Bulgaria: First Review Under the Stand-By Arrangement and Request for Waivers of Nonobservance of Performance Criteria

Bulgaria’s First Review Under the Stand-By Arrangement and Request for Waiver of Performance Criteria are discussed. With macroeconomic conditions expected to remain favorable, competitiveness at an adequate level, and a lower current account deficit, concerns about external vulnerability have lessened somewhat. Nonetheless, policies must remain prudent, and the program for 2005 envisages some fiscal easing, a slowdown in credit expansion, and reinvigorated structural reforms. The authorities have agreed to tighten the fiscal stance at the time of the second review if external current account developments are weaker than expected.

Abstract

Bulgaria’s First Review Under the Stand-By Arrangement and Request for Waiver of Performance Criteria are discussed. With macroeconomic conditions expected to remain favorable, competitiveness at an adequate level, and a lower current account deficit, concerns about external vulnerability have lessened somewhat. Nonetheless, policies must remain prudent, and the program for 2005 envisages some fiscal easing, a slowdown in credit expansion, and reinvigorated structural reforms. The authorities have agreed to tighten the fiscal stance at the time of the second review if external current account developments are weaker than expected.

I. Introduction

1. A staff team1 visited Sofia during December 2-16, 2004 and March 10-16, 2005 for discussions on the first review under the Stand-By Arrangement (SBA). The 25-month SBA, equivalent to SDR 100 million (15.62 percent of quota), was approved on August 6, 2004 (see IMF Country Report No. 04/267 and Table 1.). The authorities continue to treat the arrangement as precautionary and intend to make all outstanding repurchases to the Fund on the expectations schedule.

Table 1.

Bulgaria: Schedule of Purchases Under the Stand-By Arrangement

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Source: Fund staff calculations.

Assuming maximum proposed access. The authorities plan to treat the arrangement as precautionary and do not intend to make any purchases.

Includes access originally proposed to be available on meeting the end-March performance criteria. These performance criteria were to be set at the time of the first review, earlier envisaged to be completed before end-March 2005.

Board date for 2006 Article IV consultation.

Brought forward to include within the program period.

2. Although several end-December 2004 quantitative and structural performance criteria (PCs) and benchmarks were not observed, their nonobservance was generally minor or technical in nature or is being addressed as part of the 2005 program (Tables 2 and 3). Two quantitative PCs—the ceilings on general government expenditure and central government arrears—were missed. In the case of the former, this reflected a transfer of funds to a new state enterprise created for the purpose of infrastructure spending in 2005, which also resulted in the nonobservance of the structural benchmark proscribing the creation of state enterprises. On the missed arrears PC, the outstanding amount was less than 1/100 of 1 percent of GDP and not subject to day-to-day control of the government. Two structural PCs—on the incorporation of the judiciary’s expenditure accounts in the budgetary payments system and the parliamentary adoption of the Bulstat number as the single identification for all tax and social security payments—were also missed (one of them partly), as were some structural benchmarks, for the reasons given in Table 2.

Table 2.

Bulgaria: Observance of Structural Conditionality Under the Stand-By Arrangement in 2004 1/

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Details of the performance criteria and benchmarks are included in the Annexes to the Memorandum of Economic and Financial Policies, IMF Country Report No./04/267.

SPC denotes structural performance criterion, PC denotes performance criteria, SB denotes structural benchmark, and PA denotes prior action.

Table 3.

Bulgaria: Quantitative Performance Criteria and Indicative Targets Under the Stand-By Arrangement 1/

(In millions of leva, unless otherwise indicated)

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Definitions of the performance criteria are included in the Annexes to the Memorandum of Economic and Financial Policies, August 2004 and the Supplementary Memorandum of Economic and Financial Policies, March 2005.

Indicative limit or target.

Cumulative change from January 1, 2004 for 2004 performance criteria and from January 1, 2005 for 2005 performance criteria.

Includes reduction in central government arrears.

Targets have changed compared to IMF Country Report No./04/267 due to the privatization of BTC in Q2 2004 and Balkan Mine 2000, Open coal mine, and Brikel SOEs in Q3 2004, and of Mina Zdravec EAD and Eood Central Base-Pernik in Q4 2004.

In millions of euro. Cumulative change from December 31, 2004 for 2004 performance criteria and December 31, 2005 for 2005 performance criteria.

3. Regardless of the outcome of the June 25 parliamentary election major policy slippages are unlikely given the broadly shared objectives to join the EU in 2007 and maintain the currency board arrangement (CBA). Pre-election political maneuvering has intensified. Prompted in part by the failed privatization of several cigarette companies (see paragraph 6), the opposition earlier this year succeeded in dismissing the speaker of parliament. However, ahead of a subsequent vote of no confidence, the governing coalition was broadened from two to three parties, restoring its parliamentary majority. Notwithstanding these upheavals, EU accession and maintenance of the CBA remain common goals across the political spectrum, reducing the potential for policy slippage.

II. REcent EConomic DEvelopments

4. Macroeconomic performance in 2004 was stronger than expected, although private sector credit exceeded programmed levels and private external debt rose sharply:

  • Real GDP rose 5.6 percent, compared with 5.2 percent in the original program, the highest growth rate in recent history and higher than average growth in the new EU members (Table 4.,Text Table 1., Figure 1., and Text Figure 1.). Activity was buoyed by continued rapid growth in domestic demand (particularly investment), financed by bank credit, and a large reduction in the negative contribution of net exports. Strong output growth helped the unemployment rate fall to a five-year low of 11.7 percent in September, before increasing for seasonal reasons to 13.1 percent in February 2005.

  • Despite buoyant economic activity and surging oil prices, 12-month consumer price inflation fell steadily in the second half Text Figure 2.. Change in Private Sector Credit (In percent of GDP) of the year as a sharp rise in food prices in the wake of a 2003 drought was reversed, with the euro’s appreciation also dampening price pressures. CPI inflation averaged 6.1 percent, ending 2004 at 4 percent. Inflation remained below this level on average in the first three months of 2005. Real wages increased by less than 1 percent in 2004, but showed an increasing trend in the latter half of the year.

  • Despite measures to reduce bank liquidity, credit to the nongovernment sector grew 48.7 percent in 2004, far exceeding program expectations. The rapid credit expansion—fast even by regional standards (Text Figure 2.)—was funded by both strong deposit growth and a drawdown of banks’ net foreign assets (mainly by foreign borrowing; Text Figure 3.). While business credit remains around two-thirds of total credit, the most dynamic component has been household credit, particularly mortgages (Table 5., Figure 2.). Bank asset quality has not yet 27 percent, and system-wide 0 capital adequacy at 17 percent (Table 6.). Meanwhile, sovereign bond spreads narrowed, with the Bulgarian component of the EMBI+ currently at 98 basis points.

  • The external current account deficit was 7.5 percent of GDP, compared to deficits of 8.8 percent envisaged in the original program and 9.2 percent in 2003 (Table 7. and Figure 3.).2 At nearly 14 percent of GDP, the merchandise trade deficit was roughly as projected in the original program, as the effect of higher oil prices on import values was offset by higher export commodity prices (particularly metals and petroleum products). The better current account outturn reflected much stronger net services and transfers, owing partly to the growing attraction of Bulgaria’s tourist destinations, and better recording of the flows. The financial account was stronger than in 2003, with lower net FDI and net portfolio investment more than offset by other private sector inflows.3 Gross international reserves increased to 5.3 months of projected imports and cover nearly 200 percent of short-term debt. Gross external debt rose to 63.7 percent of GDP, as a sharp rise in private debt (by over 11 percentage points of GDP) more than offset a decline in public debt. Net external debt, however, declined 4 percentage points of GDP.

  • International competitiveness remains adequate. While Bulgaria’s REER (CPI-deflated) appreciated modestly in 2004, unit labor costs fell and the share in EU imports continued to rise (Figure 4.).4

Text Table 1.

Bulgaria: Selected Macroeconomic Indicators, 2003-04

(Annual percent change, unless otherwise stated)

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Sources: Bulgarian authorities; and Fund staff estimates and projections.
Table 4.

Bulgaria: Selected Economic Indicators, 2001-2005

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Sources: Bulgarian authorities, Fund staff estimates, and World Development Indicators database.

As projected in the July 2005 Stand-By-Arrangement.

Domestic debt as reported by Ministry of Finance and external debt as reported by BNB.

Starting in 2002, a new format was adopted for monetary data resulting in revisions to historical series.

Includes only foreign currency deposits in M3.

Includes trade credits.

2001 figure for gross primary enrollment and income/consumption distribution. 2002 figure for per capita GNI, urban population, poverty rate, life expectancy, and infant mortality. 2003 figure for total population.

Table 5:

Bulgaria, Monetary Survey, 2001-2006

(End-period; in millions of leva, unless otherwise stated)

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Source: BNB, National Statistics Institute, and IMF staff estimates.

Excluding fictitious credits to the non-government sector of an estimated Leva 1,516 million that were officially extended during March and deposited with commercial banks. The incentive for extending these credits was to circumvent the credit growth measures of the BNB.

Table 6.

Bulgaria: Selected Vulnerability Indicators, 2001-2005

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Sources: Bulgarian authorities; and Fund staff estimates.

Staff estimates, projections, or latest available observations as indicated in the last column.

Current account deficit plus amortization of external debt at original maturity.

Public sector covers central government, autonomous budgets, social security funds, municipal budgets, and extra budgetary funds.

Based on averages for the last five years for the relevant variables (i.e., growth, interest rates).

Overall balance plus debt amortization.

Amorization on domestic and external debt (excluding external debt to official creditors) in 2005 divided by 2004 total debt stock.

Debt in foreign currency or linked to the exchange rate, domestic and external. Does not exclude external debt on concessional terms.

ST debt and maturing medium- and long-term debt at variable interest rates, domestic and external.

Public sector gross debt minus balance of the fiscal reserve account.

Financial sector covers banking sector only excluding insurance, pension funds and capital market institutions.

Total loans exclude interbank loans. Non-performing loans including watch, substandard, doubtful, and loss.

Does not include off-balance sheet items.

Table 7.

Bulgaria: Balance of Payments, 2002-2006

(In millions of euros)

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Sources: Bulgarian authorities, and Fund staff estimates.

All FDI is assumed to be non-debt creating, except the 200 m euros inflow related to the acquisition of a local mobile telephone company (see below).

The figures for the second and third quarters are influenced by a complex debt financed merger and acquisition transaction of a local mobile telephone company that led to a sharp increase in its equity value, and a transfer of the realized capital gains out of the country by the original owners. This resulted in a net FDI outflow of 650 million euros and an increase in gross external debt by 590 million euros.

According to expectations schedule.

Historical figures include valuation changes.

Gross international reserves minus reserve money.

External debt minus gross foreign assets of the banking system.

Figure 1.
Figure 1.

Bulgaria: Real Sector Developments, 2001-05

Citation: IMF Staff Country Reports 2005, 169; 10.5089/9781451804515.002.A001

Source: Bulgarian authorities.
Figure 2.
Figure 2.

Bulgaria: Money and Financial Indicators, 2001-05

Citation: IMF Staff Country Reports 2005, 169; 10.5089/9781451804515.002.A001

Sources: Bulgarian National Bank; Bloomberg; and Fund staff calculations.1/ Basic rate is determined on the basis of the average annual yield achieved at the primary market for three-month government securities.
Figure 3.
Figure 3.

Bulgaria: External Sector Developments, 2001-05

Citation: IMF Staff Country Reports 2005, 169; 10.5089/9781451804515.002.A001

Source: Bulgarian authorities.
Figure 4.
Figure 4.

Bulgaria: Indicators of Competitiveness, 2001-05

Citation: IMF Staff Country Reports 2005, 169; 10.5089/9781451804515.002.A001

Sources: National authorities; and INS.
Text Figure 1.
Text Figure 1.

Real GDP Growth

(Annual percent change)

Citation: IMF Staff Country Reports 2005, 169; 10.5089/9781451804515.002.A001

Text Figure 2.
Text Figure 2.

Change in Private Sector Credit

(In percent of GDP)

Citation: IMF Staff Country Reports 2005, 169; 10.5089/9781451804515.002.A001

Text Figure 3.
Text Figure 3.

Credit to the Nongovernment Sector and Its Main Sources, 2000-04

(In percent of GDP)

Citation: IMF Staff Country Reports 2005, 169; 10.5089/9781451804515.002.A001

5. The general government recorded a much higher surplus than envisaged in the program (Tables 8. and 9.). The fiscal surplus was 1¾ percent of GDP, compared to 0.9 percent projected in the program, thanks largely to rapid growth in revenue occasioned by buoyant economic activity and improved compliance. 5 Despite the tax cuts, revenue was about one percentage point of GDP higher than in 2003, reaching 39.2 percent of GDP (0.8 percentage point higher than programmed). VAT, excise and fuel import duties, and social security contributions registered particularly sharp increases. Expenditure was 37.5 percent of GDP, ¾ percentage point lower than in 2003 because of lower subsidies owing to continued structural reform and lower social assistance and unemployment spending associated with reduced unemployment.

Table 8.

Bulgaria: General Government Operations, 2001-2006

(In millions of leva)

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Sources: Ministry of Finance; and Fund staff projections.

In late 2004, a state enterprise for infrastructure projects (“PIP”) was created, capitalized with BGN 340 million to execute spending in 2005. PIP is consolidated with the general government.

Pension and unemployment contributions were combined in January 2002.

From 2004, total expenditure is adjusted for clearance of arrears (net). Net arrears clearance in 2004 amounted to BGN -84.7 million, and is assumed to be zero thereafter.

Includes additional compulsory social security contributions (for the second pillar of the pension system) for public sector employees.

Under the 2003 and 2004 budgets, these transfers were envisaged to be made below the line for various purposes.

Slight differences between privatization receipts in the balance of payments and the fiscal accounts are due to domestic privatization. In 2004, however, about BGN 500 million (1.3 percent of GDP) of previously completed bank privatizations was transferred to the government upon the closure of the Bank Consolidation Company.