September to withdraw subsidies from selected DHCs. However, owing to delays in amending the Energy Act, other components of the plan could not be implemented.

  • An action plan adopted in June identified additional coal mine pits where production would cease or unviable activities would be liquidated. The liquidation of 5 nonviable coal mine companies has been initiated.

  • The rehabilitation program for the gas monopoly, Bulgargaz, continued to be implemented, although the opening of the domestic gas market was postponed pending the approval of amendments to the Energy Act.

Governance. Several steps have been taken to enhance the business climate and improve the provision of public services.

  • Red tape was reduced through the removal or simplification of 121 licensing and regulatory requirements.

  • A “one-stop shop” program was introduced in the ministries, districts, and 14 municipalities.

  • As part of a comprehensive reform of public administration, the organization structure of ministries and government bodies was redesigned, and progress was made in setting the parameters of a new merit-based compensation system.

Trade liberalization. Further progress has been made in liberalizing Bulgaria’s already relatively open trade regime.

  • The last remaining export tax (on lumber) was removed in January, and the last non-tariff barrier (export ban on raw tobacco) was eliminated in April.

  • In January 2000, the average MFN tariff was cut to 13.7 percent from 15.2 percent, and the number of tariff bands was reduced. In January 2001, the average tariff was cut to 12.4 percent, and the number of tariff bands was reduced further.

9. Despite a pickup in inflation, the macroeconomic situation at end-2000 was quite comfortable:

  • GDP growth in 2000 is estimated at 5 percent, compared with the targeted 4.5 percent (Figure 2). In the first three quarters, GDP increased by 5.3 percent year on year, albeit from a low base, as activity in the first half of 1999 was affected by the Kosovo crisis. Net exports and domestic demand contributed roughly equally to the brisk growth. Export volume rose by 23 percent, reflecting mainly a favorable external environment and, to a lesser extent, the supply response from enterprise restructuring. The growth of domestic demand was driven by fixed investment (up by 10 percent), whereas private consumption rose by a moderate 3 percent. Available indicators suggest that the recovery that started in mid-1999 continued in the last quarter of 2000. In that quarter, industrial production increased by 4 percent year on year and sales for exports by 20 percent, while retail sales were flat.

  • Inflation rose to double digits, mainly reflecting temporary shocks. In December, year-on-year inflation stood at 11.4 percent—well above the projection of 6 percent made at the time of the fourth program review last summer. The higher-than-projected inflation resulted mainly from two factors that were beyond the authorities’ control and are likely to be temporary: imported inflation (reflecting the weakening of the euro and a rise in world energy prices) and a drought. It did not reflect a loosening of credit conditions. Lending rates remain clearly positive in real terms, and commercial banks’ net foreign assets have continued to increase more rapidly than credit to the private sector. Also, velocity has been broadly unchanged, once the revaluation of U.S.-dollar-denominated deposits is corrected for.

  • The pickup in inflation notwithstanding, competitiveness seems to remain adequate (Figure 3). This is evidenced by the rapid growth of exports (especially by companies in labor-intensive sectors and by companies sold to foreign investors), a stable real effective exchange rate, and sharply lower unit labor costs, stemming from productivity gains as a result of restructuring and investment.

  • Also, the external position is under control (Figure 4). The current account deficit amounted to US$696 million (5.8 percent of GDP) in 2000, roughly the same as in the previous year, as increased receipts from exports and tourism offset the impact of a sharp rise in energy imports. The current account gap was fully covered by foreign direct investment (which has shifted toward greenfield investment) and other inflows: at end-December gross official reserves were at US$3.5 billion, somewhat above the program projection and providing reserve cover of five months of imports of goods and nonfactor services.

  • The contagion from financial turmoil in Turkey and Argentina has been limited (Table 4 and Figure 5). The spreads on Bulgaria’s Brady bonds widened temporarily between September and early December 2000, and again in the second half of February 2001. The widening exceeded that on the EMBI+ index, reflecting geographical proximity with Turkey and perceived similarity in the exchange rate regime with both countries. However, Bulgaria’s financial markets have remained calm and the banking system has been little affected. The further impact of the financial crisis in Turkey on Bulgaria’s economy is also likely to be limited. Bulgaria’s fundamentals (reserves, budget, current account, structural progress) are sound, the external financing needs for 2001 are expected to be fully covered by foreign direct investment and official financing, and Turkey accounts for only some 5 percent of Bulgaria’s trade.

Figure 2.
Figure 2.

Bulgaria: Real Sector Developments, 1992-2001

Citation: IMF Staff Country Reports 2001, 053; 10.5089/9781451804355.002.A001

Sources: Bulgarian authorities; and Fund staff calculations.
Figure 3.
Figure 3.

Bulgaria: Indicators of Competitiveness, 1992-2000

Citation: IMF Staff Country Reports 2001, 053; 10.5089/9781451804355.002.A001

Sources: National Statistical Institute; and Fund staff calculations.
Figure 4.
Figure 4.

Bulgaria: External Sector Developments, 1996-2000

Citation: IMF Staff Country Reports 2001, 053; 10.5089/9781451804355.002.A001

Source: Bulgarian authorities.
Table 4.

Bulgaria: Indicators of External Vulnerability, 1995-2001

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Sources: Bulgarian authorities; press reports; and staff calculations.

Change relative to the same period of the previous year unless otherwise stated.

In redenominated leva.

Outlook positive.

Outlook stable.

Figure 5.
Figure 5.

Bulgaria: Monetary and Financial Indicators, 1996-2001

Citation: IMF Staff Country Reports 2001, 053; 10.5089/9781451804355.002.A001

Source: The Bulgarian National Bank; Bloomberg; and Fund staff calculations.

10. Despite the encouraging developments, Bulgaria can hardly rest on its laurels. First, unemployment reached record levels in early 2000, largely owing to labor shedding related to restructuring. While joblessness has since started to decline, it remains high, at 17.9 percent in December 2000. Second, Bulgaria is still far from its goal of EU accession, which it ambitiously targets for 2006 (Figures 68).2 To join the EU, the authorities need to remove major structural obstacles to catch up with per capita incomes in other accession countries and to make the economy fully competitive. The bottlenecks include: inefficiencies in the enterprise sector, owing to the large share of insider deals in privatization and slow exit procedures; a low level of financial intermediation; the high energy intensity of production, stemming from an exceptionally high reliance on energy under central planning and a slow start in restructuring the energy sector; and burdensome bureaucracy, red tape, and corruption.

Figure 6.
Figure 6.

Bulgaria: Macroeconomic Indicators in Selected EU Accession Countries, 1999

Citation: IMF Staff Country Reports 2001, 053; 10.5089/9781451804355.002.A001

Source: World Economic Outlook.Note: BUL, Bulgaria; CZE, Czech Republic; EST, Estonia; HUN, Hungary; LVA, Latvia; LTU, Lithuania; POL, Poland; SVK, Slovak Republic; and SVN, Slovenia.1/ Estonia, Latvia, Lithuania, Romania, economy-wide wages; Hungary, Poland, and Slovenia, manufacturing gross wages.
Figure 7.
Figure 7.

Bulgaria: Relative Progress in Structural Reform, 1999

(Higher ratings indicate more progress)

Citation: IMF Staff Country Reports 2001, 053; 10.5089/9781451804355.002.A001

Source: EBRD.
Figure 8.
Figure 8.

Bulgaria: Relative Progress in Institutional Reform, 1999

(Higher ratings indicate more progress)

Citation: IMF Staff Country Reports 2001, 053; 10.5089/9781451804355.002.A001

Source: EBRD, EUROMONEY, BEATRICE WEDER, “Institutional Reform in Transition Economies” (IMF, 2000).1/ Data for 1997–98.

11. While the good policy record of the past few years bodes well for the future, Bulgaria’s economy faces risks. In the near term, the main downside risk is a relaxation of policy efforts ahead of the elections. Bulgaria would also suffer from any significant slowdown in the EU, the destination of over one half of its exports, although the effect of this would be partly offset by an expected pickup in regional trade and investor confidence resulting from recent developments in the FR Yugoslavia. In the medium term, the risks include low growth owing to the slow pace of reform, fiscal pressures on the expenditure side (including those related to EU and NATO accession and social sector reforms), and contagion from other currency board countries or emerging markets (particularly as Bulgaria moves toward reliance on market borrowing over the next few years).

III. Report on the Discussions

12. The discussions focused on how to ensure that policies remain supportive of the authorities’ goals of rapid sustained growth and a fully competitive market economy both before and after the mid-2001 elections. The staff underscored the need to stay the course before the elections: the 2001 budget had to be implemented conservatively, unwarranted wage increases in state enterprises avoided, and the momentum of structural reform maintained. The staff also noted that the post-election government would be well advised to continue the CBA-based strategy of prudent fiscal policy, wage discipline, and ambitious structural reform. This strategy had served Bulgaria well in recent years, and would offer the best prospects for removing the obstacles to income convergence with the other EU candidates and a fully functioning market economy. For their part, the authorities were determined to bring the current Fund-supported program to a successful conclusion. They also indicated willingness to continue with the current strategy, while noting that discussions on a possible new Fund arrangement would be left to the new government. Staff discussions with the opposition also suggested broad agreement with the goals and thrust of the CBA-based strategy.

A. Macroeconomic Framework

13. The authorities concurred with the staff’s assessment that the prospects for 2001 were good, provided economic policies remained sound (Tables 57 and ¶5–6).3 Based on the strong momentum from last year and projected productivity gains from structural reform, the staff considered that the GDP growth target of 5 percent was well within reach. On the demand side, private consumption and investment would be the main sources of growth, as the external environment would be more neutral than in 2000. The authorities were confident that inflation would come down significantly in 2001, noting that key factors underlying the hike in inflation last year (higher energy prices and a weaker euro) appeared to be temporary and that prices in Bulgaria were quite flexible. Indeed, in January 2001 inflation already fell markedly, to 8.7 percent year on year. The staff concurred, and estimated jointly with the authorities that inflation would come down to 4½ percent by the end of the year, assuming some continued pressure on food prices stemming from the persistent drought and planned adjustments in administered prices. Both the staff and the authorities expected the current account deficit to narrow by 1 point to 4½ percent of GDP, owing to an easing of international energy prices. Although Bulgaria’s debt service would rise sharply this year (to US$1.6 billion from last year’s US$1.1 billion, reflecting increased amortization of official debt and Fund repurchases), the financing needs were expected to be broadly covered by foreign direct investment and official loans and grants. Should these prove insufficient, the authorities would make use of the annual budget law’s authorization to issue Eurobonds up to US$200 million. The staff and the authorities shared the view that the projected favorable outcomes were predicated on a broadly neutral fiscal stance, continued wage discipline in state enterprises, and structural reforms to promote private sector activity.

Table 5.

Bulgaria: Macroeconomic Framework, 1997-2006

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Sources: Bulgarian authorities; and staff projections.

Projections for 2000 at the time of the Fourth Review under the Extended Arrangement.

Annual real return from monthly reinvestment at basic rate.

In 2000 and 2001 corrected for a large deposit at the BNB related to the sals of Bulbank.

From 1999 on, corrected for outstanding credits at non-operating banks.

Net imports of goods and nonfactor services.

Gross domestic saving equals gross national saving less net factor income and transfers from abroad. The government contribution to gross domestic saving equals revenues less current expenditures, excluding external interest payments.

Medium- and long-term external debt.

Table 6.

Bulgaria: Monetary Survey, 1997-2001

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Sources: Bulgarian National Bank; National Statistical Institute; and staff estimates.

In December 2000 and 2001 corrected for a large deposit at the BNB related to the sale of Bulbank.

In December 1998 claims on government have decreased by around BGR 500 million, as commercial banks started to report government securities at their market value, instead of their nominal value.

Real index, December 1997 = 36.5.

Table 7.

Bulgaria: Balance of Payments, 1998-2006

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Sources: Bulgarian authorities and staff projections.

Customs basis.

Includes the discrepancy between settlements and customs data in the trade account, clearing account transactions, changes in net foreign assets of deposit money banks, and other short-term capital flows.