Bulgaria: Selected Issues and Statistical Appendix

This Selected Issues paper and Statistical Appendix analyzes the reasons behind the relatively low rates of savings in Bulgaria and prospects for their evolution over the medium term. The paper argues that low saving rates largely reflect the current stage of transition—characterized by still low income levels, incomplete structural reforms, the memories of the financial and banking crises of 1996–97, and an adverse demographic structure. An analysis of prospective saving rates indicates that as the transition process advances, saving rates may increase by 5 percentage points over the medium term.


This Selected Issues paper and Statistical Appendix analyzes the reasons behind the relatively low rates of savings in Bulgaria and prospects for their evolution over the medium term. The paper argues that low saving rates largely reflect the current stage of transition—characterized by still low income levels, incomplete structural reforms, the memories of the financial and banking crises of 1996–97, and an adverse demographic structure. An analysis of prospective saving rates indicates that as the transition process advances, saving rates may increase by 5 percentage points over the medium term.

IV. Recent Developments in Public Debt Management1

A. Introduction

1. The level and sustainability of public debt—often cited as a major constraint on Bulgaria’s fiscal policy—is a function of the fiscal stance, and of non-debt creating financing flows to the budget, such as privatization revenues. Public debt management supports fiscal policy by ensuring that the government’s financing needs and its payment obligations are met at the lowest possible cost over the medium term, subject to a prudent amount of risk. The case of Bulgaria illustrates the risks emanating from external debt in the context of a fixed exchange rate regime, and how the active management of public debt can alleviate these risks.

2. In this chapter we review Bulgaria’s debt management policy over the last year in this light. The next three sections provide some background on the history of public debt, on the specific implications of the currency board arrangement (CBA) for public debt management, and on the policy prerogatives and legislative measures that are being put in place. Section V then provides a more detailed analysis of the management of external and domestic debt over the last year. Based on this, the concluding section VI charts some options and trade-offs for the medium term.

B. The Context

3. Throughout its five year history under the currency board arrangement, Bulgaria’s fiscal policy has been constrained by a large public debt burden that had been inherited from previous governments. Following large sovereign borrowing under the communist regime in the second half of the 1980s, total external debt amounted to US$10.2 billion in 1989. In 1990, faced with growing debt service problems, the government declared a moratorium on its principal and interest payments. Three years later, unpaid and accrued interest had led to an increase in government foreign debt to US$13.8 billion, or 131 percent of GDP. The 1994 commercial debt restructuring with London Club creditors resulted in the issuance of US$5.1 billion in Brady Bonds, and the budget has been running sizable primary surpluses since then.2

4. At the end of May 2002, Brady bonds account for 40 percent of public external debt, and hence explain the large share of floating rate, US dollar denominated debt. The large share of Brady debt brings with it a number of risks, most importantly the currency mismatch between debt service on the one hand, and most other public sector revenues and international reserves on the other. Also, Brady bonds contain a number of provisions through which principal repayments increased sharply from 2001, and previously below-market interest payments on the so-called Front Loaded Interest Reduction Bonds (FLIRBs) are now tied to the LIBOR benchmark (Table 1). At the same time, Brady debt has a number of positive features, among them the long maturity, the lag between changes in international interest rates and the corresponding debt service, and partial hedging through the requirement to hold collateral for principal and interest payments.

Table 1.

Bulgaria: Projected External Debt Service of the Public Sector, 1999-2007

(In millions of U.S. dollars)

article image
Source: Ministry of Finance.

5. Between 1997 and 2001, the government reduced the public debt to GDP ratio in line with economic growth and the limited public sector financing needs. A stated policy objective was to preserve liquidity in the Fiscal Reserve Account (FRA) and, by implication, to maintain confidence in the currency board arrangement.3 In addition, disputes with individual private and public creditors were resolved, and in 2000 Bulgaria reached agreement with Paris Club creditors on the possibility of swapping debt service obligations for investment in infrastructure, environmental and social projects. Yet the volume of such swaps has remained disappointingly low, at only ε 12 million. Given the high level of international interest rates between 1998 and 2001, the government refrained from swapping the floating rate Brady debt into fixed rate global bonds.

6. The relatively high stock of public debt has also impacted Bulgaria’s credit ratings, which currently stands at BB- (Standard & Poors), following an upgrade in November 2001. Upgrades by other rating agencies also confirm the good impression prudent fiscal policies over recent years and the 2002 budget have made on the international investment community (Figure 1).

Figure 1.
Figure 1.

Bulgaria: Ratings of Sovereign Long-Term Foreign Currency Debt

Citation: IMF Staff Country Reports 2002, 173; 10.5089/9781451804454.002.A004

Source: Bloomberg.

7. By mid-2001 public debt amounted to about 70 percent of GDP, of which only about 8 percent (or 5.6 percent of GDP) was held by domestic residents. Public external debt amounted to US$8.7 billion, or about 64 percent of GDP, sharply down from 84 percent of GDP at the end of 1997 (Table 2). Among the foreign debt, the large share of floating rate instruments (74 percent) and of U.S. dollar denominated debt (67 percent) still posed a number of risks that the government has sought to reduce over the last year.

Table 2.

Bulgaria: Key Indicators of Bulgaria’s Public Debt, 1999–2002

article image
Source: Ministry of Finance.

C. Public Debt Management in the Context of a Currency Board Regime

8. A key concern of macroeconomic policy is the sustainability of public debt - the requirement that the present discounted value of current and future fiscal expenditures does not exceed that of revenues net of current indebtedness. Given the absence of monetary policy instruments in the context of the Bulgarian currency board arrangement, fiscal policy is constrained by two principal tasks: first, to generate a stream of primary fiscal surpluses sufficient to service—and reduce—the public debt burden, and, secondly, to contain contingent fiscal liabilities through the process of structural reform. This indeed has been government policy since the restructuring of external debt in 1994.

9. The role of public debt management is to reduce debt service costs, while containing the various risks associated with external debt and future financing needs. Given the structure of Bulgaria’s public debt, market risks emanate from variations in international interest and exchange rates. Rollover risk is an equally important concern at a time when access to international capital markets has only recently been established, and may prove elusive in the future. The prerogative for Bulgarian public debt management is to meet the budget’s limited financing needs. To reduce risk and debt service costs it avails itself of a wide range of instruments, including hedging, and the restructuring of maturities, of currency denominations, and of fixed and floating interest debt.

10. Bulgaria’s CBA holds two implications for the currency denomination of public debt. First, issuing foreign currency debt signals the authorities’ commitment to the continuation of the fixed parity. However, by enhancing private sector confidence in the CBA, public debt management may reduce private sector incentives to properly manage currency risks, for instance through hedging. Costs from private unhedged external liabilities may end up with the public sector (the moral hazard problem). Even though Bulgarian private external debt is still low, it should therefore be carefully monitored over the next few years. Second, as recent currency crises have amply demonstrated, the presence of a large share of foreign currency debt may set off dangerous and mutually-reinforcing dynamics between devaluation and default. While this may not be an immediate concern—the financing needs of the public sector are covered, and short term debt is low in relation to international reserves—over the long term such risks require that the authorities implement the policies required to safeguard the CBA. In addition, the presence of these risks makes it incumbent on Bulgarian debt management to inform the policy debate regarding prudent public debt levels, and criteria for the contracting and guaranteeing of public debt, and for limits on sub-national entities’ contracting external liabilities.

11. The Bulgarian currency board has been designed to avoid the transmission of periodic public external debt service payments to the monetary base. The liabilities of the BNB to the central government—the bulk of the Fiscal Reserve Account—are fully covered by international reserves but are not part of the base money. The BNB already structures its international reserves in a way to meet the periodic liquidity needs of the public sector. While this shelters the economy from monetary shocks due to large debt service payments, it also dispenses with an adjustment mechanism that a traditional currency board arrangement would impose. Again, the onus is on fiscal policy to anticipate these financing needs and provide fiscal flexibility to respond to them.

D. The Legislative Framework for Debt Management

12. The new government began its tenure stating repeatedly that a more active debt management would form part of its economic policy. The government’s economic program, set out in October 2001, together with more recent statements by Ministry of Finance officials essentially envisages four objectives for fiscal policy, and its supporting debt management operations:

  • a reduction in the consolidated public debt to GDP ratio below 60 percent (consistent with one of the Maastricht conditions for EMU membership);

  • a reduction of macroeconomic vulnerabilities—in particular to exchange rates—through an increase in the share of Euro-denominated debt, and of fixed interest rate loans, resulting in better sovereign credit ratings;

  • access to international capital markets, and maintaining it through the development of a sovereign yield curve in Euros and dollars in the expectation that this will facilitate capital market access of the Bulgarian private sector;

  • expansion of the domestic bond market, thereby reducing reliance on foreign financing, and facilitating the development of domestic financial markets. In recent statements, Ministry of Finance officials envisaged a tripling of the size of the domestic bond market (currently about 6 percent of GDP). Establishment of an extended yield curve in domestic sovereign credit is typically regarded as a key factor in support of expanding private domestic credit and in lengthening its maturity.

13. In support of these objectives, the government has revived efforts to adopt a sovereign debt law, which has been under consideration since 1999. Such a law is needed to clarify the responsibilities for contracting external debt and to provide for transparency and accountability vis-à-vis domestic institutions. Following comments from various parties, including the Fund, a revised version has passed the first reading in Parliament, and final adoption is expected in late July. The draft version imposes strict numerical limits on the consolidated public debt as a ratio of GDP, curtails municipalities in contracting external debt, and facilitates individual debt management operations of the government.

14. While this law will provide a much needed legal framework, the government also seeks to formulate an explicit debt management strategy (a previous version was adopted as an internal government document in April 2000). Based on experience in other countries, a set of good practices for such documents has recently been summarized.4 Typically, projections for key variables—such as the share of certain currencies, or of floating interest debt—and for the net issuance in foreign and domestic markets are tied to the medium term macroeconomic framework. The debt strategy may thereby help to operationalize stated policy objectives, enhance the transparency of government policy and avert sudden adjustments in private sector expectations.

E. Recent Debt Management Operations

15. Recently the Bulgarian authorities have bought back their own Brady debt, floated a five year Eurobond, and swapped nearly a third of their outstanding Brady Bonds. These operations have been in line with an international trend towards swapping Brady Bonds for new global bonds. Up to mid-2001 about US$40 billion of such bonds have been retired internationally. On the one hand this reflects an attempt on the side of debtor countries to divest of restructured instruments that appear to signal an inability to manage external liabilities. Moreover, borrowers were increasingly aware of the costs of tying up collateral required under Brady bond statutes, as well as stepped up interest payments and scheduled amortization payments. International investors showed demand for new issues as a yield differential opened up between Brady bonds and comparable instruments, in particular after Ecuador’s default on Brady bonds in 1999. Moreover, through the collateral features Brady bonds do not offer a pure exposure to sovereign debt, and a number of investment funds are barred from holding such instruments entirely.5

16. Over the last two years the outstanding stock of Brady bonds held by non-residents has declined by about US$220 million, most of which can be attributed to buybacks financed out of the FRA. The volume of such transactions is of course limited by their potential effect on secondary market prices. As for any sovereign debt, price is a probability-weighted average of the discounted value of scheduled debt service, and a recovery value of collateral in the case of default. Following the buyback the recovery value will be available for a smaller stock of outstanding principal, and by consequence the secondary market price rises. The market value of outstanding debt may hence decline by less than the cost of the buyback. This so-called Bulow-Rogoff critique of buybacks of sovereign debt hinges on the assumptions that market participants are fully informed about the identity of the buyer and the amount of the impending transaction. Sovereign borrowers therefore typically only engage in discrete transactions of small amounts, and at times when they hold an informational advantage over market participants, or when their debt is affected by unrelated events, such as financial contagion. Nevertheless, effectiveness and importance of buybacks as a tool of public debt management will remain limited. Also, buybacks raise important concerns about transparency vis-à-vis domestic institutions regarding the use of public funds.

17. Following the government’s buyback operations, Bulgaria’s debut Eurobond in November 2001 not only replenished reserves, but also created a first sovereign benchmark yield. The issue of € 250 million (with a 7.25 percent coupon, maturing in March 2007) was five times oversubscribed, and eventually priced at 376bp over the benchmark yield, tightening further in subsequent trading. The issued bonds were distributed to accounts in Germany (32 percent), the UK (18 percent) and Italy (11 percent). Strong liquidity in Bulgaria itself allowed the domestic bid to take up 10 percent of the deal. Asset managers accounted for 45 percent of the allocation, with banks taking 30 percent, retail investors 20 percent and insurance companies 5 percent. According to market commentary, the issue attracted substantial demand from institutional investors seeking to invest their funds in sovereign emerging markets credit—and especially in the rare EU convergence assets—that was not linked to Argentina. Moreover, the new government was given credit for its prudent fiscal and financial policies, reaffirmed by a Standard & Poor’s credit upgrade a week before the issuance. The timing of the issue was also helped by rate cuts of the European Central Bank and the Federal Reserve.

18. A second important transaction followed with the debt swap in March 2002. US$1326 million of Brady bonds, or 28 percent of the total outstanding stock was exchanged for new global bonds (US$512 million with a 8.25 percent coupon, maturing in 2015, and € 835 million with a 7.5 percent coupon maturing in 2013). Just under half of the Euro-denominated bond was used to raise cash for a straight buyback of outstanding Brady bonds. In this way, the Bulgarian authorities managed to change the investor base towards more stable European retail investors, and also established two more benchmarks on their sovereign dollar and Euro yield curves.

19. This transaction has moved Bulgaria some way further towards the achievement of its debt management objectives. The face value of the outstanding debt stock was reduced (by US$79 million), total debt service over the remaining life of the bonded debt has been lowered by US$90 million (a US$75 million NPV gain), and US$200 million collateral have been released. By swapping the amortizing Brady bonds (interest arrears bonds, IABs, and FLIRBs), the average duration of the portfolio was increased from 5.5 to 5.9 years, and the yield reduced from 9 to 8.8 percent. By reducing the shares of dollar-denominated and of floating-interest debt the vulnerabilities to changes in external parameters have been addressed. While debt amortization payments have been substantially reduced over the next years, these gains came at the cost of increasing the interest costs to the budget over the next five years by about US$104 million, and of a substantial concentration of repayment obligations in the years when the new bonds will mature in 2013 and 2015 (Figure 2).

Figure 2.
Figure 2.

Bulgaria: Effects of the March 2002 Brady Bond Exchange

Citation: IMF Staff Country Reports 2002, 173; 10.5089/9781451804454.002.A004

20. By contrast, the market in domestic public debt has remained extremely limited. Domestic debt amounts to 1.9 billion leva, or about 6.2 percent of GDP, of which about 1.2 billion have been issued since 1996 for deficit financing purposes.6 The remainder consists of debt that has been issued to finance the restructuring of state owned enterprises (so-called Zunks). While a large share of Zunks is denominated in U.S. dollar and Euro, specific covenants reduce the marketability of these instruments.

21. In the year to end-April 2002, there has been about 120 million leva net issue, and for 2002 as a whole the government expects a net issue of about 80 million leva, well in excess of its financing need. Domestic government debt now spans the entire spectrum of maturities, from 3 months to 10 years, and includes a small Euro-denominated bond. The first issue of a 10-year maturity in April 2002 was received surprisingly well, largely due to strong demand from domestic pension funds. Through these operations the government has extended the weighted average maturity of domestic debt from 31 months at end-June 2001 to 50 months one year later.

F. Prospects for the Medium Term

22. While these measures have addressed some of the concerns that motivated the government’s debt strategy, all four of the above objectives for public debt management set out above remain valid:

  • Bulgaria’s public debt to GDP ratio remains high compared to other countries in the region, which began the transition process with much lower debt stocks and have since reduced debt further. The authorities’ continuing commitment to the CBA underlines the need for a further reduction of public debt (Table 3).

  • Through its external debt Bulgaria remains exposed to fluctuations in international interest and exchange rates. Current projections incorporate the exchange rates of March 2002; it is estimated that, should the dollar-Euro rate remain at its current level, the level of public debt would be reduced to below 60 percent of GDP. At the same time, a one percent increase in international benchmark interest rates would increase next year’s public sector interest payments by about US$50 million, or about 0.35 percent of GDP.

  • Despite the issue of two Euro-denominated global bonds (at five and eleven years maturity), and of one dollar-denominated bond (thirteen years maturity) the credit outstanding is still insufficient for the establishment of a sovereign yield curve in the dollar and Euro bond markets. In particular more liquid issues at the short end of the maturity spectrum would be needed.

  • The market in domestic government paper remains highly illiquid. Secondary market trading is thin, so that the primary market yield is the only reference rate published by the BNB. However, the transmission into monetary conditions is limited, and banks use an internal cost of funds as a reference rate.

Table 3.

Public Debt to GDP Ratios for Selected Transition Countries, 1995–2001

(In percent)

article image
Source: EBRD.

23. Current staff projections show only limited financing needs of the public sector over the medium term. The government is committed to gradually achieving a balanced budget over the next four years, and annual amortization payments on external debt will average about US$500 million over that time (Table 1). At the same time, privatization revenues, the ongoing IMF arrangement, the envisaged World Bank Programmatic Adjustment Loan (PAL), and other loans to budgetary institutions will provide sufficient financing to the public sector. Moreover, in its fiscal reserve account with the BNB the government holds ample resources, at present amounting to 3.3 billion leva. Without drawing on this stock of reserves, or issuing additional debt in the foreign or domestic capital markets the public sector is expected to be fully financed. Pursuing all four of the above policy objectives will therefore result in a number of difficult trade-offs for public debt management.

24. One option would be to substitute foreign debt into domestic bonds, at a pace at which Brady bonds amortize or can be bought back. This course of debt management policy would hence meet the objectives of reducing macro-financial vulnerability, and increasing liquidity in the domestic bond market. To date domestic yields have been kept low as government paper was targeted to a captive market, largely domestic pension funds. An analysis undertaken in the context of the FSAP in late 2001 demonstrated that to maintain a liquid domestic bond market would require an annual gross issue of 3.5 billion leva, in domestic currency only. However, domestic banks and pension funds have shown a preference for holding instruments in dollar or Euro. While the fully-capitalized second pillar of the pension system will be expanded over the next few years, and hence provide for some captive domestic demand, such an issue volume would be certain to raise domestic yields considerably. The government would therefore maintain a domestic bond market at a premium, even though its long term prospect is membership in the European Union and therefore in an integrated European financial market.

25. A second possible policy option would be to maintain the current foreign currency exposure, and dispense with the costly objective of expanding the domestic debt market. Issuing domestic debt in Euro may further underline the authorities’ commitment to the currency board arrangement. At the same time such a policy would essentially preempt any adjustments to the parity in the run-up to EMU membership. These long term implications of current debt management policy underline the extent to which public debt management needs to conform with prospects for monetary relations with the EU.


Table A1.

Bulgaria: National Accounts, 1991-95

(Old classification) 1/

article image
Sources: National Statistical Institute

In 1996, the classification of activities changed.

Including holding gains.

Table A2.

Bulgaria: National Accounts, 1996-2001

(NCEA, based on NACE, Rev.l)

article image
Sources: National Statistical Institute.

Preliminary data.

Includes: hotels and restaurants, real estate, renting and business activities, health and education; public administration and defense.

Table A3:

Bulgaria: Selected Transition Economies: Cumulative Change in GDP, 1989-2001

article image
Source: WEO.

Compares the GDP in the year of its lowest level since the beginning of the transition with the level of 1989.

Table A4.

Bulgaria: Industrial Sector, 1991-95 1/

(Old classification) 2/

article image
Sources: National Statistical Institute

Includes state and private sectors, using the SNA methodology.

The classification changed in 1996.

Including holding gains/losses.

Self-employed and other small private unincorporated firms engaged in market production; included in other headings from 1997.

Table A5.

Bulgaria: Industrial Sector, 1996-2001

(NCEA, based on NACE, Rev.l) 1/

article image
Sources: National Statistical Institute

For 1996, according to the former classification in use - CBNE’86.

Preliminary data

Table A6.

Bulgaria: Services Sector: Total, State, and Private, 1991-2001

article image
Sources: National statistical Institute

Including holding gains/losses.

Preliminary data.

From 1996 on, including repairs of motor vehicles and personal and household appliances

Includes: housing and municipal services; business services; science; education, culture and art; health and social security, sports recreation and tourism; finance, credit and insurance; government; and NPISNs.

Table A7.

Bulgaria: Services by Branches, 1992-2001

(CBNE’86) 1/

article image
Source: National Statistical Institute.

Classification system changed in 1996.

Preliminary data.

Table A8.

Bulgaria: Total and Private Agricultural Production, 1992-2001 1/

article image
Sources: National Statistical Institute

According to National Classification of Economic Activities.

Preliminary data