Bulgaria: Ex Post Assessment of Longer-Term Program Engagement

This paper examines Bulgaria’s 2004 Article IV Consultation and Ex Post Assessment of Longer-Term Program Engagement. Foreign direct investment inflows have been strong, reserves are rising, and competitiveness appears broadly adequate. Fiscal policy has been tightened in 2003, as the government saved half of the revenue overperformance and reduced the deficit to 0.4 percent of GDP. The pace of structural reform has slowed, with two large privatizations and fiscal structural measures delayed.


This paper examines Bulgaria’s 2004 Article IV Consultation and Ex Post Assessment of Longer-Term Program Engagement. Foreign direct investment inflows have been strong, reserves are rising, and competitiveness appears broadly adequate. Fiscal policy has been tightened in 2003, as the government saved half of the revenue overperformance and reduced the deficit to 0.4 percent of GDP. The pace of structural reform has slowed, with two large privatizations and fiscal structural measures delayed.

I. Introduction

1. Bulgaria’s transition from central planning was initially difficult. In the context of loose macroeconomic policies and slow structural reform, GDP fell almost steadily through 1997, when it was 40 percent below its 1990 level (Figure 1). Inflation averaged 233 percent per year during 1990-97, and turned into hyperinflation in late 1996-early 1997, at the peak of a major banking and exchange rate crisis (Table 1 and Figure 2). In the same period, the fiscal deficit averaged 8½ percent of GDP, and large quasi-fiscal deficits were also recorded. The external current account deficit, in the context of a managed float, was small, except in 1992-93, reflecting compressed domestic demand and financing constraints.

Table 1.

Bulgaria: Selected Economic Indicators, 1990-2003

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Sources: Bulgarian authorities; and staff reports.

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

In 2003, includes below-the-line transfers. Excluding such transfers, the overall balance as a percent of GDP was zero.

Domestic debt as reported by Ministry of Finance and external debt as reported by BNB, in US$.

In leva and other currencies.

Banking system claims on non-government sector.

Data are US dollar-based ratio before 1999 and euro-based from 1999 onwards.

End-of-period, in redenominated leva.

Figure 1.
Figure 1.

Real GDP, 1990-2003


Citation: IMF Staff Country Reports 2004, 176; 10.5089/9781451804430.002.A002

Sources: Bulgarian authorities; World Economic Outlook.
Figure 2.
Figure 2.

Bulgaria: Selected Economic Indicators, 1990-2003

Citation: IMF Staff Country Reports 2004, 176; 10.5089/9781451804430.002.A002

Sources: Bulgarian authorities; and Fund staff estimates.1/ Data are US dollar-based ratios before 1999 and euro-based from 1999 onwards.

2. However, since the 1996-97 crisis, macroeconomic performance has dramatically improved. In that year, Bulgaria embarked on a comprehensive reform agenda, anchored by a currency board arrangement (CBA) that yielded high and stable growth (in the 4–5½ percent range during 2000–2003) and low inflation. But risks remain. Unemployment and poverty are still high and signs of reform fatigue have emerged. The macroeconomic outlook is also not without risks: the external current account deficit has recently widened and bank credit is booming, two possible signs of overheating.

3. Bulgaria’s transition was supported by Fund resources both during the early difficult years, and during the later more successful period. In the first period, after the completion of a one-year SBA, three consecutive SBAs went off track (Table 2). In contrast, starting in 1997 two SBAs and one EFF were successfully completed. Alongside, other facilities were also used. Altogether, Bulgaria was engaged with Fund-supported programs for 118 out of 168 months during 1990–2003, and for 94 out of 120 months during the last ten years.

Table 2.

Bulgaria: History of Lending Arrangements (In millions of SDRs; unless otherwise indicated)

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Source: IMF, FIN Department.

4. World Bank support started in 1990, but, owing to flagging interest in reforms, was scaled down in the mid-1990s (Figure 3). Later, the Bank started to become reengaged, supporting the reforms through 29 operations. IFC investments also increased markedly.

Figure 3.
Figure 3.

Bulgaria: IMF versus World Bank Disbursements, 1991-2003

(In millions of US Dollars)

Citation: IMF Staff Country Reports 2004, 176; 10.5089/9781451804430.002.A002

Source: World Bank, IMF.

5. Against this background, following a bird’s eye view of Bulgaria’s economic record since the start of the transition, three key issues are discussed:

  • Why did the pre-1997 programs fail and why did the later programs succeed?

  • Why was Fund support needed for seven years after the successful stabilization?

  • What are now the risks, and does Bulgaria still need Fund support?

II. The Facts

A. Transition to Crisis: 1990-Early 1997

6. Bulgaria’s transition started under more difficult circumstances than in most other central and eastern European (CEE) countries, reflecting a legacy of stricter central planning,1 higher exposure to Comecon trade,2 and a larger external debt burden (Figure 4). The latter, in the context of weakening external conditions, forced Bulgaria to declare a debt moratorium in 1990. Political factors were also less favorable. Under communism, Bulgaria had reduced the gap with other CEE countries. Thus, the old leadership was not as discredited as elsewhere, and there was no organized opposition to the regime (Giatzidis 2002).3 While many Bulgarians supported reforms, the socialist party (the offspring of the communist party) remained a viable political force, and a rapid succession of governments during 1990–97 (Table 3) suggests a lack of reform consensus.

Figure 4.
Figure 4.

Bulgaria: External Debt to GDP, 1991

Citation: IMF Staff Country Reports 2004, 176; 10.5089/9781451804430.002.A002

Source: World Economic Outlook.
Table 3.

Bulgaria: Prime Ministers and Governing Coalitions Since 1990

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Notes:BKP/BSP - Bulgarian Communist and later Socialist Party.BZnS - Bulgarian People’s Farmers Union.DP - Democratic Party.MRF - Movement for Rights and Freedoms.SNM - Simeon II National Movement.UDF - Union of Democratic Forces (center-right).

7. In this context, early programs, aimed primarily at stabilizing the economy, soon ran into problems. While a first SBA was completed in March 1992, a second SBA went off track in late 1992. In parallel, GDP dropped, unemployment surged, and the external current account deficit approached 13 percent of GDP in 1993. After the failure of the second SBA, a hiatus followed during which, in the context of persistently lax monetary and fiscal policies and little progress in structural reform, macroeconomic conditions deteriorated further, leading to a first currency crisis in late 1993-early 1994. A new stabilization effort supported by a third SBA in April 1994 was derailed in the Fall, when the government fell.

8. In this period, at the core of Bulgaria’s instability was the poor state of public enterprises, and their dangerous symbiosis with banks. The unreformed state-owned enterprises (SOEs) were problematic in two ways. First, their large deficits were financed by state (and private) banks and, indirectly, the central bank, fueling inflation, and undermining the population’s trust in the banking system. Second, lack of reform depressed output, thus making any stabilization attempt difficult to sustain over time. Finally, weak governance in both public and private firms fostered corruption and a rent-seeking culture (Box 1).

SOEs and Banks in Bulgaria Before 1997: A Dangerous Symbiosis

Until the middle of 1996, no large- to medium-sized loss-making SOEs had been declared bankrupt, and by end-1996, less than 6 percent of the assets of SOEs had been privatized. The cumulative losses of SOEs averaged 22 percent of GDP during 1993-95 (OECD, 1997). These losses were financed by arrears (to suppliers and the government) and bank loans, which in turn were refinanced by the central bank. Periodically, the state took over the related banks’ bad loans: bonds issued for this purpose amounted to half of domestic debt in 1993–95 (OECD, 1997). This subjugation of banks to SOEs’ needs was facilitated by poor accounting, auditing, reporting, and disclosure standards. Indeed, in a climate characterized by insufficient protection against insiders’ interests, private banks also extended credit irresponsibly. Moreover, the unstable macroeconomic conditions, and the absence of adequate supervision, encouraged banks to take speculative positions, including in the foreign exchange market. In early 1996, 70 percent of outstanding loans were classified as nonperforming, and the negative net worth of the banking system was estimated at 10 percent of GDP.

9. However, pre-1997 programs did not successfully address the SOEs/banks problem. Supported by an SBA, a remarkable attempt was made in 1994 to strengthen the central budget position through major cuts in public spending. This yielded large primary surpluses averaging 8½ percent of GDP during 1994–96. In those years, the central budget, adjusted for inflation, was much lower than the headline figure (Feyzioğlu et al., 1999, p. 37). But, without SOE and bank reform, the adjustment fell disproportionately on some population groups and, in the midst of further political instability, was ultimately unsustainable. A last-ditch attempt at stabilization—probably too little and certainly too late—was launched in mid-1996, with the support of a fourth SBA. The 1996 program responded to a rapid surge in inflation and depreciation, and a collapse of confidence. It involved a further fiscal adjustment in the central budget (with the primary surplus rising to 9¼ percent of GDP that year), a strengthening of bank supervision, and commitments to launch SOE reforms. But, Fund endorsement failed to catalyze support,4 as the government continued to be seen as lacking reform credentials. Indeed, implementation of structural reforms was once more too hesitant.5 Eventually, a simultaneous loss of confidence in the lev and in the banking system led to the 1996/97 financial crisis.6 By September 1996, one-third of banks had been closed, but through a disorderly process, and by year-end, Bulgaria was experiencing hyperinflation, international reserves had collapsed, and support for the government had dissipated.7

B. Stabilization and Growth: 1997 Onwards

10. The severity of the crisis made it clear that a new policy strategy and a pro-reform government were needed. Under the weight of the crisis, the socialist government resigned in December 1996, and a reform-minded caretaker government was established to resolve the crisis. Thereafter, the reformists won the April 1997 elections in a landslide, and, in the same month, a new 14-month SBA was approved.

11. The new program envisaged bold reforms underpinned by a CBA. While no major measures were envisaged at the central budget level, and indeed the primary surplus was allowed to decline over time as the burden of interest payments fell, the critical link between SOEs and banks was severed by acting on both sides of the problem. On the one hand, the new currency board—whose introduction was preceded by a wide-ranging public debate that enhanced ownership—prevented the central bank from financing banks and the budget. On the other hand, key upfront steps were taken to reform SOEs and banks. This was achieved by closing and restructuring the loss-making SOEs,8 and, following the closure of problem banks in late 1996, by strengthening bank supervision (by increasing the independence of bank supervision and its power to intervene in banks, and by making the prudential framework consistent with international standards). Incomes policy for SOEs was also strengthened to harden their budget constraints and guide wage expectations. Moreover, the privatization program was revived.

12. The program was immediately well received by markets. Bulgaria’s gap against the EMBI fell by 250 basis points the week after the socialist government resigned, and by 100 bps after the IMF board approved the new program (Figure 5). It continued to fall later as markets became increasingly convinced that reforms would continue. By 1998 the gap was approaching zero. Bulgaria’s rating was upgraded in early 1998. Domestic interest rates fell from 400 percent in 1996 to 7 percent in 1997, and international reserves surged.

Figure 5.
Figure 5.

Bulgaria, Emerging Market Spreads and US Fed Funds Rate 1990-2003

Citation: IMF Staff Country Reports 2004, 176; 10.5089/9781451804430.002.A002

Source: Bloomberg.

13. The 1997 SBA was successfully completed and followed by two new arrangements. The latter, in the context of a stable political environment, focused on continued fiscal prudence—with falling interest payments permitting a reduction in the primary surplus—and further reforms. A virtuous circle was set in motion: with macroeconomic stabilization achieved, the government could focus on addressing remaining structural problems. This in turn put macroeconomic policies on a sounder footing. Privatization was accelerated (especially in 1999–2000), SOE restructuring pushed further ahead, banking sector laws strengthened, price liberalization continued, and the process of land restitution completed. Throughout this period, and increasingly, Bulgaria’s desire to join the EU provided an additional incentive to keep reforms on track. Performance also improved with respect to Fund conditionality. Some waivers were needed after 1997, but this partly reflected the rising number of actions subject to conditionality (Table 4). However, under the most recent SBA the number of structural conditions met with delay or not met increased in relative terms. More generally, the structural reform process has slowed down.

Table 4.

Bulgaria: Performance under Fund Supported Programs

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Source: MONA and Staff Reports.

14. Output has recovered significantly since 1997, rising by 22½ percent in the last five years, despite adverse external shocks—the Asian, Russian, and Kosovo crises. Inflation fell to single digits, and external debt declined. On the external front, in the context of significant trade liberalization,9 imports picked up rapidly, while the rise in exports was more contained (Figure 6). Correspondingly, the external current account deficit increased with respect to pre-crisis years, but to levels (about 4¼ percent of GDP during 1998-2002) easily financed by FDI. However, as discussed below, the external current account deficit rose to 8½ percent of GDP in 2003, as imports, spurred by a credit boom, accelerated.

Figure 6.
Figure 6.

Bulgaria: Exports and Imports, 1996-2003 1/

(In percent of GDP)

Citation: IMF Staff Country Reports 2004, 176; 10.5089/9781451804430.002.A002

Source: Bulgarian authorities.1/ In real terms from National Accounts.


15. This section focuses on three questions: (i) What changed in 1997? (ii) Why did the change not occur earlier? (iii) Why did the Fund support programs that were too weak?

A. What Changed in 1997?

16. There was broad consensus during the EPA interviews that, in terms of policy implementation, the 1997 program succeeded because it credibly severed the SOEs/banks link. Earlier programs did involve sizable adjustments in the central budget, but this approach was too narrowly based, and, thus, unsustainable. Severing the SOEs/bank link broadened the scope of the adjustment and hit at the core of Bulgaria’s inflationary spiral.

17. Both components of the strategy to sever that link (structural reform and the CBA) were critically important:

  • SOE/bank structural reform and privatization were covered in the 1997 SBA and in the following EFF by very detailed conditionality. The EPA interviews highlighted that the Fund’s conditionality became the blueprint for reform and greatly facilitated policy coordination within Bulgaria. It was also noted that it would have been significantly more difficult, at least de facto, to have such a detailed conditionality, had the 2002 guidelines on streamlining conditionality been in place.

  • The CBA played two roles. First, it provided a strong institutional barrier against the risk that money growth would be subordinated to the needs of SOEs and banks. Second, as a communication tool, it provided a “banner” around which virtually all components of society seemed to coalesce. Since 1997, consistency with the CBA has become the ultimate litmus test for assessing the key economic policy decisions. Its importance, vis-à-vis the structural reforms steps, in stabilizing expectations should not be underestimated. While key structural measures were taken early on, the reform agenda was far from completed in 1997. Remarkably, the EBRD transition index, while improving in 1997 more than in any other year, remained well below the average of transition countries, and improved further only after 1998 (Figure 7). Also, some gradualism that had failed to impress markets in 1996 (e.g., putting some SOEs in “isolation,” rather than closing them) was well received in 1997. The CBA increased the credibility of the reform process, avoiding the need for an excessive front-loading. However, the EPA interviews also underscored that the CBA would not have worked in isolation. The two components of the strategy were mutually reinforcing.

Figure 7.
Figure 7.

Average EBRD Transition Index, 1991-2003

Citation: IMF Staff Country Reports 2004, 176; 10.5089/9781451804430.002.A002

Source: EBRD.

18. Equally important in stabilizing expectations was the change in the political landscape. The government formed in mid-1997 was homogeneously reformist and was supported by a wide parliamentary majority. This reassured markets that the period of political instability was over and that the reforms would continue over time.

19. There was less agreement on the extent to which other factors may have been relevant. Conditions at the outset of the program, the external environment, and financial support were somewhat better in 1997 than before, but not decisively so. These factors are discussed in Box 2, together with the role that over-optimism in policy design may have played in the failure of the pre-1997 programs.

Initial Conditions, External Environment, Over-Optimism, and Financing

Initial conditions: Bulgaria’s starting point on the transition route was weak. By 1997, in spite of remaining major shortcomings, some structural progress had been made. Implementation capacity had also increased. Moreover, the early 1997 hyperinflation cut the burden of domestic debt dramatically, strengthening the fiscal accounts. The importance of these factors should not be exaggerated, though: in other respects, Bulgaria in 1997 was in worse shape than in the early 1990s: inflation expectations had been rooted, per capita GDP was lower, unemployment had surged, and external debt had been inflated by the depreciation.

External environment: Market sentiment towards emerging markets was weak in 1994, and, while improving, remained weak in 1996. In contrast, the 1997 program benefited from more favorable conditions. For example, the average of the EMBI spread for the six months around the program’s starting date was 727 basis points for the 1996 program and 449 basis points for the 1997 program. However, external financing conditions had been propitious also in the early 1990s. Moreover, the post-1996 program was resilient to sizable external shocks: for example, the Russian crisis caused only a brief rise in Bulgaria’s spread.

Over-optimism: An interesting, and separate, issue is whether the external environment had been assumed to be better than it turned out to be, and, more generally, whether over-optimism had contributed to the failure of earlier programs. Clearly, the repeated failures of pre-1997 programs resulted in sizable over-prediction of growth performance (and under-prediction of inflation). But was this the result of the failure, or of optimistic assumptions on outcomes, given the program policies? The EPA team could not explore this issue fully, due to resource constraints. However, during the EPA interviews over-optimism was not mentioned as a relevant cause of failure.

Financing: Lack of financing was not a key factor behind the failure of the pre-1997 programs. By end-1995, the Fund was Bulgaria’s largest creditor accounting for 8¼ percent of external debt. Fund support to the failed 1996 program was broadly equal to that to the successful 1997 program, and was frontloaded. However, it has been noted that the 1996 program was underfunded vis-à-vis borrowing needs, and that larger access could have bought time to push reforms through. Be this as it may, the Fund in 1996 did contact donors for additional support, but their lack of enthusiasm may have reflected the authorities’ poor track record.

B. Why Did The Change Not Occur Earlier?

20. The EPA interviews highlighted the central role the 1996–97 crisis played in exposing the failure of earlier policies and in triggering the change in policies. The view that there simply was not enough consensus for reform before 1997, within the government, parliament, and the population at large, was undisputed during the interviews. Pre-1997 governments, while including reformers, were not homogeneously reformist, reflecting an underlying lack of pro-reform consensus in the population at large and the political economy factors discussed in paragraph 6.10 With the crisis, output collapsed, unemployment surged, and the savings of the populations vanished as prices skyrocketed. This triggered the change that allowed addressing at the core the SOEs/banks link.

21. Was the change also delayed by lack of understanding by the Fund about the nature of Bulgaria’s problems? This does not seem to have been the case. While data problems were significant (Box 3), at least as of 1993, the Fund had singled out the criticality of the SOEs/banks link. Indeed, the Executive Board, in the context of the 1993 Article IV consultation, highlighted the vulnerabilities created by the lagging reform effort. Program discussions were delayed in 1993 by lack of consensus on reforms.11 Both the 1994 and the 1996 programs regarded SOE/banking reforms as critical.12 The centrality the Fund attributed to these reforms is confirmed by internal documents and the EPA interviews. One could note, however, that neither the 1994 nor the 1996 program conditionality covered SOEs/banking reform to an extent comparable with the 1997 program. These programs did envisage reforms but these were described in relatively general terms, with conditionality operating primarily through the program review process. However, as detailed in Box 4, this more limited conditionality does not indicate lack of understanding of the importance of structural problems, nor did it have major implications for the failure of the 1994 and 1996 programs. A few participants in the EPA interviews argued that more detailed conditionality might have facilitated the implementation of reforms. Be this as it may, quantitative macro-conditionality was able, indirectly, to catch the authorities’ structural slippages, which the authorities decided not to correct. However, when ownership was strong in 1997, the specification of detailed structural conditionality did help, primarily in providing the authorities with a blueprint for their reform agenda.

Did Lack of Data Prevent Diagnosing the SOEs/Banks Problem?

As in other transition countries, program design in Bulgaria was hampered by lack of adequate data. The government’s quasi-fiscal activities were notoriously hard to pin down. While by the mid-1990s all SOEs had to provide their financial data quarterly, poor accounting standards made the reported data relatively unreliable. But the existence of severe problems in SOEs and banks was well known, and was confirmed by the repeated need for the government to cover bank losses through the injection of securities, and for the central bank to provide liquidity.

Structural Conditionality (or lack thereof) In the 1994 and 1996 Programs

The 1994 letter of intent committed the authorities to SOE reform and privatization. However, these actions were not covered by conditionality, except through the program review process. With ample evidence that the pre-program discussions had clearly focused on the SOE/banks link, this cannot be due to an underestimation of the problem. Rather, the Fund preferred to rely on an indirect, and more traditional, approach to enforce SOE/bank reform, namely through credit ceilings. Failure to deliver on the structural side would have implied breaching these ceilings, as it did.

The 1996 program did involve a series of structural prior actions, but they were not sufficiently comprehensive. One prior action was to agree with the World Bank on a program for enterprise reform, which was achieved “in principle”. As to banks, the authorities were not willing to go ahead with a complete restructuring. The Fund eventually accepted a “two-step” approach on the condition that the banking strategy would be quickly revised if market confidence was not restored (this involved agreement on a side letter, whose leak may have deepened the crisis further). In addition, an early review was provided for to assess financial sector developments and progress in SOE reform.

C. Why Did the Fund Support Programs That Were Too Weak?

22. If the main reason for the failure of the programs was the lack of a pro-reform consensus, did the Fund fail to see this? The World Bank decided to delay the conclusion of program discussions in 1994 and held the release of its adjustment operation tranche in 1995-96 due to lack of progress in structural reforms. The Fund went ahead. Did the Fund fail to appreciate political risks?

23. This does not seem to be the case. The prolonged program discussions ahead of both the 1994 and the 1996 programs, the authorities’ unwillingness to take adequate measures, and the repeated slippages in earlier programs were clear evidence of problems to come. Moreover, internal Fund documents did repeatedly point at the risks of the political situation.

24. Three reasons were mentioned in the EPA interviews to explain why the Fund went ahead in spite of these political economy risks:

  • The most important one was that the decisions to support Bulgaria in 1994 and 1996 were taken under crisis situations, that is, when it is inherently more difficult to deny support, particularly for an institution that has crisis prevention at the core of its mandate. The Fund faced the difficult choice of not supporting Bulgaria, with virtual certainty of deepening the crisis, or supporting her with a modest chance of success. This dilemma is illustrated, for example, by the discussions ahead of the 1996 program. At that time, the authorities were unable to reach agreement with the World Bank on key structural reforms, particularly on enterprise reform. On that occasion, Fund management took the view that waiting for this agreement could have slowed down discussions and delay completion until September/October 1996. However, the crisis situation required putting in place a program expeditiously. One could take the “cynical view” that a deeper crisis was needed to shake up the political system, but such a position comes out as the best course of action only with the benefit of hindsight, and in the absence of a counterfactual.

  • The authorities’ performance was not uniformly bad. As noted, both in 1994 and 1996, the central budget position was strengthened significantly, also reflecting the fact that the Ministry of Finance was controlled by the most reformist component of the government’s coalition. 13 The fact that this was the main ministry counterpart of the Fund in the discussions may have made it more difficult to deny support.

  • The increased attention of the international community and the Fund to ownership issues is relatively recent. In the mid-1990s, it would have perhaps been harder for Fund staff to deny support to a program based on ownership considerations.

25. It is difficult to assess whether better cooperation between the Fund and the World Bank would have avoided giving support to the 1994-96 programs. The World Bank felt that Bulgaria did not deserve support at that time, while the Fund supported the two failed programs. In 1997, the Fund again took the lead, this time in supporting the successful program. Indeed, in the absence of a World Bank supported program, the Fund had to take the lead in the negotiations of both macroeconomic policies and structural reform, including in the critical banking and SOE sectors.14 One would be tempted to find in all this an example of the Fund’s alleged bias towards giving the benefit of the doubt, or of the Bank’s alleged propensity for caution. With the Fund’s mandate including crisis prevention, its propensity to take risks may have been higher. Moreover, when two institutions are involved in decisions that are, by and large, judgmental, there are bound to be cases of disagreement, which may complicate approaching the authorities with a unified front.

IV. Did Bulgaria Need Seven Years of Fund Support after 1996?

26. Fund support is usually seen as providing three benefits: financial, catalytic, and “political economic”. The first relates to the classical role Fund resources can play in closing a financing (balance of payments) gap. The second relates to the effect of the Fund’s stamp of approval on the availability of financial resources from other sources. The third relates to the role the Fund can play in mobilizing internal support for appropriate policies. Of course, if a program were fully owned by the government, the opposition, and the population at large, this latter role would be meaningless. Conversely, the discipline provided by Fund monitoring cannot be a substitute for a sufficient degree of ownership. But, in between these two extremes, there is a continuum of situations in which appealing to an external source of discipline may facilitate policy implementation.

27. The EPA interviews highlighted that the relevance of the first two roles declined over time for Bulgaria, while the third role remained important, or even increased in importance. This justified not only the EFF that followed the 1997 SBA, but also the most recent SBA, although in the latter case a precautionary SBA may have been as effective.

A. Financial Benefits

28. The direct financial benefit of IMF support (in closing the financing gap) is difficult to quantify but was not trivial. Under the extreme case in which Bulgaria had not been able to borrow additional resources at all, the adjustment would have occurred through a lower level of activity, which would have involved sizable losses.15 At the other extreme, one could assume that Bulgaria could have borrowed from international markets additional resources at the rates it was actually borrowing. Taking into account the spread between those rates and the IMF lending rate, the saving for Bulgaria from borrowing from the Fund declined over time: the 1997 SBA, the 1998 EFF, and the 2002 SBA involved annual benefits, respectively, of 0.4 percent of GDP, 0.3 percent of GDP, and less than 0.1 percent of GDP. The decline reflected the falling spread on Bulgaria’s debt and, for the last program, the smaller size of support.16

B. Catalytic Effects?

29. As noted, unlike later programs, the 1997 SBA contributed to a tightening of spreads, consistent with the existence of a catalytic effect. However, quantifying the catalytic effect of Fund programs is complicated by the difficulty of separating the effect of the change in policies and the political environment from the mere effect of the Fund’s stamp of approval.17 The effect on spreads was more limited in later programs. To these effects, one should add those related to financing from other multilateral creditors (EU, World Bank, EBRD), which may have been missing without a Fund-supported program.

C. Mobilizing Internal Support

30. The consensus view in the EPA interviews was that Fund endorsement facilitated reform implementation significantly, particularly in later years. As discussed, until 1997, Fund endorsement was not sufficient to promote good policies. Conversely, it could be argued that the reforms may have been implemented even without Fund support in 1997, given the overwhelming popular support for reform. Be this as it may, the Fund has generally been well regarded in Bulgaria, so that its support for a certain measure has typically added to its legitimacy, making it less likely to be opposed in parliament. In this respect, the importance of Fund endorsement may have increased in later years, as parliamentary majorities became more fragmented. This appears to have been particularly important in justifying the 2002 SBA, as the government elected in 2001 did not have a strong majority, and included less reform-minded coalition partners.18 It may also provide a rationale for a new program.

V. A New Fund-Supported Program?

A. The Risks Ahead

31. Important macroeconomic risks remain. Bank credit is booming and the current account deficit nearly doubled in 2003, possibly signaling the emergence of unsustainable imbalances (Box 5). The extent these developments pose risks is uncertain. As to credit growth, “bad” credit booms are hard to distinguish from “good” credit booms based on macro indicators,19 and the assessment for Bulgaria is complicated by the fact that the level of bank credit is still relatively low (Figure 9).20 Prudential indicators do not yet show signs of deterioration (although such indicators provide a lagging signal of bank asset quality). As to the widening of the external deficit, it could reflect the need to raise Bulgaria’s output and export capacity, and is still largely financed by FDI. Financial markets have viewed these developments in a benign way. But, markets have been wrong before, and, with external debt still high (Figure 10), Bulgaria remains exposed to the vagaries of market sentiment.

Figure 8.
Figure 8.

Bulgaria: Competitiveness Indicators, 1997-2003

Citation: IMF Staff Country Reports 2004, 176; 10.5089/9781451804430.002.A002

Source: National Statistical Institute; INS; Direction of Trade Statistics; and Fund staff estimates.1/ Bulgaria, Czech Republic, and Hungary: Authorities’ data; and Romania: Direction of Trade Statistics.
Figure 9.
Figure 9.

Bulgaria: Claims on Non-Government Sector as a Percent of GDP 1997-2003

Citation: IMF Staff Country Reports 2004, 176; 10.5089/9781451804430.002.A002

Sources: Bulgarian National Bank; and Fund staff estimates.
Figure 10.
Figure 10.

Bulgaria: External Debt to GDP, 2003

(U. S. Dollar based)

Citation: IMF Staff Country Reports 2004, 176; 10.5089/9781451804430.002.A002

Source: National authorities.

The Recent Widening of the Current Account Deficit and External Sustainability

The external current account deficit almost doubled in 2003, to 8½ percent of GDP, while bank credit to the private sector rose by close to 50 percent. Both consumer and investment goods’ imports surged. In parallel, credit growth was driven by both households and business. If credit does not slow, the current account deficit could widen further. A compensating factor is that, while declining, FDI coverage of the current account deficit was 82 percent in 2003 (but only 63 percent excluding privatization receipts). Bulgaria’s real effective appreciation also bears watching. The CPI-based REER has appreciated significantly in recent years, including vis-à-vis other CEE countries and Turkey (Figure 8). Other competitiveness indicators are more favorable: unit labor costs have fallen, and Bulgaria’s export market shares have risen.

32. There are also political and social risks. Growth performance has been good, but not impressive. Moreover, unemployment and poverty, while better than in 1997, are still relatively high (World Bank, 2002b). Reflecting these problems, the political situation is not as solid as in the late 1990s and there may be a risk of reform fatigue. The recent local elections have shown that support for the government has weakened, and the coalition’s cohesion has eroded. While there may be little appetite for early elections, opinion polls suggest that, on present trends, a new government coalition is likely to be formed after the mid-2005 elections, but its composition remains highly uncertain. This uncertainty is partly offset by the consensus to maintain the CBA and advance EU accession.

B. Nature of Future Fund Engagement and Exit Strategy

33. The authorities are interested in a new precautionary SBA in support of a program aimed at reducing current risks while preserving the growth momentum. This seems to require lowering the external current account deficit and, preferably, external debt. The current account deficit is now some 1½ percentage points of GDP above what staff regards as adequate to stabilize the external debt ratio without relying on one-off privatization receipts and given reasonable assumptions on greenfield investment. A larger deficit may eventually prove viable, but the still high external debt ratio, the lack of exchange rate flexibility, the need to avoid risks to the credibility of the CBA, uncertainty about the prospects for FDI, and the relatively distant date of EU entry, call for prudence. Within the context of a declining current account deficit, one-off privatization receipts—which could be high in the next two years—should be used to lower external debt. There is also a need to keep credit growth under close watch, to ensure that it does not give rise to an unsustainable financial bubble.

34. Achieving these goals would require appropriate macroeconomic and structural policies. More specifically:

  • The external current account deterioration appears to be related primarily to rapid domestic demand growth (in addition to the cyclical weakness of demand in the euro area), partly driven by fast credit growth. Tight fiscal policy will have to be the main instrument to contain excessive domestic demand growth. Its specific parameters will have to be set in light of updated macroeconomic developments and their definition goes beyond the scope of this paper. But, in any case, it will be important to maintain fiscal flexibility in response to shocks.21 At the same time, the quality of fiscal policy, which has recently been skewed towards short-term measures, should be improved. Structural fiscal measures should focus on enhancing tax administration and expenditure management. The 1999 pension reform should also be strengthened in some respects.22

  • Containing external risks will also require strict incomes policies in the public sector and increased labor market flexibility through labor market reform, so as to reduce inflationary pressures and boost competitiveness.

  • Should credit growth be excessive, the authorities must stand ready to implement further measures—including perhaps tightening reserve requirements and prudential regulations (although the effectiveness of these measures would depend on the extent of capital mobility and the degree of capitalization of banks, both or which are high). More generally, a continued strengthening of financial supervision is needed to reduce financial stability risks.

  • Reforms to further improve the business environment are needed to attract foreign capital and boost potential output and exports. Earlier sections have once again confirmed the strict connection between macroeconomic performance and structural policies, and the important role that Fund conditionality has played in this area in Bulgaria. Looking ahead, the reform agenda should include completing privatization, and strengthening governance and the fight on crime (Bulgaria ranks 54th out of 133 countries in the Transparency International Corruption Perceptions Index; Transparency International, 2003).

35. The balance of the arguments would be for recommending continued program involvement, assuming a successful completion of the program discussions:

  • At the economic level, market sentiment towards Bulgaria is currently favorable, and there does not appear to be an imminent balance of payments need. However, as discussed, economic and political risks are nontrivial. There is little room for policy slippages, given Bulgaria’s lack of monetary flexibility, and a potential balance of payments need cannot be ruled out.

  • The macroeconomic nature of the risks justifies the Fund’s involvement.

  • The authorities have stressed that Fund support could: (i) facilitate internal consensus on appropriate policies, including in the run up to the 2005 elections; and (ii) provide confidence to foreign investors, rating agencies, and perhaps other multilateral institutions. As to the first objective, the EPA team concurs that the Fund’s presence has and would likely continue to facilitate the enactment of appropriate policies. As noted in reviewing the 1997–2003 programs, the Fund’s presence may be perhaps more important at a juncture when caution in macroeconomic policies may be jeopardized by the more fragmented political situation. As to the second objective, while catalytic effects vis-à-vis private capital are unlikely to be strong in the future, other multilaterals—the EBRD, the European Commission, and the World Bank—may prefer to engage with Bulgaria in the context of Fund arrangements.

  • As highlighted earlier, the longer-term program engagement between Bulgaria and the IMF during 1997-2003 has not reflected a lack of receptivity of Fund advice, but rather the appreciation that the authorities have had for that advice. Thus, most of the drawbacks identified by the IMF’s Independent Evaluation Office (2002) in case of longer-term program engagement—weaker incentives to take decisive action, loss of credibility for the Fund in supporting weak programs, poor ownership, and weakening of the surveillance function of the Fund—do not apply to Bulgaria.

36. A surveillance-only relationship, while feasible, would be significantly less effective in supporting the authorities’ program. In particular, the EPA interviews highlighted that a surveillance-only relationship would be seen as signaling a more detached role for the Fund in the eyes of Bulgaria’s public opinion. As such, it may not be very effective in maintaining policy discipline. Program conditionality would facilitate gathering the political support for appropriate policies.

37. However, given the longer-term program engagement and the absence of an imminent financing need, a new SBA should be lower access and precautionary. A precautionary SBA is in line with Executive Board decisions on signaling devices. The Board has agreed that precautionary agreements will continue to provide a framework for monitoring policies in countries that meet standards for Fund financial support, but which do not have an immediate financing need. Indeed, Management’s guidance note to the staff for Assessments of Countries with a Longer-Term Program Engagement (IMF (2003)) points out that “precautionary arrangements may provide a more effective device for facilitating the transition from sustained reliance on Fund resources….”

38. The new arrangement is expected to be the last one, with EU accession serving as a natural exit from a program-based relationship. A precautionary arrangement could cover a period of two to three years, thus bridging the gap before possible EU accession in early 2007. By then program policies are expected to have achieved the targeted decline in the external deficit and brought closer to completion the structural reform agenda. Moreover, the proximity of EU accession, and later the need to progress towards adoption of the euro, will provide an alternative to the discipline arising from Fund support. As intended by the authorities, euro adoption would be, in a successful scenario, the exit strategy from the CBA.

39. Program discussions should focus on understanding better the extent of the risks. Attention should be paid to the level of competitiveness, the determinants of the import boom (particularly to what extent it is driven by investment that would raise export capacity), the prospects for greenfield FDI, and the determinants of the credit boom, especially any sign of emerging asset price bubbles. The latter will require, in particular, further analysis of the breakdown of credit (by borrowing sector, maturity, and currency composition), of risk management practices, and of banks’ funding sources. Equally important, political economy factors should be assessed to evaluate the risk of noncompliance.

VI. Conclusions

40. The EPA team reached a number of conclusions:

  • The nature of Bulgaria’s longer-term engagement with the Fund differs deeply between the pre-1997 period and the later period. In the former, that engagement occurred in the context of programs that failed to achieve their objectives; in the latter, it occurred within the context of successful programs and reflected the authorities’ belief that the Fund could play a useful role in supporting the transition process even after the initial stabilization.

  • The pre-1997 programs failed primarily because they were not implemented in their entirety, which in turn reflected insufficient ownership and support for reform. Policy implementation was good only in some areas (e.g., the central budget), which were perhaps under closer control of the reformists within the government, but did not extend to the critical SOEs/bank sector. The programs did recognize that macroeconomic stabilization required SOE/bank reforms. While the 1994 and 1996 programs did not include conditionality on these reforms to the extent of later programs, they did include policy commitments and quantitative macro-conditionality consistent with the reform goals. But those commitments were violated.

  • The major shortcoming in the Fund’s actions was its willingness to support programs that lacked sufficient ownership. This underscores the importance of an adequate assessment of political economy factors. But the fact is that the Fund has no control over those factors and that, in those circumstances, the best it can do is to deny support. This becomes more difficult when a country is in crisis, and when a program has even a modest chance of success.

  • The 1996–97 crisis proved to be a watershed for the country, and triggered the change in politics and policies, boosting programs’ ownership. As of 1997, Bulgaria benefited from Fund support in a number of ways that could not have been realized through a surveillance-only relationship. The most important one was the role the Fund played in providing a blueprint for reform and in mustering domestic support to implement it. In the most recent period, this role may even have become more important, given the less homogeneous composition of government forces.

  • The cooperation between the Fund and the World Bank on Bulgaria went through different phases. In both 1994 and 1996, the Fund supported Bulgaria without a World Bank supported program. In 1997, the Fund again took the lead, this time in supporting the successful program. Indeed, in the absence of a World Bank supported program, the Fund took the lead also in the design of structural conditionality. In more recent years, the cooperation between the two institutions was more consonant with their respective areas of responsibility (and was mentioned as an example of effective collaboration in the recent Joint Fund-Bank Progress Report on Fund-Bank Conditionality and Collaboration). However, from the point of view of program design, Bulgaria’s post-crisis experience suggests that detailed structural conditionality may have played a useful role in coordinating domestic policies particularly during 1997–2001. The use of structural conditionality to the extent of, in particular, the 1997–1999 programs would, de facto, have been significantly more difficult under the 2002 guidelines on streamlining conditionality.

  • Looking forward, the balance of arguments is in favor of accepting the authorities’ request for a new precautionary SBA, provided policies are right. Economic risks ahead are nontrivial, and a program-based engagement could help mobilize support for appropriate policies and reforms, minimizing those risks. A surveillance-based relationship would unlikely be as effective. Prospective EU accession in early 2007 is seen as a natural exit from Fund programs.

  • A new program should contain measures to limit the risks related to the widening of the external current account deficit and the ongoing bank lending boom. This falls squarely within the mandate of the Fund, including in the area of financial sector stability. Alongside, the reform process should continue with the goal of further privatization, and improvement in the business climate. This is needed to stimulate a supply response, which is critical for the political sustainability of macroeconomic stability. Cooperation with the World Bank in this area is essential. While the Bank should take the lead in the structural area, Fund conditionality can play selectively an important role, in areas of more direct macroeconomic implication such as privatization (given its relevance for lowering external debt).

  • During the program discussion, there is a need to evaluate not only current macroeconomic risks, but also implementation risk arising from political economy factors. The EPA for Bulgaria has confirmed that a proper evaluation of these risks should be a necessary component of any pre-program discussion.


  • Bristow, J.A., 1996, The Bulgarian Economy in Transition, Edward Elgar: UK.

  • Cottarelli, C., G. Dell’Ariccia, and I. Vladkova-Hollar, 2003, “Early Birds, Late Risers, and Sleeping Beauties: Bank Credit Growth to the Private Sector in Central and Eastern Europe and the Balkans,IMF Working Paper No. 03/213 (Washington: International Monetary Fund).

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  • Feyzioğlu, T., B. Horváth, P. Stella, M. Cangiano, and A. Doughty, 1999, Bulgaria: Recent Economic Developments and Statistical Appendix,IMF Staff Country Report No. 99/26, (Washington: International Monetary Fund).

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  • Giatzidis, E., 2002, “An Introduction to Post-Communist Bulgaria: Political, Economic, and Social Transformation,” Manchester University Press: UK.

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  • Gourinchas, P.-O., R. Valdes, and O. Landerretche, 2001, “Lending Booms: Latin America and the World,Economia, pp. 4799. (Spring)

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State ownership was near complete. Moreover, Bulgaria’s exposure to market institutions, which helped promote reforms in other CEE countries, was limited (World Bank 2002a).


At over 70 percent of GDP in 1990, Comecon imports and exports were higher than in other CEE countries (Bristow, 1996).


Bulgaria’s demographic structure (an “older” population compared to other CEE countries) may also have slowed down the political transition.


The gap between Bulgaria’s spread and the EMBI remained about unchanged at the inception of the program, and rose dramatically a few weeks later.


Following board approval of the SBA, NDA growth was well above targets, triggering a renewed worsening of the crisis after a brief pause. Corrective measures discussed during the first review were never implemented and the review was not completed.


Confidence in banks may have been weakened by the proposal in December 1995 to introduce a partial deposit insurance scheme, while previously bank deposits had been regarded as implicitly covered fully by the state (the Fund had recommended not introducing partial deposit insurance as public confidence in banks was low). Finally, public confidence was also shaken by the collapse of pyramid schemes in mid-1995.


The closure of some banks contributed to the panic, partly because of lack of full deposit insurance. Another contributing factor may have been the leak of a side letter to the Fund committing the authorities to close more banks if the initial strategy proved insufficient.


Sixty four SOEs responsible for 29 percent of the losses in 1995 were to be shut down; 79 SOEs responsible for 55 percent of losses were put on an “isolation” list and denied new credit.


Average tariffs dropped from about 17 percent in 1997 to 11½ percent in 2003.


Political instability before 1997 was obviously also an obstacle to policy implementation. But this instability was, in itself, also a reflection of lack of a pro-reform consensus.


During 1995 staff argued that, without reforms, the macroeconomic stabilization achieved after the 1994 crisis was not sustainable. At the end of the 1995 Article IV consultation, Executive Directors also highlighted the need to reinvigorate reform efforts, and stated that “as regards the banking sector, rehabilitation plans need to be bold and implemented vigorously to avoid a looming banking crisis….”


For example, the 1994 LoI (paragraph 15) stated that “losses of the enterprise sector in 1993 represented a quasi-fiscal deficit that is estimated to be roughly of the same magnitude of the budget deficit in this year. We recognize that these deficits threaten Bulgaria’s economic and financial stability and the time has come to address this challenge.”


In early-1994, the central budget position was even stronger than targeted. Moreover, some structural reforms were undertaken in 1994: a VAT was introduced, the bankruptcy law required to close loss-making SOEs was approved, and an external debt reduction was successfully negotiated. And, in 1996, insolvent banks started being closed.


In reviewing Bulgaria’s experience in 1997, the Bank’s Operations Evaluation Department noted that:

“After 1997, once the new Government adopted a Currency Board and began implementing reforms, the Bank adopted a prudent stance and only gradually launched a full lending program With growing evidence of government commitment and achievement of macroeconomic stabilization, the Bank began to support a broad reform program through a series of sectoral adjustment loans addressing, enterprise, banking, agricultural, social protection, and energy sector reforms….”

This confirms that the Bank resumed support only after growing evidence that macroeconomic stabilization had been achieved. The latter, however, did require early structural reforms, which were initiated under the Fund’s SBA.


Quantifying these losses would require making a number of assumptions (on the effect on growth, the response of capital flows, and the alternative use of international reserves).


Considering the outstanding stock of Fund resources committed in earlier programs, the financial benefit for Bulgaria would be about 0.7 percent of GDP per year during 1997–2002.


Recent studies that try to disentangle these effects would suggest that the fall in Bulgaria’s spread was not due to catalytic effects. Mody and Saravia (2003) conclude that catalytic effects emerge only when the program country’s fundamentals are initially “not too bad,” as defined by middle-of-the range external debt-to-GDP ratios and/or reserves-to-imports ratios. Thus, in principle, given Bulgaria’s high external debt ratio, no program with Bulgaria was likely to have had a catalytic effect.


For example, the fiscal tightening in 2003 (with respect to original plans) would most likely not have been implemented as promptly in the absence of a Fund-supported program.


As Gourinchas, Valdez, and Landerretche (2001) note “while most banking crises may be preceded by a lending boom, most lending booms are not followed by a banking crisis.”


A model-based approach suggests that the post-transition equilibrium level of the bank credit-to-GDP ratio for a country with Bulgaria’s fundamentals is some 50 percent (Cottarelli, Dell’Ariccia, and Vladkova-Hollar, 2003). The actual 2003 level was 27½ percent.


Public asset and liability management can also help avoid overheating. Borrowing domestically rather than externally, or shifting government deposits from commercial banks to the central bank, would tighten domestic liquidity, ceteris paribus.


The modalities of pension indexation should be set by law. Moreover, the procedures for granting disability pensions, which have increased rapidly, should be reviewed.

Bulgaria: Staff Report for the 2004 Article IV Consultation
Author: International Monetary Fund