Bulgaria: Request for Stand-By Arrangement

This paper evaluates Bulgaria’s Request for Stand-By Arrangement (SBA). Macroeconomic developments remain broadly favorable, although a rise in the external current account deficit is a concern. Real GDP growth is estimated to have moderated to about 4½ percent in 2001. The authorities have requested a two-year SBA in the amount of SDR 240 million, or 37 percent of quota. The requested SBA would be centered on the currency-board arrangement, a continuation of prudent fiscal and incomes policies, and an acceleration of privatization and other structural reforms.

Abstract

This paper evaluates Bulgaria’s Request for Stand-By Arrangement (SBA). Macroeconomic developments remain broadly favorable, although a rise in the external current account deficit is a concern. Real GDP growth is estimated to have moderated to about 4½ percent in 2001. The authorities have requested a two-year SBA in the amount of SDR 240 million, or 37 percent of quota. The requested SBA would be centered on the currency-board arrangement, a continuation of prudent fiscal and incomes policies, and an acceleration of privatization and other structural reforms.

I. Background

1. Bulgaria started late its transition to a market economy, but has come a long way in four years thanks to sound macroeconomic policies and deep structural reforms. During the early years of transition, progress in economic reforms was slow and macroeconomic policies erratic, leading to a severe financial crisis in 1996-97 (Figure 1 and Table 1). Since then, Bulgaria has witnessed significant structural changes in its economy, as most of the non-infrastructure enterprises and banks have been privatized or liquidated, trade and prices liberalized, bank supervision enhanced, and pension and health care reforms initiated. Macroeconomic stability was achieved and maintained through tight fiscal and incomes policies in the context of the Currency Board Arrangement (CBA) established in mid-1997. As a result of these policies, output growth has picked up from negative levels, led by investment and exports, inflation has declined to single digits from hyperinflationary levels, and the external debt-to-GDP ratio, near 100 percent in 1997, has come down rapidly. The EU recognized these achievements in its 2001 Regular Report, noting that Bulgaria has established a satisfactory track record of macroeconomic performance and is close to being a functioning market economy.1

Figure 1.
Figure 1.

Bulgaria: Selected Economic Indicators, 1991-2002 1/

Citation: IMF Staff Country Reports 2002, 049; 10.5089/9781451804362.002.A001

Sources: Bulgarian authorities; and Fund staff estimates and projections.1/ Data for 2001 are estimates; and 2002 are projections.
Table 1.

Bulgaria: Selected Economic Indicators, 1996-2001

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Sources: Bulgarian authorities; and staff estimates.

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

Includes the republican budget, municipalities, and extrabudgetary 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.

End-of-period, in redenominated leva.

2. Despite the overall positive performance, progress in several areas has remained slow. In two key sectors, energy and transportation, reform efforts have been inadequate; governance issues have not been addressed effectively; and administrative capacity has not been strengthened sufficiently to implement fully the new legislative and regulatory frameworks. Lack of good progress in these areas required cuts in much-needed social spending and public investment to achieve the desired fiscal stance.

3. GDP growth in 2001 is estimated to have moderated to about 4½ percent, owing to adverse external shocks. After registering close to 6 percent growth in 2000, GDP growth in the first three quarters of 2001 eased to 4.7 percent, as export growth decelerated with the slowdown in the EU and the crisis in Turkey (Figure 2). Year-on-year volume growth of exports of goods and services stood at 12½ percent, compared with 24 percent in 2000. Imports, on the other hand, continued to grow at a strong pace (16½ percent), fueled by demand for raw materials and consumption goods. Domestic demand remained robust, led by strong investment, which surged 18½ percent. According to national account statistics, household consumption remained flat, although strong growth in imports of consumer goods, rapid credit growth to households, and positive increases in real wages suggest that consumption figures could be revised upward.2 On the supply side, growth continued to be driven mainly by industry and services. Available evidence suggests that growth eased further in the last quarter, as indicators of industrial production, export sales, and retail sales all slowed. Unemployment leveled off at around 18 percent in 2001, while real wages increased by 4½ percent in the first three quarters (Box 1 and Figure 3).

Figure 2.
Figure 2.

Bulgaria: Real Sector Developments, 1992-2001

Citation: IMF Staff Country Reports 2002, 049; 10.5089/9781451804362.002.A001

Sources: Bulgarian authorities; and Fund staff estimates.1/ In adjusting for seasonality, the impact of the 1997 crisis has been eliminated.
Figure 3.
Figure 3.

Bulgaria: Unemployment Indicators, 1993-2001

Citation: IMF Staff Country Reports 2002, 049; 10.5089/9781451804362.002.A001

Sources: World Economic Outlook; National Statistical Institutes; OECD-CCET Labor Market Database on EU applicants; and Unicef.1/ 2001 data are projections.

4. Inflation remained subdued throughout the year. Moderate price increases reflected a reversal of the previous year’s surge in food prices, lower oil prices, and delayed adjustment in administered prices, including for energy. As a result, the 12-month inflation rate, after having peaked at 12.4 percent in October 2000, declined to 4.8 percent by end 2001.

5. The growth in monetary and credit aggregates signals a further recovery in money demand and an improvement in lending to the private sector, in the context of a sound banking system (Figure 4 and Table 2). The domestic currency component of M3 increased by 19 percent in real terms in the 12-month period to November 2001, evidence that confidence in the lev has been sustained. Lending to the non-government sector (excluding outstanding loans from non-operating banks) increased by 19 percent in real terms, a solid expansion, from a low base, on account of both consumer and enterprise credits. Banks remained profitable and well capitalized, and all major banks met or exceeded prudential regulations. Stress tests performed in the context of the recent FSAP suggest that the banking system is resilient to foreign exchange and interest rate risks, and can also absorb considerable credit risk.3

Figure 4.
Figure 4.

Bulgaria: Monetary and Financial Indicators, 1996-2001

Citation: IMF Staff Country Reports 2002, 049; 10.5089/9781451804362.002.A001

Sources: The Bulgarian National Bank; and Fund staff calculations.
Table 2.

Bulgaria: Monetary Survey, 1997-2002

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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.

6. The current account balance is estimated to have widened to 6½ percent of GDP in 2001 (Figure 5 and Table 3). The estimated deterioration of the trade account deficit from 10 percent of GDP in 2000 to 12 percent of GDP in 2001 is largely explained by the slowdown in exports of raw materials and in exports to Turkey and the EU.4 On the other hand, exports of light manufacturing, such as textiles and clothing, and tourism performed very strongly in 2001. The net impact of September 11 events on the current account is estimated to be limited, as the additional slowdown in export growth has been likely offset by the reduction in oil prices and lower world interest rates.

Figure 5.
Figure 5.

Bulgaria: External Sector Developments, 1996-2002

Citation: IMF Staff Country Reports 2002, 049; 10.5089/9781451804362.002.A001

Sources: Bulgarian authorities; Bloomberg; and Fund staff estimates.
Table 3.

Bulgaria: Balance of Payments Projections, 1999-2006

(In millions of U.S. dollar)

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Sources: Bulgarian Authorities, and Fund staff estimates.

Excluding valuation changes.

Historical figures include valuation changes.

Includes most obligations to the IMF.

Recent Labor Market Developments

Overall employment declined by more than 10 percent during 1997-2001, as the large contraction in the public sector was not fully offset by gains in the private sector. As a result, the unemployment rate increased from 14 percent to 18 percent over 1997—2000, before leveling off in 2001. Job creation in the formal private sector remained sluggish in part owing to the Russian crises in late 1998 and the Kosovo conflict in 1999, but also because restructuring lagged behind in many privatized companies sold to management-employee buyouts.

Unemployment affects disproportionately certain regions, the young and the unskilled. Also, more than half of unemployed have been so for more than a year. Higher unemployment rates for the unskilled as well as substantial long-term unemployment appear to reflect in part a mismatch between the skills of these groups and the needs of a growing private sector, while large regional disparities point to a lack of geographic mobility, owing in part to rigidities in the housing market.

Real wages have been on an upward trend since mid-1997. The increase appears to have been broad-based with cumulative gains of 57 percent and 42 percent in the private and public sectors respectively. However, real wages have not yet reached the level of the early 1990s.

The recovery in wages has contributed to a decline in poverty: According to the latest figures available from the World Bank, 12 [6] percent of the population lived below a poverty line of 2/3 [1/2] of per capita income in 2001 compared to 36 [20] percent in 1997. Still, poverty rates remained at more than double the level in 1995. Absolute poverty is comparable to that of Romania and Latvia—with about 6½ percent of the population living under US$2.15 per day—but it exceeds the level in countries such as Hungary and Poland.

Notwithstanding recent steps to enhance labor market flexibility, some rigidities remain to be addressed. Amendments to the labor code approved in 2001 allowed for the termination of contracts for economic reasons, more flexibility in working hours, and reduced the cost of overtime work. However, procedures for collective redundancies remain rigid and require difficult coordination with the labor unions, representing an obstacle to firm-level restructuring. Also, wage setting remains largely negotiated at the national level, which appears inappropriate in light of the high and persistent regional unemployment differentials; and payroll taxes are still very high, which hinders job creation in the formal sector.

7. In response to the deteriorating current account balance, and given the still high debt-to-GDP ratios, the authorities tightened the fiscal stance in the last quarter of 2001 (Table 4 and 5). Specifically, the government revised the annual deficit target to 0.9 percent of GDP from the budgeted 1½ percent of GDP. Achieving the revised target was difficult, as lower-than-expected interest expenditure was more than offset by overruns in subsidies and the election-related capital spending earlier in the year (with an estimated additional pressure of 0.5 percent of GDP on the deficit). Nevertheless, the authorities met their target by maintaining most discretionary spending at 90 percent of budgeted levels through the fourth quarter, avoiding starting up any new investment projects, postponing wage increases in the budgetary sector scheduled for October, and reducing the number of central administration employees by 10 percent in October. However, bowing to political pressures, the government extended a one-time payment of 20 leva (US$10) per pensioner and increased transfers to municipalities to cover arrears, financed in part by moving forward to 2001 a part of the 2002 dividend payments of several profitable state-owned monopolies.

Table 4.

Bulgaria: General Government, 1999-2002

(In millions of leva)

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Sources: Ministry of Finance; and staff projections.

To make 2001 projections comparable with the 2000 figures, the activities of the air traffic control fund, which exited the general government sphere as it became a commercial enterprise, should be added back. This would increase non-tax revenues by 152 million leva, wages by 30 million leva, maintenance and operations by 52 million leva, and capital expenditure by 123 million leva.

To make it comparable with the 2000 figure, the 1999 figure has been mortified to include the revenues of the extrabudgetary funds for the Road Network and for Environmental Protection.

To make the 2001 actuals comparable with the 2001 budget figures, the impact of the health care reform should be taken into account as follows: the 2001 budget figures on wages should be reduced by 169 million level, maintenance and operations reduced by 136 million leva, and subsidies increased by 365 million leva (which includes 60 million leva social security contributions, which was earlier netted out in the consolidated government accounts).

Table 5.

Bulgaria: General Government, 1999-2002

(In percent of GDP)

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Sources: Ministry of Finance; and staff projections.

To make 2001 projections comparable with the 2000 figures, the activities of the air traffic control fund, which exited the general government sphere as it became a commercial enterprise, should be added back. This would increase non-tax revenues by 152 million leva, wages by 30 million leva, maintenance and operations by 52 million leva, and capital expenditure by 123 million leva.

To make it comparable with the 2000 figure, the 1999 figure has been modified to include the revenues of the extrabudgetary funds for the Road Network and for Environmental Protection.

To make the 2001 actuals comparable with the 2001 budget figures, the impact of the health care reform should be taken into account as follows: the 2001 budget figures on wages should be reduced by 169 million leva, maintenance and operations reduced by 136 million leva, and subsidies increased by 365 million leva (which includes 60 million leva social security contributions, which was earlier netted out in the consolidated government accounts).

8. The external position has remained under control:

  • The current account deficit was fully financed, including through Bulgaria’s debut Eurobond issue, leaving end-year reserves at an adequate level. The combined capital and financial account recorded a surplus of US$1.1 billion in the first 11 months of 2001 in spite of a slowdown in foreign direct investment. Despite delays in privatization, FDI covered about three-fourths of the current account deficit, allowing the external debt-to-GDP ratio to fall quite significantly to below 78 percent. In addition, the authorities issued a 250 million euro Eurobond with a maturity of 5 years and 3 months in November, noting their desire to maintain reserves levels and take advantage of lower interest rates. This issue, at 376 basis points spread over benchmark five-year German bonds, was oversubscribed. As a result, end-year reserves stood at US$3.6 billion (or 4.8 months of prospective imports of goods and nonfactor services).

  • Contagion from Argentina and Turkey has been limited. Spreads on Bulgaria’s Brady bonds have been narrowing since the June election, reflecting prudent policies and markets’ expectation of a more active debt management strategy. The collapse of the CBA in Argentina has not had any significant impact on this trend. There have been no discernable contagion effects on Bulgaria’s domestic financial markets either, and financial fundamentals and indicators of external vulnerability remain comfortable (Table 6). Since November, Standard and Poor’s, Moody’s, and Fitch have upgraded Bulgaria’s credit rating.

  • More fundamentally, Bulgaria’s competitiveness remains adequate (Box 2 and Figure 6).

Table 6.

Bulgaria: Indicators of Financial and External Vulnerability, 1997-2002

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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.

On a residual maturity basis.

In redenominated leva.

Outlook positive.