Abstract
This Selected Issues paper for Bulgaria highlights that the rapid credit expansion has not raised significant financial stability issues, but has been a key factor in the sharp weakening of the external current account. Although the deficit has been mostly financed by foreign direct investment (FDI) inflows, deficits of this magnitude cannot be sustained as privatization inflows will dry up with the completion of the government’s privatization program. Concurrent with the surge in bank credit, the external current account has weakened, reaching a deficit of 8½ percent of GDP in 2003.
II. Bulgaria—External Sustainability and Vulnerability23
A. Introduction
26. Bulgaria’s external current account deficit has sharply increased in the space of one year, diverging substantially from the average current account deficits of about 5½ percent of GDP during 1999-2002. At the same time, coverage of the deficit by nondebt creating inflows has declined from above 100 percent on average during 1999-2002 to about 82 percent in 2003. As a result, the external debt-to-GDP ratio (excluding the effect of exchange rate changes) has declined only marginally in 2003. Similarly, net external debt (again excluding exchange rate changes) has remained constant.
27. This chapter assesses Bulgaria’s external sustainability and vulnerability. It argues that, for a variety of reasons, recent developments in the current account are not as worrying as they appear, but that, on the other hand, external vulnerabilities have increased and can be expected to remain larger than hitherto. Nevertheless, an analysis of sectoral asset and liability positions indicates that overall Bulgaria has—at least for the time being—sufficient buffers to manage a potential drop in confidence. A comparison with the Baltic countries (Box 1) also indicates that Bulgaria is relatively well-placed from a vulnerability viewpoint.
B. Analytical Framework
28. An assessment of external sustainability is in essence one of external debt sustainability. Assessing sustainability in the first instance means forming a view of how outstanding stocks of liabilities are likely to evolve over time. The question of external sustainability thereby turns into one of whether the external debt can be serviced without an unrealistically large future correction in the balance of income and expenditure. In essence, this becomes a question of whether the external debt stock remains constant (or is falling) as a share of GDP. The key determinants of the evolution of the stock of external liabilities over time are the current account deficit and the net inflows of non-debt creating financing.
29. External sustainability is closely linked to vulnerability.24 Therefore, not only does debt financing matter, but also the amount of non-debt financing, i.e., the size of the external current account deficit, and the risks to these financing flows. The larger the imbalance between income and absorption, the larger is in principle the vulnerability of the economy to a loss of confidence, or other shocks. Furthermore, for an assessment of vulnerability, the composition of non-debt financing, as well as the level and composition of the external debt stock are important. Therefore, even if external sustainability appears sound, this does not necessarily imply that vulnerability is low.
30. In assessing vulnerability, a useful complement to the analysis of flow variables is the perspective of the balance sheet approach.25 It permits an analysis of existing currency and maturity mismatches and thus related liquidity and solvency risks. It also allows to gauge the transmission mechanism and impact of a devaluation of the domestic currency. Thereby, it helps to shed light on the economy’s vulnerability to external shocks and, consequently, policy choices should such shocks occur.26
C. External Sustainability
Level and composition of the current account deficit
31. Bulgaria’s 12-month current account deficit has increased sharply since late 2002, and reached 8.5 percent of GDP at end-2003. The main contributing factor (almost 90 percent of the deterioration) was the merchandise trade balance, itself the result of a rapid rise in imports (Figure 1).
The merchandise trade balance, which has been in a large deficit for some time, widened further to 12½ percent of GDP. Exports increased markedly in euro terms (10 percent, or €600 million), and even more so in volume terms (17 percent), but were outpaced by import growth (14 percent or €1.1 billion in euro terms, and 20 percent in volume terms).27
The nonfactor services balance remained unchanged. An increase in tourist arrivals by 18 percent and the associated increase of net tourism receipts by 0.7 percent of GDP offset a decline in net non-travel receipts.28
The income balance declined somewhat. Lower interest payments due to low rates were more than offset by a large one-off profit remittance (about ½ percent of GDP).
Transfers remained broadly unchanged in net terms. Net private transfers rose strongly, while official transfers declined somewhat on account of a doubling of government transfers abroad.
Bulgaria: Current Account
(In percent of GDP)
Citation: IMF Staff Country Reports 2004, 177; 10.5089/9781451804478.002.A002
Source: Bulgarian authorities.Bulgaria: Current Account
(In percent of GDP)
Citation: IMF Staff Country Reports 2004, 177; 10.5089/9781451804478.002.A002
Source: Bulgarian authorities.Bulgaria: Current Account
(In percent of GDP)
Citation: IMF Staff Country Reports 2004, 177; 10.5089/9781451804478.002.A002
Source: Bulgarian authorities.32. A factor complicating the analysis is the reliability of data. Net errors and omissions exhibit large changes from one year to the next. However, most of these swings are likely to be concentrated in the capital account.
Sources of the current account deterioration
33. The main underlying source of the strong rise in imports was the rapid growth of credit to the private sector. Credit outstanding to the non-government sector (which includes public enterprises) has increased by 48 percent in nominal terms at end-2003, compared to a year before. The expansion of credit has fueled in broadly equal parts a rise in investment (from 20 percent of GDP in 2002 to 22 percent in 2003) and a consumption boom. This is also reflected in the import composition, where the shares of investment and consumption goods in total imports have remained broadly constant.
34. Increasing FDI inflows are unlikely to be the main source of high import growth. The increase in non-privatization inflows amounted to only €95 million, less than a third of the rise in imports of investment goods. However, while non-privatization equity inflows declined, reinvested earnings and loans from parent companies, which arguably have a somewhat higher import propensity than equity investment, grew by €265 million.
35. Competitiveness does not appear to have been a significant factor in the deterioration of the trade balance, though the evolution of competitiveness indicators requires careful monitoring. Since the euro started appreciating in late-2002, Bulgaria’s CPI-based REER has appreciated more than those of other Central and Eastern European (CEE) countries whose exchange rates are not rigidly pegged to the euro. However, while the position relative to other CEE countries has deteriorated to some extent, a comparison with the Eurozone indicates that unit labor costs in manufacturing, in particular relative to major trading partners like Germany and Italy, have declined strongly (Figure 2). Further, while economy-wide productivity growth turned negative in 2003, this can be attributed partly to the government-sponsored employment creation program. Productivity declined only in the services sector, where the publicly-funded employment was generated, while productivity in the manufacturing sector—albeit slowing down recently—has continued to increase, above the rate of real wage growth (calculated by deflating nominal wages by the Eurozone CPI). Nevertheless, declining rates of productivity growth in all sectors warrant caution (Figure 3). On the other hand, Bulgaria’s market share in the world as well as in the European Union has continued to increase.
Unit Labor Costs
(1998 = 100; Manufacturing sector, unless otherwise indicated)
Citation: IMF Staff Country Reports 2004, 177; 10.5089/9781451804478.002.A002
Sources: Bulgarian authorities, and WEOUnit Labor Costs
(1998 = 100; Manufacturing sector, unless otherwise indicated)
Citation: IMF Staff Country Reports 2004, 177; 10.5089/9781451804478.002.A002
Sources: Bulgarian authorities, and WEOUnit Labor Costs
(1998 = 100; Manufacturing sector, unless otherwise indicated)
Citation: IMF Staff Country Reports 2004, 177; 10.5089/9781451804478.002.A002
Sources: Bulgarian authorities, and WEO
Productivity and Wages
(Percentage change)
Citation: IMF Staff Country Reports 2004, 177; 10.5089/9781451804478.002.A002
Sources: Bulgarian authorities, and Fund staff estiamtes.Productivity and Wages
(Percentage change)
Citation: IMF Staff Country Reports 2004, 177; 10.5089/9781451804478.002.A002
Sources: Bulgarian authorities, and Fund staff estiamtes.Productivity and Wages
(Percentage change)
Citation: IMF Staff Country Reports 2004, 177; 10.5089/9781451804478.002.A002
Sources: Bulgarian authorities, and Fund staff estiamtes.Financing of the current account deficit
36. Critical for the assessment of sustainability is the financing of the current account deficit. The main criterion for sustainability is therefore whether the current account can be financed while still retaining room for reserves to continue to increase at a pace allowing to compensate for the private sector’s foreign exchange mismatches (see below) and for the external debt-to-GDP ratio to be further reduced.
37. The balance of payments has been in surplus every year since 1999. Correspondingly, gross international reserves have increased from €2.6 billion (23 percent of GDP) at end-1998 to €5.3 billion (30 percent of GDP) at end-2003. In that year, despite a record current account deficit, reserves rose by another €817 million. The capital account has been bolstered by a large increase in FDI (including privatization), though the FDI-current account ratio declined from over 100 percent in 2002 to 82 percent in 2003, by net external borrowing by the public sector, and by continued large repatriations of foreign assets by domestic banks. Meanwhile, the non-bank private sector decreased its net borrowing, compared to 2002.
38. As the coverage of the current account deficit by FDI inflows has declined, the rapid reduction of the external debt stock observed in recent years has almost come to a halt. After decreasing from about 89 percent of GDP in 1999 to 65 percent at end-2002), the reduction in the external-debt to GDP ratio by 6¼ percentage points in 2003 is almost exclusively due to exchange rate effects—at constant exchange rates, the decline would have been less than one percentage point. Similarly, the net external debt ratio, while declining by 6 percentage points, would have remained virtually unchanged at constant exchange rates, at about 26 percent of GDP.
Outlook
39. The debt-stabilizing non-interest current account deficit is currently at around 7¼ percent of GDP. 29 This is around the level projected for 2004, but higher than in the medium term. Furthermore, with the authorities’ privatization plans, projected inflows of FDI during 2004-07 are forecast to generally exceed current levels. Both factors are expected to permit a further reduction of external debt (albeit gradually) and a further reserve build-up. Both are needed to reduce external vulnerability.
40. However, there are risks to this scenario. Slower external demand—mainly if the medium-term performance in the EU is not as envisaged—and a failure to implement productivity-improving structural reforms could keep the trade deficit at high levels.30 At the same time, lower non-privatization FDI—again due to lagging structural reforms—and a possible failure of major privatizations would lead to a declining coverage of the current account by non-debt creating inflows. In a scenario where these risks materialize (Figure 4), the external debt-to-GDP ratio would not decline but start to embark on an explosive path, or reserves would need to be drawn down. While the baseline scenario is rather conservative, this adverse scenario is not extreme, indicating that the borders of sustainability are easily being reached. However, the main risks relate less to potential external shocks but rather to policy failures. Therefore, it is in the authorities’ hands to minimize the probability of adverse debt or reserve dynamics.
Bulgaria: Scenarios 1/
(In percent of GDP)
Citation: IMF Staff Country Reports 2004, 177; 10.5089/9781451804478.002.A002
Source: Fund staff projections.1/ The temporary decline in the current account deficit in 2008 arises from the overlap in pre- and post accession transfers from the EU.Bulgaria: Scenarios 1/
(In percent of GDP)
Citation: IMF Staff Country Reports 2004, 177; 10.5089/9781451804478.002.A002
Source: Fund staff projections.1/ The temporary decline in the current account deficit in 2008 arises from the overlap in pre- and post accession transfers from the EU.Bulgaria: Scenarios 1/
(In percent of GDP)
Citation: IMF Staff Country Reports 2004, 177; 10.5089/9781451804478.002.A002
Source: Fund staff projections.1/ The temporary decline in the current account deficit in 2008 arises from the overlap in pre- and post accession transfers from the EU.41. If structural and macroeconomic policies are sound, therefore, medium-term sustainability looks reasonably assured, despite the recent widening of the current account deficit and the much smaller reduction of external debt in 2003 than hitherto.
D. Vulnerability
42. However, while sustainability seems quite solid, vulnerability has increased. First, while total external debt has decreased as a share of GDP, short-term external debt has increased. Second, even FDI, while reducing sustainability concerns as “credit” risk is transferred to the foreign investor, gives rise to vulnerability in a similar way as debt. Third, the balance sheets of individual economic sectors exhibit substantial currency and maturity mismatches.
External debt
43. The external debt stock amounted to 59 percent of GDP at end-2003. This level of external debt is still relatively high.31 While 48 percent of this stock consists of debt to multilateral creditors and Brady bonds, the share of short-term debt has increased steadily, even as the total external debt stock has declined. Short-term external debt stands now at 19 percent of the total (by original maturity; 23 percent by remaining maturity), implying a steady rise from 9 percent of GDP in 2001 to 11 percent (by original maturity) at end-2003, increasing rollover risks (though part of this increase may be due to trade credits, which are less subject to rollover risk). On the other hand, the increase in short-term debt has been accompanied by an increase in foreign reserves of the central bank, keeping the coverage of short-term debt (by original maturity) by reserves at over 250 percent (though the coverage by excess reserves—i.e., reserves over and above the amount required to cover the monetary base under the currency board arrangement—declined somewhat, from 144 percent in 1999 to 133 percent at end-2003).
44. The government is considering to pre-pay some of its external debt. While this would lower the external debt-to-GDP ratio, and decrease net interest payments, it would not reduce the net external debt stock. Also, it would lower the stock of freely available reserves, which are a useful buffer against risks arising from the private sector’s overall short position in foreign currency (see below).
Foreign direct investment
45. FDI is often viewed as a financing panacea. The key advantage of FDI over debt financing is that the future obligations it creates (profit remittances) are directly linked to the “capacity to repay”, i.e., actual profits. The risk of “repayment” is therefore borne by the investor, even in the case of loans from parent companies that are subsumed under FDI. Furthermore, FDI inflows are generally thought to encompass a longer-term commitment and are viewed as a sign of confidence in the economy.
46. However, FDI is not without risks. It can stop or reverse in a relatively short time frame, depending on the confidence of investors. Further, and more importantly, the outflows generated by profit remittances (and repayment of intra-company loans), like other outflows, are generating pressure on foreign exchange reserves, if the investment is not in sectors that produce primarily for export (only FDI in export sectors is naturally hedged). In Bulgaria, recent FDI has been concentrated in the nontradables sector: FDI in manufacturing has been less than 20 percent of the total during 2000-03, while two-thirds of FDI went into the financial, real estate, communications, and wholesale and retail trade sectors (Figure 5). Should foreign investors lose confidence in the stability of the exchange rate on which they have based their earnings forecasts, they are bound to seek to protect their earnings in foreign currency by hedging their expected domestic-currency revenues. Therefore, while FDI financing is supporting sustainability, it gives rise to vulnerability.
Bulgaria: FDI
(In billions of euro)
Citation: IMF Staff Country Reports 2004, 177; 10.5089/9781451804478.002.A002
Source: Bulgarian authorities, and Fund staff estimates.Bulgaria: FDI
(In billions of euro)
Citation: IMF Staff Country Reports 2004, 177; 10.5089/9781451804478.002.A002
Source: Bulgarian authorities, and Fund staff estimates.Bulgaria: FDI
(In billions of euro)
Citation: IMF Staff Country Reports 2004, 177; 10.5089/9781451804478.002.A002
Source: Bulgarian authorities, and Fund staff estimates.Balance sheets
47. At end-2003, there were sizable currency and maturity mismatches in individual sectors, though they were contained at the aggregate level (Figure 6 and Table 1). Shortterm external liabilities in foreign currency exceeded liquid external foreign-currency assets of the private sector (both financial and nonfinancial). However, this short position was more than outweighed by the public sector’s net liquid foreign assets.
Bulgaria: Balance Sheet Indicators
Citation: IMF Staff Country Reports 2004, 177; 10.5089/9781451804478.002.A002
FX: Foreign currency; STFX: Short-term position in foreign currency; STFXE: Short-term external position in foreign currency.FX columns: Assets liabilities and mismatch; STFX columns: Liquid foreign currency-denominated assets, short-term foreign currency-denominated liabilities mismatch;STFXE columns: Liquid external assets short-term external liabilities mismatch.Bulgaria: Balance Sheet Indicators
Citation: IMF Staff Country Reports 2004, 177; 10.5089/9781451804478.002.A002
FX: Foreign currency; STFX: Short-term position in foreign currency; STFXE: Short-term external position in foreign currency.FX columns: Assets liabilities and mismatch; STFX columns: Liquid foreign currency-denominated assets, short-term foreign currency-denominated liabilities mismatch;STFXE columns: Liquid external assets short-term external liabilities mismatch.Bulgaria: Balance Sheet Indicators
Citation: IMF Staff Country Reports 2004, 177; 10.5089/9781451804478.002.A002
FX: Foreign currency; STFX: Short-term position in foreign currency; STFXE: Short-term external position in foreign currency.FX columns: Assets liabilities and mismatch; STFX columns: Liquid foreign currency-denominated assets, short-term foreign currency-denominated liabilities mismatch;STFXE columns: Liquid external assets short-term external liabilities mismatch.Bulgaria: Intersectoral Asset and Liability Position
(end-December 2003, in millions of euros)
Excludes insurance sector.
Bulgaria: Intersectoral Asset and Liability Position
(end-December 2003, in millions of euros)
| Issuer of Liability (Debtor) | Holder of Liability (Creditor) | ||||||
|---|---|---|---|---|---|---|---|
| Government Sector (I) | Financial Private Sector 1/ (II) | Nonfinancial Private Sector (III) | Rest of the World (IV) | ||||
| Government and BNB |  | ||||||
| Monetary Base | 1,981 | 712 | 0 | ||||
| Total Other Liabilities | 1,049 | 1,132 | 7,201 | ||||
| Short-term | 27 | 88 | 0 | ||||
| Domestic Currency | 27 | 88 | 0 | ||||
| Foreign Currency | 0 | 0 | 0 | ||||
| Medium- and Long-Term | 1,022 | 1,044 | 7,201 | ||||
| Domestic Currency | 575 | 248 | 0 | ||||
| Foreign Currency | 447 | 796 | 7,201 | ||||
| Financial Private Sector1/ | | ||||||
| Total Liabilities | 934 | 4,978 | 766 | ||||
| Short-term | 907 | 4,909 | 536 | ||||
| Domestic Currency | 553 | 2,812 | 68 | ||||
| Foreign Currency | 354 | 2,097 | 468 | ||||
| Medium- and Long-Term | 27 | 69 | 230 | ||||
| Domestic Currency | 24 | 28 | 0 | ||||
| Foreign Currency | 3 | 41 | 230 | ||||
| Equity | 0 | 0 | 0 | ||||
| Nonfinancial Private Sector | | ||||||
| Total Liabilities | … | 4,532 | 2,514 | ||||
| Short-term | … | 1,162 | 1,418 | ||||
| Domestic Currency | … | 634 | 0 | ||||
| Foreign Currency | … | 528 | 1,418 | ||||
| Medium- and Long-Term | … | 3,370 | 1,096 | ||||
| Domestic Currency | … | 1,959 | 0 | ||||
| Foreign Currency | … | 1,411 | 1,096 | ||||
| Equity | … | 14 | 4,785 | ||||
| Rest of the World | | ||||||
| Total Liabilities | 5,308 | 1,503 | 389 | ||||
| Currency and Short-term | 5,308 | 185 | 389 | ||||
| Medium- and Long-Term | 0 | 1,318 | 0 | ||||
| Equity | … | 1 | … | ||||
Excludes insurance sector.
Bulgaria: Intersectoral Asset and Liability Position
(end-December 2003, in millions of euros)
| Issuer of Liability (Debtor) | Holder of Liability (Creditor) | ||||||
|---|---|---|---|---|---|---|---|
| Government Sector (I) | Financial Private Sector 1/ (II) | Nonfinancial Private Sector (III) | Rest of the World (IV) | ||||
| Government and BNB | | ||||||
| Monetary Base | 1,981 | 712 | 0 | ||||
| Total Other Liabilities | 1,049 | 1,132 | 7,201 | ||||
| Short-term | 27 | 88 | 0 | ||||
| Domestic Currency | 27 | 88 | 0 | ||||
| Foreign Currency | 0 | 0 | 0 | ||||
| Medium- and Long-Term | 1,022 | 1,044 | 7,201 | ||||
| Domestic Currency | 575 | 248 | 0 | ||||
| Foreign Currency | 447 | 796 | 7,201 | ||||
| Financial Private Sector1/ | | ||||||
| Total Liabilities | 934 | 4,978 | 766 | ||||
| Short-term | 907 | 4,909 | 536 | ||||
| Domestic Currency | 553 | 2,812 | 68 | ||||
| Foreign Currency | 354 | 2,097 | 468 | ||||
| Medium- and Long-Term | 27 | 69 | 230 | ||||
| Domestic Currency | 24 | 28 | 0 | ||||
| Foreign Currency | 3 | 41 | 230 | ||||
| Equity | 0 | 0 | 0 | ||||
| Nonfinancial Private Sector | | ||||||
| Total Liabilities | … | 4,532 | 2,514 | ||||
| Short-term | … | 1,162 | 1,418 | ||||
| Domestic Currency | … | 634 | 0 | ||||
| Foreign Currency | … | 528 | 1,418 | ||||
| Medium- and Long-Term | … | 3,370 | 1,096 | ||||
| Domestic Currency | … | 1,959 | 0 | ||||
| Foreign Currency | … | 1,411 | 1,096 | ||||
| Equity | … | 14 | 4,785 | ||||
| Rest of the World | | ||||||
| Total Liabilities | 5,308 | 1,503 | 389 | ||||
| Currency and Short-term | 5,308 | 185 | 389 | ||||
| Medium- and Long-Term | 0 | 1,318 | 0 | ||||
| Equity | … | 1 | … | ||||
Excludes insurance sector.
For the nonfinancial private sector (NFPS), overall foreign-currency liabilities (medium- and long-term as well as short-term) exceeded assets, but short-term foreign-currency assets exceeded liabilities. However, short-term external liabilities in foreign currency exceeded liquid external foreign-currency assets by a sizable margin (about 6 percent of GDP; Figure 6, Panel 1). This implies that potential pressures on the short-term external position of the NFPS—e.g., from reduced rollover of credit lines—would be transmitted to the domestic banking sector, as foreign-currency denominated liquid liabilities of the banking sector to the NFPS would likely be called.
The financial private sector (FPS) had a long overall foreign-currency position, but its short-term foreign-currency liabilities exceeded liquid foreign-currency assets by a wide margin (12½ percent of GDP), deriving from the financial intermediation role of the sector, and the considerable degree of euroization (48 percent of the sector’s liabilities are in foreign currency, mostly euros). Meanwhile, short-term external liabilities in foreign currency exceeded liquid external foreign-currency assets only by a small amount (Figure 6, Panel 2). This suggests that, though some risks arise from the banks’ own balance sheets, the larger risk to the banking system arises from the domestic NFPS, with its sizable potential demand on banks’ foreign exchange.
The public sector’s short overall foreign-currency position derives from its large external debt. However, this debt is all medium and long-term (by original maturities), and there is thus little short-term refinancing risk.32 This is reflected in liquid foreign-currency assets exceeding short-term foreign-currency liabilities by a wide margin: even if the coverage of the monetary base by foreign exchange (required by the currency board) is treated as a foreign-currency liability, liquid foreigncurrency denominated assets exceeded short-term foreign-currency liabilities by more than 11 percent of GDP. The situation is similar for the external short-term foreign currency position (Figure 6, Panel 3).
48. Therefore, the public external short-term foreign currency position is strong enough to offset weaknesses in the private sector (Figure 6, Panel 4). Should the nonfinancial private sector withdraw deposits from banks (to meet external payments obligations), the public sector could support the banking system. This reduces the risk of potential rollover difficulties of firms in the NFPS (which is unlikely to be uniform across firms) being transmitted via the banking system to the entire economy. In the banking sector itself, this reduces the risks from one of foreign-currency positions to one of the usual maturity mismatches that financial intermediation creates, regardless of currency.
49. However, this insurance is neither complete nor costless. The transfer of risks across sectors, and in particular to the public sector, is not without cost. First, there are the opportunity costs of holding large lowly-remunerated reserves. Second, and perhaps more importantly, there is a moral hazard problem as the private sector relies on the public sector to assume the burden of providing insurance for the risks to the economy created by banks and corporations. These drawbacks need to be weighed against the (potential) cost of providing no or more limited insurance.
50. There are also risks going forward. Continued high current account deficits put pressure on both the public and private sectors’ external positions. The current account will need to be financed by drawing down foreign assets and/or increasing foreign liabilities, weakening the private sector’s external position (though long-term foreign credit, e.g., from parent banks, could mitigate the effect on the short-term external position) and increasing demands on the public sector to compensate for this deterioration. At the same time, the accumulation of additional foreign exchange reserves is becoming more difficult.
51. In summary, the strength of the short-term external foreign currency position in Bulgaria depends on the public sector. At present, the cushion of official reserves is sufficient to counterbalance weaknesses in the private sector’s balance sheets, but this comes at a cost and involves moral hazard. In addition, credit developments are likely to weaken private sector balance sheets further, putting greater demands on public reserves and requiring continued reserve build-up through inflows on non-debt creating financing, while at the same time aggravating moral hazard, as well as political and budgetary costs.
E. Conclusions
52. Recent developments indicate that external sustainability is not in immediate jeopardy, but risks have increased. While the current account deficit has increased considerably and is projected to remain relatively high for some time, non-debt financing has been sizable and can be expected to continue, in particular as EU accession approaches. On the other hand, the slowing pace of decline in the external debt-to GDP ratio indicates that the boundaries of sustainability are being reached.
53. Vulnerability has increased overall. Increased financing requirements, both due to the widening current account deficit and increasing short-term debt levels, imply greater vulnerability to a potential loss of confidence. Likewise, FDI, while it mitigates some risks, does not represent a cure-all. Also, the still high degree of euroization is a risk to the balance sheets of the private sector. On the other hand, the short-term foreign-exchange position of the public sector is still strong enough to mitigate those risks, and thereby bolster confidence. However, this implicit insurance is not without cost.
Comparing Bulgaria with the Baltic Countries1
A comparison of external indicators with the Baltic first-wave accession countries indicates that Bulgaria, in some respects, is stronger positioned, while it also exhibits weaknesses. This section focuses on comparisons with the Baltic countries, as they have either currency board arrangements (Estonia and Lithuania), or a hard peg (Latvia), which makes their policy constraints similar to those faced by Bulgaria. In comparing Bulgaria with the Baltics, it is important to bear in mind that Bulgaria’s most recent systemic crisis was in 1997, while the Baltic countries experienced their most severe output contraction in 1991/92 (though GDP continued to shrink in 1993).2 Therefore, the comparison does not only compare the state of the respective economies in a given year, but also looks at their evolution since their most recent crises.
Bulgaria’s current account, as well as its financing by FDI, broadly follows the same trends as in the Baltics (Box Figure 1). The current account (CA) balances of the Baltics, after significant surpluses through 1992 (and in Latvia, through 1993), deteriorated rapidly, reaching or surpassing deficits of 10 percent of GDP. If the scales are normalized, with t indicating the last crisis year (1992 for the Baltics, and 1997 for Bulgaria), current account developments are similar, with Bulgaria showing relatively modest deficits so far. Taking the current account and FDI together, developments show a similar pattern (Box Figure 2). In the initial years after their respective crises, current account deficits were more than covered by FDI, but this declined as economies recovered and current account deficits widened.
Current Account Balance
(In percent of GDP)
Citation: IMF Staff Country Reports 2004, 177; 10.5089/9781451804478.002.A002
Current Account Balance
(In percent of GDP)
Citation: IMF Staff Country Reports 2004, 177; 10.5089/9781451804478.002.A002
Current Account Balance
(In percent of GDP)
Citation: IMF Staff Country Reports 2004, 177; 10.5089/9781451804478.002.A002
CA + FDI (net)
(In percent of GDP)
Citation: IMF Staff Country Reports 2004, 177; 10.5089/9781451804478.002.A002
CA + FDI (net)
(In percent of GDP)
Citation: IMF Staff Country Reports 2004, 177; 10.5089/9781451804478.002.A002
CA + FDI (net)
(In percent of GDP)
Citation: IMF Staff Country Reports 2004, 177; 10.5089/9781451804478.002.A002
At the same time, Bulgaria is lagging in saving and investment performance. As current account deficits are similar, Bulgaria’ s relatively low savings rate translates into low investment (Box Figures 3 and 4). Correspondingly, output growth in the Baltics has shifted to some 6–8 percent per year after the 1999 crisis, after an initial burst of 7-10 percent in 1997 (Box Figure 5). Bulgaria has not reached that stage after its systemic crisis yet, but the rather low saving and investment rates need to be raised to increase future growth.
Gross National Saving
(In percent of GDP)
Citation: IMF Staff Country Reports 2004, 177; 10.5089/9781451804478.002.A002
Gross National Saving
(In percent of GDP)
Citation: IMF Staff Country Reports 2004, 177; 10.5089/9781451804478.002.A002
Gross National Saving
(In percent of GDP)
Citation: IMF Staff Country Reports 2004, 177; 10.5089/9781451804478.002.A002
Gross Fixed Capital Formation
(In percent of GDP)
Citation: IMF Staff Country Reports 2004, 177; 10.5089/9781451804478.002.A002
Gross Fixed Capital Formation
(In percent of GDP)
Citation: IMF Staff Country Reports 2004, 177; 10.5089/9781451804478.002.A002
Gross Fixed Capital Formation
(In percent of GDP)
Citation: IMF Staff Country Reports 2004, 177; 10.5089/9781451804478.002.A002
Real GDP
(Percent change)
Citation: IMF Staff Country Reports 2004, 177; 10.5089/9781451804478.002.A002
Real GDP
(Percent change)
Citation: IMF Staff Country Reports 2004, 177; 10.5089/9781451804478.002.A002
Real GDP
(Percent change)
Citation: IMF Staff Country Reports 2004, 177; 10.5089/9781451804478.002.A002
Both Bulgaria and the Baltics adopted fiscal discipline with the introduction of currency boards (in 1992 in Estonia, in 1994 in Latvia and Lithuania). However, there are surprisingly large variations (Box Figure 6). In all Baltic countries, the fiscal balance deteriorated significantly in the 1999 recession, reaching 8 percent of GDP in Lithuania. Overall, Bulgaria is one of the best performers, with its fiscal deficit never exceeding one percent of GDP (in cash terms), comparable only to Estonia.
Fiscal Balance
(In percent of GDP)
Citation: IMF Staff Country Reports 2004, 177; 10.5089/9781451804478.002.A002
Fiscal Balance
(In percent of GDP)
Citation: IMF Staff Country Reports 2004, 177; 10.5089/9781451804478.002.A002
Fiscal Balance
(In percent of GDP)
Citation: IMF Staff Country Reports 2004, 177; 10.5089/9781451804478.002.A002
Bulgaria started with a very large external debt stock, which it managed to bring down substantially. In contrast, the Baltics began with zero external debt, but their debt stocks (public and private combined) rose to levels now observed in Bulgaria (with the exception of Lithuania; Box Figure 7). At the same time, Bulgaria’s external reserves remained high at over 20 percent of GDP, while the Baltics’ are substantially lower (Box Figure 8).
Total External Debt
(In percent of GDP)
Citation: IMF Staff Country Reports 2004, 177; 10.5089/9781451804478.002.A002
Total External Debt
(In percent of GDP)
Citation: IMF Staff Country Reports 2004, 177; 10.5089/9781451804478.002.A002
Total External Debt
(In percent of GDP)
Citation: IMF Staff Country Reports 2004, 177; 10.5089/9781451804478.002.A002
Foreign Reserves
(In percent of GDP)
Citation: IMF Staff Country Reports 2004, 177; 10.5089/9781451804478.002.A002
Foreign Reserves
(In percent of GDP)
Citation: IMF Staff Country Reports 2004, 177; 10.5089/9781451804478.002.A002
Foreign Reserves
(In percent of GDP)
Citation: IMF Staff Country Reports 2004, 177; 10.5089/9781451804478.002.A002
Overall, Bulgaria exhibits many similarities to the Baltic countries. From a vulnerability viewpoint, Bulgaria appears well-placed. However, savings and investment are relatively low and must be raised to ensure future growth.
1 Source: WEO.2 In this context, the recession in 1999 (due to the 1998 Russian crisis) is not viewed as a systemic crisis. Indeed, all the Baltic countries weathered this shock rather well.Prepared by Alexander Pitt.
The latter requirement captures the notion that the social and political willingness to service debt has limits.
See “Debt-Related Vulnerabilities and Financial Crises—An Application of the Balance Sheet Approach to Emerging Market Countries” (forthcoming).
There are limitations to balance sheet analysis. The division of the economy in only three sectors (public sector, financial private sector, and nonfinancial private sector) implies a high level of aggregation, which could obscure within-sector vulnerabilities. Furthermore, data limitations generally limit the reliability of analysis. In Bulgaria, data availability and quality are broadly sufficient for the purpose of this exercise.
Part of this increase may be due to efforts at improving customs control.
However, the method used by the authorities to compile tourism revenue—based on an estimated amount of nominal euro receipts per traveler (unchanged since 1999)—risks increasing underreporting over time, as this implies assumed zero inflation for this type of expenditure at a time when inflation both in Bulgaria and the Eurozone—where most travelers originate—was positive. Yet, there are also downward pressures on revenues per tourist: (i) strong competition in the travel business is likely to have compressed price increases, and (ii) Bulgaria is a relatively cheap destination and may be selected especially by price-conscious holidaymakers. Furthermore, the same methodology is applied on the debit side, which partly counteracts this effect, even though inflows are more than twice as high as outflows.
Based on the assumption that key variables, including nominal GDP growth, non-debt creating inflows (in percent of GDP), and interest rates remain constant at their 2003 levels.
Higher oil prices are also a source of risks. An oil price higher by US$1 implies a deterioration of the current account by 0.2 percentage points of GDP.
In 47 percent of sovereign defaults over the past 30 years, the external debt was below 60 percent of GNP, but in only 17 percent of defaults below 40 percent (Reinhart, Rogoff and Savastano, “Debt Intolerance,” in Brookings Papers on Economic Activity: 1, Brookings Institution 2003, pp. 1-62).
The amortization of medium- and long-term external debt falling due in 2004 is €241 million (1.4 percent of GDP).
