Bulgaria: 2006 Article IV Consultation, Third Review Under the Stand-By Arrangement, and Request for Rephasing, Waiver of Applicability and Nonobservance of Performance Criteria and Extension of the Arrangement—Staff Report; Staff Statement; and Public Information Notice and Press Release on the Executive Board Discussion

The current account deficit in Bulgaria, which doubled in 2005 to 11.8 percent of GDP, deteriorated further to 14.6 percent of GDP during the first four months of 2006. The current account deficit continues to be substantially financed by foreign direct investment (FDI) flows. Fiscal policy has been cautious for several years, and is being tightened further in 2006. The Bulgarian National Bank (BNB) introduced successively tighter credit limits and enhanced prudential measures. The discussions centered on policies to contain macroeconomic imbalances and achieve sustainable high growth.

Abstract

The current account deficit in Bulgaria, which doubled in 2005 to 11.8 percent of GDP, deteriorated further to 14.6 percent of GDP during the first four months of 2006. The current account deficit continues to be substantially financed by foreign direct investment (FDI) flows. Fiscal policy has been cautious for several years, and is being tightened further in 2006. The Bulgarian National Bank (BNB) introduced successively tighter credit limits and enhanced prudential measures. The discussions centered on policies to contain macroeconomic imbalances and achieve sustainable high growth.

I. introduction

1. A staff team1 visited Sofia during May 4-17, 2006 to conduct the 2006 Article IV consultation and the Third Review under the Stand-By Arrangement (SBA). The 25-month precautionary arrangement in the amount of SDR 100 million (15.62 percent of quota) was approved on August 6, 2004. The second review was completed on April 3, 2006 (IMF Country Report No. 06/131). Discussions focused on policies to end-2006 following the authorities’ decision to request extension of the SBA to end-March 2007 (LOI, ¶4).

2. The three-party government formed after parliamentary elections in June 2005 remains coalesced around achieving EU accession in 2007. The European Commission (EC) has announced that its recommendation on the timing of accession will be delayed until September 2006 and will be contingent on progress in areas such as combating organized crime, corruption and money laundering, and strengthened financial controls over EU project funds. Presidential elections follow soon after in November.

3. This Article IV consultation takes place against a backdrop of broadly favorable economic performance but greater underlying vulnerabilities. The benign international economic environment of recent years and confidence in Bulgaria’s transition prospects have buoyed investment and growth. At the same time, the external current account deficit has widened and external debt has increased. Managing risks remains the central challenge facing the authorities and is a principal aim of the program under the SBA.

II. Background to the discussions

A. Recent Economic Developments

4. GDP growth has been strong. GDP grew by 5½ percent in 2005, up from an average of 4.8 percent during 2001-04 (Text Table 1). The contribution of domestic demand to growth jumped sharply in 2005 (Table 2); both consumption and investment grew strongly while net exports fell, a pattern that was sustained during the first quarter of 2006. The buoyancy of domestic demand can be traced to rapid growth of credit to businesses and households. With the general government budget surplus rising in 2004-2005, and prospectively again in 2006, fiscal policy has been providing partially offsetting negative impulses.

Text Table 1.

Macroeconomic Developments, 2001–06

(in percent of GDP unless otherwise noted)

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Sources: Bulgarian authorities; and Fund staff estimates and projections.
Table 2.

Bulgaria: Real GDP by Expenditure, 2001-2006

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Sources: National Statistical Institute for actuals; Agency for Economic Forecasting and Analysis, Bulgarian National Bank, and staff estimates.

Private and public sector decomposition based on staff calculations and not officially reported by the NSI.

Sum of contributions to real GDP growth may not add up to total growth due to statistical discrepancy in the official data.

5. There has been a steady increase in inflation over the last year, although core inflation has fallen recently (Figure 1). Rising inflation reflected both temporary and more durable factors. Oil price hikes and flood-related shortages in 2005 raised CPI inflation to 6.5 percent by end-2005. Inflation has increased sharply during the first five months of 2006, due largely to excise tax increases, reaching 8.5 percent in May. Core inflation closely tracked the overall CPI during the first half of 2005, but has declined since.

Figure 1.
Figure 1.

Bulgaria: Real Sector Developments, 2003–06

(In percent, unless otherwise noted)

Citation: IMF Staff Country Reports 2006, 298; 10.5089/9781451804546.002.A001

Sources: Bulgarian authorities; and Fund staff estimates.

6. Wage growth has remained moderate. Incomes policies have generally helped to moderate economy-wide wage demands, contributing to a fall in unemployment, which reached a low of 9.7 percent (ILO definition) in the first quarter of 2006. Wages in the manufacturing sector have remained in line with productivity growth.

7. Credit growth has slowed considerably, constrained by ceilings imposed by the BNB (Table 3). Bank credit growth decelerated to 32 percent in 2005 from nearly 50 percent in 2004.2 However, the high cost of the penalty deposits imposed under the credit ceilings has increased banks’ incentives for circumvention, notably by transferring existing credits abroad and through intermediation via non-bank financial institutions. Nevertheless, banks remain profitable and capital adequacy ratios are high (Table 4). Although non-standard loans (overdue by 30 days) increased during 2005, NPLs (overdue by 90 days) remain stable at around 2.3 percent of total loans.

Table 3:

Bulgaria, Monetary Survey, 2004-2011

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

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

Net deposits by the Public Investment Projects Company (PIP), local governments and social security funds are excluded from deposits and included in net lending to the general government.

Table 4.

Bulgaria: Selected Vulnerability Indicators, 2002-2006

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Sources: Bulgarian authorities; and Fund staff estimates.

For 2005, staff estimates or latest available observations as indicated in the last column. For 2006, staff projection.

Current account deficit plus amortization of external debt.

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.

Total debt at variable interest rate (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.

Loans overdue by more than 30 days.

Does not include off-balance sheet items.

8. The current account deficit, which doubled in 2005 to 11.8 percent of GDP, deteriorated further to 14.6 percent of GDP during the first four months of 2006 (Table 5). Both buoyant domestic demand and supply shocks have contributed to the deterioration, while competitiveness indicators are satisfactory.

Table 5.

Bulgaria: Balance of Payments, 2004-2006

(In millions of euros)

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Sources: Bulgarian authorities, and Fund staff estimates.

All FDI are assumed to be non-debt creating in the projections.

The figures for 2004 and 2005 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 in 2004.

Privatization receipts for the electricity distribution companies are included in 2005. These are included in the receipts for 2004 in the balance of payments presentation of the BNB. The present treatment aligns them with its receipt in the fiscal accounts.

According to expectations schedule.

Historical numbers include valuation changes. From 2006-10 includes reserves posted as a guarantee for defense related purchases. Reserve coverage ratios are calculated net of impaired reserves.

Gross international reserves minus reserve money. For 2006-08, reserves posted as a guarantee for defense related purchases are excluded.

Projections include assumptions on disbursements related to debt not already contracted.

External debt minus gross foreign assets of the banking system.

  • Real import growth has remained high despite a sharp increase in import prices. The growth of goods imports has been dominated by capital goods, propelled by strong investment growth, both domestic-sourced and FDI.

  • Higher oil prices have pushed up nominal imports.

  • One-off factors, including adverse effects of summer floods last year and a temporary shutdown of a major steel producer for plant expansion, explain much of the weakened export outcome.

  • Although the ULC-based REER appreciated slightly during 2005, most competitiveness indicators are satisfactory (Box 1). Moreover, when viewed in a wider CEEC context, the drop in export growth in 2005 appears to have had a regional dimension.3

9. The current account deficit continues to be substantially financed by FDI flows. During the first quarter of 2006, net FDI inflows covered 70 percent of the deficit.4 With early repayments to the IMF and the World Bank, gross reserves declined modestly since end-2005, but remained at 140 percent of short-term debt at original maturity. External debt, however, rose to nearly 69.5 percent of GDP by the end of the first quarter of 2006, up by about 9¼ percentage points from end-2003.

B. Policy Developments

10. Fiscal policy has been cautious for several years, and is being tightened further in 2006 (Table 6). Following budget surpluses of 1.8 and 2.3 percent of GDP in 2004 and 2005, a surplus of 3 percent of GDP is planned for 2006. Recent data suggest that the surplus target may be exceeded, due largely to buoyant tax revenues. Bulgaria’s fiscal position in recent years compares favorably with other emerging markets (Text Figure 1).

Table 6.

Bulgaria: General Government Operations, 2001-2007

(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 variation of arrears (net). Net variation in arrears amounted to BGN -84.7 million and BGN 8.2 million in 2004 and 2005, respectively.

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.