Statement by the IMF Staff Representative

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.

1. The following information, received since the issuance of the staff report, does not change the thrust of the staff appraisal. It does, however, indicate that the macroeconomic risks to the program objectives remain. If these risks materialize, the fiscal surplus target for 2005 will need to be raised at the time of the second review.

2. All five prior actions have been implemented. Four were taken well in advance of the Board meeting, and the last one—submission to Parliament of the new tax laws to make the National Revenue Agency operational—was taken on May 11, 2005, just short of the required five working days prior to the Board meeting. The new tax laws were approved by the Council of Ministers on May 5, but on condition of minor changes, which delayed their submission to Parliament. Nevertheless, the staff has had sufficient time to verify the implementation of these prior actions.

3. High frequency indicators of economic activity are broadly in line with annual projections. The unemployment rate started its seasonal decline, dropping to 12.7 percent in March (compared with 13.7 percent in March 2004). Year-on-year inflation in April increased to 5.1 percent, bringing inflation during January–April to 4.1 percent year-on-year, compared with 3.9 percent projected under the program. The more rapid inflation was mainly due to higher oil prices and a weather-related increase in food prices.

4. The balance of payments is also evolving broadly as envisaged. The external current account deficit widened to 7.9 percent of GDP in the twelve months to February due to higher than programmed oil prices and one-off imports early in the year, including investment imports associated with recent privatizations. However, first-quarter trade data indicate that by end-March export and import growth had reverted to levels in line with program projections. On the financial account, bids received for two thermal power generation companies suggest that FDI receipts for the year could exceed program projections.

5. As foreshadowed in the staff report, banks sought to circumvent the credit curbs that took effect in the second quarter, prompting the Bulgarian National Bank (BNB) to take offsetting action. As the measures announced by the BNB in February linked maximum quarterly credit growth rates to the end-March stock, banks increased credit sharply in March—a 22 percent month-on-month expansion, compared to a program projection of 30 percent growth for the year as a whole (which translates to growth equivalent to 10 percentage points of GDP). Some of this increase consisted of genuine credits, but most were artificial transactions of various types, many of which have since been unwound. In response, the BNB revised its lending restrictions by limiting the base from which credit growth is to be measured to 4 percent above each bank’s end-February credit stock, switching from end-period to daily-average measurement of credit stocks, introducing cumulative limits of 5, 12.5 and 17.5 percent for average credit growth in the second, third and fourth quarters of 2005, and tightening capital adequacy rules. However, to minimize the disruption to the banking system, the BNB will allow some flexibility, permitting banks, on a case-by-case basis, to expand credit in the second quarter by up to 10 percent above the adjusted end-March base (as opposed to the original intention to allow a 6 percent expansion per quarter) before the punitive reserve requirements begin to apply. Although the projection for credit growth during 2005 remains unchanged at the equivalent of 10 percent of GDP, staff estimates that the flow of credit during the first half could be as high as 6.6 percent of GDP (1.3 percentage point above program projections) if all banks benefit to the full extent from this additional flexibility. The BNB regrets the higher than projected credit expansion during the first half of the year and has provided assurances that it will strictly examine the justification for granting the additional flexibility in each case.

6. The effect on demand of the higher than projected credit expansion is likely to be offset by a better than projected fiscal performance. Reflecting higher revenue and lower expenditure, the general government recorded a cash surplus of almost 1.2 percent of annual GDP in the first quarter. This suggests overperformance of 0.7 percent of GDP relative to the accruals based program target. Although some of the revenue overperformance was one-off in nature, the authorities believe that second-quarter expenditure, including notably for public investment projects, will fall short of projected amounts so that the cumulative fiscal overperformance in the first half of the year may reach 1.2 percent of GDP.

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