Bulgaria: Selected Issues and Statistical Appendix

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.


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.

III. Bulgaria—Medium–Term Fiscal Framework and Sustainability and Implications of EU Apccession33

A. Introduction

54. In the aftermath of the 1996 crisis, Bulgaria adopted a currency board arrangement (CBA) supported by a tight fiscal policy. Since 1997 fiscal deficits have not exceeded 1 percent of GDP, the public debt-to-GDP ratio has been more than halved, and government saving has more than covered government investment. At the same time, government deposits in the banking system—the fiscal reserve account (FRA)—have risen to cover almost three times annual debt service. However, in 2003 a stronger than expected recovery in credit growth has exacerbated private sector demand pressure, resulting in a sharp deterioration of the current account deficit and raising the requirement for fiscal adjustment in the context of the CBA.

55. The adequacy of fiscal policy going forward remains an issue and, in this regard, a number of questions appear worth asking. Is the fiscal stance underlying the mediumterm fiscal framework (MTFF) appropriate and how does EU accession fit in? What are the risks to the MTFF? While fiscal sustainability is less of a concern now, could it become a problem in the medium term? Answering these questions would help assess the adequacy of the MTFF and allow to draw lessons for fiscal policy in the period ahead.

B. Medium-Term Fiscal Framework and Policy

Main elements of Medium-term Fiscal Framework

56. Fiscal policy has been appropriately tight, but opportunities have been missed to strengthen it further and create more room for priority spending. Since 1998 Bulgaria has operated under an implicit fiscal rule of not exceeding a cash deficit of 1 percent of GDP, with recent efforts to achieve balance being motivated by the need to offset private sector-led demand pressures resulting in part from a surge of bank credit. However, the government’s objective to curtail current spending to free up room to increase capital outlays and broaden the social safety net has not been fully achieved. In fact, there has been no success in reducing non-interest spending. The primary balance declined from an average of 2.9 percent of GDP in 1999-2001 to an average of 1.6 percent in 2002-03. During the same periods, on average, capital spending decreased by one point to 3.3 percent of GDP. In this respect, the opportunity presented by historically low interest rates to accelerate reforms while limiting spending cuts was lost.

57. The MTFF envisages a balanced budget, with the exception of 2007, the expected year of EU accession (Table 1). As the authorities are still forming a view on fiscal policy post-EU accession, the MTFF discussed below is a combination of the authorities’ broad plans up to 2006 and a normative projection for 2007-09. In response to the deterioration in the current account deficit, the authorities this year decided to cut budgeted spending by 0.7 percent of GDP to revert to a broadly neutral fiscal stance in 2004 with a deficit of 0.4 ercent of GDP. Further, they decided to devote any revenue overperformance (above about 0.1 percent of GDP pre-committed under the budget for higher subsidies) to achieving a balanced budget. A further tightening could be envisaged if the current account deficit threatens to exceed current projections. The projected gradual contraction of the current account deficit in the medium term (see Chapter II) is predicated on balanced budgets, except in 2007. As discussed in section II, new spending requirements upon accession could burden the budget by up to 3 percent of GDP in 2007 and slightly more than 1½ percent of GDP thereafter. The authorities are still discussing how to accommodate this spending, but considerations of external sustainability and vulnerability suggest to accommodate this spending partially only in 2007. Section 1.3 analyzes these points further.

Table 1.

Bulgaria: Medium-Term Fiscal Framework 1/

(In percent of GDP)

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Sources: Ministry of Finance; and Fund staff projections.

Prior to 2003 the fiscal balance does not include transfer made below the line.

Under the 2003 and 2004 budget, these transfers were envisaged to be made below the line for various purposes. From 2007 includes contribution to the EU budget.

58. Revenue projections are based on lower tax and nontax revenue and higher grants. Tax revenue is projected to decline gradually, reflecting the government’s objective to reduce tax rates to promote investment. While the tax system has maintained generally low rates and few exemptions, tax policy has focused in recent years on shifting from direct to indirect taxation (Box 1). In 2004, the profit tax was reduced from 23.5 percent to 19.5 percent and the personal income tax rate for the lowest income brackets from 15 to 12 percent. In 2005, the government envisages to further lower these tax rates to 15 percent and 10 percent, respectively, while increasing the minimum taxable income threshold. Plans are also being considered to provide tax breaks to families with children. To offset the revenue loss, excises will be further increased toward minimum EU levels consistent with EU harmonization requirements. However, as this offset may be only partial and given spending constrains, particularly associated with the EU, the planned reduction in direct taxation may need to be less ambitious. For the remainder of the medium term, tax revenue is projected to decline slightly in relation to GDP, reflecting inter alia a higher transfer of social security contributions to the privately-operated second pillar of the pension system. Nontax revenue would continue to decline before stabilizing from 2005, as privatization would entail dwindling dividend revenue. Grants—mostly from the EU—would rise slightly until 2006, reflecting improvement in the absorption capacity, and jump from 2007 with the receipt of post-accession funds.

Bulgaria: Summary of Tax Rates as of April 2004

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59. The improvements in tax and customs administrations are beginning to pay dividends through higher buoyancy of taxes and the MTFF assumes this trend will continue. Quarterly revenue series—available only from 1999—are not long enough to estimate tax buoyancy and elasticity. However, simpler indicators point to improved tax buoyancy. In 2003, nominal GDP grew by 6½ percent, whereas tax revenue rose by 15½ percent. While the surge in imports explains most revenue growth in 2003, efforts to improve collection are beginning to bear fruit, especially in the customs administration. The latter calculated that, correcting for increases in excises, the rise in customs revenue attributable to Customs’ effort to fight smuggling and fraud amounted to 3.6 percent.

60. Expenditure restructuring is a key element of the MTFF, pointing to the need to augment government saving to boost investment (Table 2). The MTFF envisages a continued lowering of current spending until 2006, mainly by allowing the wage bill to grow only by average CPI inflation, further reducing subsidies through the implementation of structural reforms in the railways, energy, and health sectors, while keeping spending for social benefits, pensions and active labor market policies in check. From 2007, EU accessionrelated requirements, particularly for agricultural subsidies, would reverse this trend somewhat, but Bulgaria could accommodate some of the additional outlays by curtailing lower priority spending. Government saving would increase gradually to finance rising capital outlays needed to upgrade and build infrastructure.

Table 2.

Bulgaria: Macroeconomic Framework, 2002–2009

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Sources: Bulgarian authorities; and Fund staff projections.

Net imports of goods and nonfactor services.

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

61. In undertaking public investment, Bulgaria faces important policy options, which could affect fiscal sustainability. The authorities have expressed interest in financing the construction of new expressways notably through PPP-type schemes. The general principles of public investment call for, on the one hand, cost-benefit analysis and the highest level of return to guide project selection and, on the other hand, project financing to avoid saddling the government with contingent liabilities. Since PPPs involve the private sector and the latter has a different objective function than the government, proper selection is very important. PPPs also raise issues regarding the government’s exposure and proper fiscal accounting of these operations. Recent Board papers recommend that “until an internationally accepted accounting and reporting standard for PPPs is developed, the actual and potential costs for the government implied by a PPP contract should be taken into account when undertaking debt sustainability analysis” www.imf.org and argue that the recording of PPP operations in fiscal accounts depends on the assessment of risks incurred by the government (www.imf.org). PPPs can be very complex and both ESA95 and GFS2001 provide only partial guidance on their fiscal accounting, leaving considerable scope for interpretation, which if not conservative could result in governments incurring large contingent liabilities. In addition to these considerations, in the road sector, Bulgaria faces a choice between giving priority to renovating and upgrading the existing road network or building new expressways. Such decisions will determine how projected capital expenditures are allocated and may have farreaching implications for fiscal sustainability.

62. Ongoing institutional strengthening will support the MTFF. Previous technical assistance, including through the posting of resident advisors, as well as the establishment of the Public Finance School in the Ministry of Finance have considerably enhanced capacity to prepare and conduct fiscal policy. Further progress is needed, however. Budget preparation starts early during the previous year, while an increasing number of line ministries are preparing program budgets (for the time being only to build this capacity) so that from 2007 the state’s budget would completely be program-based. However, lack of technical expertise constrains the ability of line ministries to prepare three-year rolling budgets in a timely manner, as required by the Ministry of Finance. Technical assistance may be necessary in moving to accrual accounting. Further progress is sought in improving tax administration and expenditure management (see paragraph 72).

Pension and health spending in the medium-term fiscal framework

63. Assuming unchanged policies, the pension system should exert a declining pressure on government spending in the medium term, but there are—mainly political—risks (Figure 1, first panel). The one-off adjustment in the monthly pension ceiling from 240 leva to 420 leva—a level that makes the ceiling almost non-binding—would result in a widening of the deficit of the National Social Security Institute (NSSI).34 However, going forward, while still high, the dependency ratio is projected to decline until 2020, allowing NSSI’s revenue to rise (Figure 2). Underpinning this projection are lower unemployment and higher participation rates, robust economic growth, a decline in the shadow economy, and administrative improvements, notably to increase revenue collection. Expenditures are envisaged to remain under control due to the gradual increase in the retirement age for females (to 60 years) and males (to 65 years) and the strict adjustment of pensions based on an indexation formula, which assigns to inflation and insurable income weights of 75 percent and 25 percent, respectively. Notwithstanding the gradual increase in the transfer to the second pillar to 5 percent by 2007, the deficit of the first pillar is projected to continue to decline toward balance by 2013—instead of 2005, as projected in 1999 when the three-pillar pension system was introduced—and accumulate surpluses thereafter. The delay in reaching balance can be attributed to over-optimistic assumptions, but more importantly reflects political pressure that resulted in new measures boosting spending. Such pressure continues to present a serious risk to the NSSI balance, particularly in light of the low level of pensions and the rapid rise in disability pensions (Table 3). However, it could be mitigated by enshrining in a law the indexation formula for pension and pensionable bases underlying the medium-term projections and by strictly controlling the disability certification process.

Figure 1.
Figure 1.

Bulgaria: NSSI Balances, 2003-2043

(In percent of GDP)

Citation: IMF Staff Country Reports 2004, 177; 10.5089/9781451804478.002.A003

Sources: National Social Security Institute (NSSI) and Staff calculations.
Figure 2.
Figure 2.

Bulgaria: Demographic and Unemployment Forecasts, 2003-2043

Citation: IMF Staff Country Reports 2004, 177; 10.5089/9781451804478.002.A003

Sources: National Social Security Institute (NSSI) and Fund staff calculations.
Table 3.

Bulgaria: Selected Pension-Related Indicators

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Sources: National Social Security Institute and Fund staff calculations

For these two categories, it is believed that wages are significantly underreported to evade taxes.

Based on the income of individuals--90 percent of all workers--working for an employer other than the armed forces.

64. Assuming additional policies to strengthen pensions and reduce labor taxation, the NSSI is projected to post a balanced budget in the long run. In addition to current policies, the following set of measures were simulated, including: (i) a change in pension indexation from the current split of 75 percent inflation and 25 percent growth of insurable income to 50-50 percent from 2013; (ii) further increases in the transfer to the second pillar to 7 percent from 2014, 8 percent from 2020, and 9 percent from 2026; (iii) from 2017, a decrease in the contribution rate by 1 percent, half a point each for employers and employees. However this simulation does not include an increase in the contribution rate for the health insurance fund from 6 to 8 percent—and therefore assumes that such adjustment would not be financed by a reduction in contributions going to the pension system. The simulation presented in Figure 1, second panel, suggests that, the NSSI could achieve and maintain balance or near balance from 2013 onwards, while raising pensions and reducing contribution rates.

65. The MTFF envisages a stabilization of health spending in relation to GDP, but the delay in completing health sector reforms poses a risk (Table 4). Compared to the past and the medium term, the 2004 budget estimate for health spending seems low. The authorities had planned to make progress in the health sector reform this year, with a significant expansion of activity-based financing of hospitals and restrictions in the reimbursement of drug expenses and various other claims. The failure to sign a National Framework Agreement with health care providers, however, makes it somewhat difficult that the budget can be strictly adhered to, presenting the risk of spending overruns—as in past years—and of a larger fiscal deficit (on an accrual basis) this year. The MTFF envisages a rise in the revenue of the National Health Insurance Fund (NHIF) in 2006 resulting from an increase in the contribution rate from 6 to 8 percent; but, even with this increase, revenue would fall short of expenditures. The MTFF also envisions that the NHIF would assume a growing share of health care spending covered only partially by subsidies redirected from the budget of the Ministry of Health, leaving the NHIF in deficit.35 Failure to advance the reforms would worsen this deficit—especially given the aging population—putting pressure on the government to loosen fiscal policy, as it would be politically difficult to make cuts in the quality and availability of health services. The authorities have not yet come to grips with this looming problem, which will require strong political commitment to accelerate the reforms.

Table 4.

Bulgaria: Health Sector Spending Under the Baseline Scenario

(In percent of GDP)

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Sources: National Health Insurance Fund and Fund staff calculations.

Appropriateness of and risks to the MTFF

66. The question of the appropriateness of the MTFF boils down to whether the underlying fiscal stance is adequate. In the short run and given the CBA, fiscal policy is the central macroeconomic instrument for offsetting the impact of the credit boom. A balanced budget for 2004-05 appears therefore appropriate, but not necessarily sufficient. Indeed, the acceleration in private demand would suggest a need for a bias toward fiscal surpluses. In the longer run, since growth is expected to accelerate toward its annual potential of 5½ percent in 2008, a balanced budget could actually be pro-cyclical.36 While a surplus might be difficult to achieve because of political constraints, aiming for a balanced budget over the cycle would seem adequate to offset excess demand pressure. Moreover, in the absence of a long-enough series of macroeconomic variables necessary to estimate the structural fiscal balance, an implicit balanced budget rule appears a prudent enough approach that would allow sufficient room for fiscal adjustment in an environment of lack of monetary stabilization tools.

67. It may not be prudent to allow a significant deviation from a balanced budget upon EU accession. Bulgaria has announced its intention to enter ERM2 with the current peg under the CBA and to maintain it as the central parity until joining EMU. There is hence no reason to deviate from the tight fiscal policy pursued so far. This would thus imply that Bulgaria should regard the Maastricht fiscal criteria as upper bounds and endeavor to stay below them, despite EU solidarity mechanisms. The need to allow room for counter-cyclical fiscal policy in case of a downturn strengthens the argument for not loosening the fiscal stance. Also, a balanced budget—and associated primary surpluses—would greatly contribute to reducing public debt, which in turn would strengthen fiscal sustainability and help keep interest rates low. Finally, a balanced budget would help bolster public savings needed to finance rising government capital investment.

68. Whether a fiscal surplus could prevent growth from accelerating to its potential would be an issue, if in fact the authorities were to go that route. This would depend on how the surplus is generated. Fiscal consolidation has been shown to have non-Keynesian effects, with the composition of the adjustment playing a crucial role in achieving expansion. Alesina and Perotti (1997) argue that fiscal adjustment that relies primarily on tax increases and cuts in public investment tend to last and are contractionary, while cuts in current spending are likely to be expansionary. Tax increases would result in higher unit labor costs and lower competitiveness especially when unions are strong, while cuts in public investment would lower growth. In contrast, credible spending cuts—particularly on the wage bill and transfers—have a favorable effect on growth by increasing competitiveness and lowering interest rates. More recently, Giudice et al. (2004) found strong evidence in favor of these arguments in the EU area. Although the right mix of revenue and expenditure measures when adjusting is country-specific, this suggests that curtailing current spending would be more benign with respect to growth and should therefore be the primary source of adjustment.

69. Experience in some previous accession countries suggests that a strong fiscal policy could help foster real convergence. Countries that aspire to join the EU hope that this would result in rapid convergence of real income to EU levels. The experience of Ireland shows that strong fiscal adjustment from initial large deficits could help accelerate real convergence (Honohan, 1999). Bulgaria already implements a strong fiscal policy, which, if maintained after EU accession, would position the country well to attract higher FDI, crucial to achieving sustained rapid growth.

70. In the context of the CBA, flexibility remains an important element of conducting fiscal policy. In addition to normal contingencies, Bulgaria has a wellestablished practice of setting aside roughly 1 percent of GDP by capping discretionary spending across-the-board during the first three quarters of the year. This approach, however, is prone to favor the accumulation of arrears and lead to less-than-desirable adjustment. The practice will change beginning with the 2005 budget through the prior identification of lower priority spending in the budget of each line ministry and other budget entities. By cutting or delaying only such spending, the quality of the adjustment, if in fact needed, would be improved. Also, in 2004 the government will experiment for the first time with quarterly expenditure ceilings. While not flexible, such ceilings would prevent revenue overperformance, as in the past, to be spent at the end of the year on low-priority items.

71. Reducing the size of the government is an important objective that could, however, be reversed after EU accession. The size of government—as measured by the ratio of total government expenditure to GDP—compares well with that in the EU and other countries in the region. Yet, the government has made further downsizing one of its mediumterm fiscal objectives, although it has not been successful in recent years. From 2007, the size of the government may increase again, reflecting EU grants and related spending. In fact, previous EU accession rounds have shown that the size of government in new EU member countries tends to converge toward the average EU level (e.g., Greece). Nevertheless, consistent with the government’s objective the MTFF does assume some substitution so that expenditure will increase by less than would have been the case otherwise. Abstracting from EU grants and related spending, the size of the general government would decline steadily during the medium term to 33¼ percent of GDP in 2009, but this crucially hinges on whether remaining structural reforms are implemented.

72. Delays in completing structural reforms could increase pressure to deviate from the MTFF path. Reforms in the energy sector have made strides with the passage of the energy law underpinning the liberalization of the sector. The railways sector, on the other hand, is still quite inefficient, with freight subsidizing passenger traffic and many idle lines still open. Both sectors continue to receive subsidies totaling about ½ percent of GDP, but the MTFF assumes some reduction. Tax administration is expected to improve notably with the introduction of the National Revenue Agency, which would consolidate the collection of taxes and social security contributions. Expenditure management would be enhanced through consolidation of budgetary entities’ accounts in the Treasury Single Account and the introduction of the Financial Management Information System. The latter would allow better control of expenditure commitments. These reforms are crucial for implementing the MTFF and delay would make it difficult to achieve its objectives. After the recent slowdown of reforms, a new impetus is needed.

73. The MTFF faces other risks. In the immediate future, the general elections may lead to a weakening of policies either before, to “buy votes,” or afterwards, if a new government decides to follow a somewhat looser fiscal policy. Slow EU growth, further substantial oil price increases and appreciation of the euro are potential occurrences that may make it more difficult to achieve the objectives of MTFF.37 A delay in EU accession could result in significant market volatility, if it is interpreted as putting in question accession altogether. In addition, there could be pressure on the CBA associated with questions regarding the exit strategy.

74. Financing of the MTFF is not an issue, but completing privatizations would provide added comfort. While external debt service requirements would be large from 2006, with a spike in 2007, ample international reserves would allow repayments without threatening coverage of base money, although the current cushion would thin out. Although the baseline scenario takes a prudent approach to projecting privatization receipts, the latter could be as much as 4¼ percentage points of (projected 2005) GDP higher cumulatively over 2005-07, further bolstering the FRA and international reserves. Completing these privatizations should therefore be one of the government’s priorities. The government can smooth out the debt service spike in 2007 through debt operations.

C. Fiscal Implications of Pre- and Post-EU Accession and NATO Requirements

75. Until 2006, Bulgaria would be able to manage the requirement for counterpart funds for EU accession. Since 1999 approved EU pre-accession funds have averaged 1½ percent of GDP, but implementation capacity has averaged only 50 percent. Co-financing has typically amounted to 20-25 percent of these funds and the government has been able to provide for this requirement within the fiscal envelope. The main reasons for low implementation include lack of technical expertise for timely project preparation and implementation, legislative and regulatory impediments, and inadequate staffing. The authorities have taken steps to address these shortcomings and implementation capacity is expected to gradually increase. Despite this improvement, until 2006 co-financing is not expected to constrain the government’s ability to post a balanced budget.

76. From 2007, however, EU requirements would make it more difficult to achieve a balanced budget (Table 5). Upon accession, Bulgaria will start making contributions to the EU budget averaging 1.1 percent of GDP yearly. Spending requirements associated with adoption of the acquis communautaire will increase, leaving a domestic financing gap of slightly more than 1½ percent of GDP per year. In 2007 specifically, advanced payment—with a transfer from the EU due only in 2008—of common agricultural policy (CAP) subsidies to Bulgarian farmers amounting to 0.8 percent of GDP will temporarily increase the gap to almost 3 percent of GDP. The authorities are still mulling whether to increase the deficit by the full amount of these gaps. But for reasons discussed in paragraph 67, it would be prudent to cut other spending to accommodate EU requirements, with the possible exception of the one-off advanced payment of CAP subsidies in 2007. The MTFF reflects this policy line.

Table 5.

Bulgaria: EU Accession-Related Transfers and Spending

(In percent of GDP)

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Sources: Bulgarian authorities.

77. Harmonization of indirect taxation with the EU presents less of a challenge than the adoption of the common external tariff (CET). At 20 percent, the VAT rate is comparable to levels in the EU and excises have been rising gradually and are at 60-70 percent of minimum EU levels, although the gap for cigarette and fuel excises remains quite wide. Bulgaria has a lower tariff protection than the EU, with the effective import duties rate averaging 1.7 percent (Box 1). Bulgaria also has free-trade agreements with many countries, some of which may not have such agreements with the EU as a group. The CET may therefore increase trade protection, which may dampen further efficiency gains in the tradable sectors—such as textiles—where Bulgaria still enjoys a comparative advantage. Furthermore, trade protection may have price effects on production factors and consumer goods with welfare losses.

78. The CAP would lead to a significant increase in subsidies. Direct subsidies would rise from 1½ percent of GDP in 2007 to 2 percent of GDP in 2009, while additional implicit subsidies would result from trade barriers against non-EU producers under the CET. The latter, however, would be limited by production quotas. The MTFF assumes that the overall level of subsidies would increase only by a fraction of these transfers, implying that the other subsidies would have been reduced through reforms.38 However, if substitution were not to take place the overall level of subsidies would increase significantly.

79. NATO accession requirements seem to represent a lesser fiscal challenge. Upon NATO accession, Bulgaria committed to spend 2.6 percent of GDP on defense and law enforcement annually. This amount is in line with what the country already spends in this sector, so that the additional burden appears negligible.

D. Medium-Term Fiscal Sustainability

80. Fiscal sustainability is assessed based upon projected levels of public debt in the medium term. According to IMF (2003), the sustainable public debt level for a typical emerging market country could be as low as 25 percent of GDP, since such countries could be subject to significant interest rate and capital volatility. Upon EU accession, solidarity mechanisms would allow Bulgaria to afford a higher debt ratio. Schadler et al. (2003) estimate that such a level could be around 45 percent of GDP for the most recent EU members. But accession is expected to take place only in 2007, with some probability that this date could slip, pointing to the need for Bulgaria to remain focused on continuing to lower its public debt ratio.

81. Public debt dynamics under the baseline scenario are favorable (Table 6). The public debt-to-GDP ratio declined steadily from 83 percent of GDP in 1999 to 53½ percent of GDP in 2003. It is projected to drop to 31 percent of GDP by 2009, well below the level determined to be prudent for the newest EU members, which points to strong medium-term fiscal sustainability. While external debt would gradually contract, domestic debt is projected to pick up from 2005, reflecting debt management policies.

Table 6.

Bulgaria: Public Debt Under the Baseline Scenario

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Sources: Bulgarian authorities and Fund staff calculations.

82. Public debt management objectives have supported the reduction and restructuring of public debt.39 These objectives include the reduction of the share of U.S. dollar-denominated and floating interest rate debt, lengthening the maturity of debt and smoothing the repayment schedule. Given the peg to the euro and the fact that Bulgaria’s trade with the EU amounts to more than 60 percent of its total trade, it makes sense to shift debt to euro and leva, the domestic currency. Moreover, the increase in domestic debt is also meant to provide additional financial instruments to domestic investors, notably pension funds, thereby deepening the financial system. To achieve these objectives, Bulgaria has at its disposal a wide array of instruments including debt swaps, buybacks, and prepayments. Some of these were used in the past, particularly the Brady bonds swap that reduced U.S. dollar-denominated debt by 16 percentage points in 2002.

83. The composition of public debt suggests that there remains room to undertake further debt operations to minimize risks (Figure 3). Foreign currency debt represents 86 percent of total public debt. US dollar-denominated debt amounts to 42 percent of the total and is subject to exchange rate fluctuations. The recent appreciation of the euro vis-à-vis the US dollar was a windfall, but since a depreciation would have increased the debt burden, the objective of lowering the US dollar share is remains sensible—although the timing of debt operations is crucial for taking full advantage of opportunities. Debt with fixed interest rates represents 43 percent, while longer-term debt (with a maturity of over 10 years) represents 40 percent of the total. These ratios could be further increased. Short-term debt (with a maturity of up to one year), however, equals only about 1 percent of the total. As can be seen in Table 1, principal repayments will jump in 2006-09, with a peak in 2007. Debt operations could be very useful in smoothing the debt service profile. For this purpose, the authorities can use the resources in the FRA subject to maintaining an adequate international reserve cover.

Figure 3.
Figure 3.

Bulgaria: Public Debt Data as of End-March 2004

Citation: IMF Staff Country Reports 2004, 177; 10.5089/9781451804478.002.A003

Sources: Ministry of Finance and Fund staff calculations.
Figure 3.
Figure 3.

Bulgaria: Public Debt Data as of End-March 2004, (continued)

Citation: IMF Staff Country Reports 2004, 177; 10.5089/9781451804478.002.A003

Sources: Ministry of Finance and Fund staff calculations.1/ The average-weighted residual term to maturity of the foreign debt is nine years and eight months.

84. A public debt sustainability analysis shows that even under extreme conditions, the public debt-to-GDP ratio would continue to decline and stay below the Maastricht limit of 60 percent (Table 7). Stress tests include the following shocks in 2004–05: higher real interest rates, lower GDP growth, lower primary balance, a substantial increase in debt creating inflows, and a 30-percent depreciation. Only the latter would result in a large increase (close to 20 percentage points) of the public debt ratio in 2005 followed by a gradual decrease to a level almost identical to the ratio in 2003. Lower growth would also lead to a less steep decline in the public debt ratio, highlighting the importance of growth for debt sustainability. In all the other cases, the public debt ratio would contract rapidly.

Table 7.

Bulgaria: Public Sector Debt Sustainability Framework, 1998–2009

(In percent of GDP, unless otherwise indicated)

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Source: Bulgarian authorities and Fund staff calculations.

This represents gross public sector debt, and thus is different from general government debt figures shown elsewhere.

Derived as [(r - π(1+g) - g + αε(1+r) ]/(1+g+π+gπ)) times previous period debt ratio, with r = interest rate; π = growth rate of GDP deflator; g = real GDP growth rate; π = share of foreign-currency denominated debt; and Є = nominal exchange rate depreciation (measured by increase in local currency value of euro).

The real interest rate contribution is derived from the denominator in footnote 2/ as r - π (1+g) and the real growth contribution as -g.

The exchange rate contribution is derived from the numerator in footnote 2/ as αε(1+r).

Defined as public sector deficit, plus amortization of medium and long-term public sector debt, plus short-term debt at end of previous period.

Derived as nominal interest expenditure divided by previous period debt stock.

The key variables include real GDP growth; real interest rate; and primary balance in percent of GDP.

Real depreciation is defined as nominal depreciation (measured by percentage fall in euro value of local currency) minus domestic inflation (based on GDP deflator).

Assumes that key variables (real GDP growth, real interest rate, and primary balance) remain at the level in percent of GDP/growth rate of the last projection year.

E. Concluding Remarks

85. The MTFF reflects constraints arising from the CBA and the need to respond to increased external vulnerability, but it faces risks. In the context of the CBA, fiscal policy is the central instrument for adjustment. The relatively high level of the current account deficit projected in the medium term and the need to maintain fiscal flexibility justify the implicit balanced budget rule. The latter would require proceeding cautiously with tax cuts and reducing current expenditures further so as to accommodate higher spending associated with EU accession, notably for public investment. However, delays in implementing reforms would make it increasingly difficult to restructure expenditures and would increase pressure to loosen fiscal policy.

86. The EU accession poses challenges to the MTFF. Until 2006, EU pre-accession related spending would not prevent achieving a balanced budget. From 2007, however, the large gap between transfers from the EU and spending related to the adoption of the acquis communautaire would entail difficult policy choices with regard to prioritization of expenditures. The implicit fiscal rule underlying the MTFF would call for efforts in advance of EU accession to create the needed fiscal room, notably through expediting reforms.

87. Fiscal sustainability in the medium term appears strong. An overall balanced budget and strong growth would ensure favorable public debt dynamics. Even under extreme conditions, the public debt-to-GDP would continue to decline to levels well below the Maastricht criterion of 60 percent by 2009. Debt management operations contemplated by the authorities would further improve the composition of public debt and reduce risks.

F. References

  • Alesina, A. and R. Perotti, 1997, “Fiscal Adjustment in the OECD Countries: Composition and Macroeconomic Effects,IMF Staff Papers, Vol 44, No. 2, pp. 21048.

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  • Giudici, G., A. Turrini, and J. I. Veld, 2004, “Can Fiscal Consolidations Be Expansionary in the EU? Ex-Post Evidence and Ex-Ante Analysis,European Commission, Economic Papers, No. 195.

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  • Honohan, P., 1999, “Fiscal Adjustment and Disinflation in Ireland: Setting the Macro Basis for Economic Recovery and Expansion,” in Barry, Frank, ed., Understanding Ireland Economic Growth, (St. Martin’s Press, 1999).

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  • Horváth, B., and I. Székely, 2001, “The Role of Medium-Term Fiscal Frameworks for Transition Countries: the Case of Bulgaria,IMF Working Paper No. 01/11 (Washington D.C., International Monetary Fund).

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  • International Monetary Fund, 2004, “Adopting the Euro in Central Europe—Challenges of the Next Step in European Integration,” (forthcoming occasional paper).

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  • International Monetary Fund, 2003, “Public Debt in Emerging Markets,World Economic Outlook, September.

  • International Monetary Fund, 2002, “The Baltics: Medium-Term Fiscal Issues Related to EU And Nato Accession,” IMF Country Report No. 02/7.

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Prepared by Philippe Egoumé-Bossogo.


The NSSI comprises the old-age (first and universal pillar of the pension system) and disability pensions; and insurance for sickness and maternity leave, unemployment, and work-related injuries. Other social benefits are administered by the Ministry of Labor and Social Affairs (with the exception of public health insurance).


The NHIF deficit would be financed by its accumulated reserves, which are included in the FRA. However, they would run out before or by 2007, depending on how fast reforms are implemented.


See Bulgaria—Selected Issues and Statistical Appendix, IMF Country Report No. 01/54.


Shocks to the MTFF are analyzed in Section C.


Agriculture accounted for 15 percent of GDP in 2003 and will likely continue to represent a significant share of the Bulgarian economy after EU accession.


See IMF Country Report No. 02/173 for a discussion of debt management and composition in Bulgaria.