This 2013 Article IV Consultation highlights that in the aftermath of the global financial crisis, growth in Bulgaria has remained low and unemployment is high. Real GDP growth is projected at about 0.5 percent in 2013 as domestic uncertainties undermined demand but exports are performing well. Domestic demand is projected to recover gradually, and exports and foreign direct investment (FDI) will benefit from recovery in Europe, allowing real GDP growth to rise to about 1.6 percent in 2014. The current account of the balance of payments is expected to be in surplus in 2013 but return to a modest deficit in the medium term, financed by FDI.
The Bulgarian authorities highly appreciate the informative and candid exchange of views with the mission during the 2013 Article IV consultation, and thank staff for their appraisal. They remain committed to prudent macroeconomic policies, and attentive to the Fund’s advice and recommendations.
Despite the external headwinds and domestic challenges, Bulgaria maintains macroeconomic and financial stability. Amid the uncertainty, the Currency Board Arrangement (CBA) continues to be the cornerstone for domestic policymaking, together with stringent prudential regulations and a strong underlying fiscal position. A new impetus for the structural reforms will come from improving public confidence in the reform process and further strengthening of the EU fund’s utilization.
The authorities’ near-term plan includes three main pillars: (1) increased attention to social issues, thereby reducing the number of people at risk of poverty or social exclusion through better targeting and increased efficiency of social spending; (2) further reduction of external and fiscal vulnerabilities through internal restructuring of the budget without deviating from the new medium-term structural deficit target; and (3) maintaining a conservative approach to bank supervision while implementing the new European Capital Requirements Directive IV (CRD IV) framework.
We focus our remarks on (1) recent macroeconomic developments; (2) fiscal sustainability; (3) the banking system; and (4) structural reforms.
Recent Macroeconomic Developments
The GDP dynamics in Q3 2013 suggested an acceleration of growth to 1.5 percent, which compared favourably to the EU average growth during the same period (0.3 percent). Growth was mainly boosted by exports, up by 9.6 percent. Even as demand from export-oriented industries led to higher imports, up by 8.6 percent, net exports sustained their positive contribution. Final consumption increased by 1.2 percent driven by the rise in public spending. Consumer prices increased by 0.2 percent in October, thus breaking the deflationary path, and the negative annual HICP decelerated to 1.1 percent. Short-term indicators also confirm these early signs of recovery.
Labor productivity broke the negative trend observed in the previous quarter, and stepped up by 1.6 percent yoy in real terms in Q3. The upward industrial productivity trend was the main driver behind the quarterly reading, up by 4 percent (yoy). The seasonally adjusted unemployment rate marginally decreased in Q3, but the trend reversed in October, and its level remained unchanged in November (12.9 percent).
The current account balance recorded a surplus of more than €1.1 billion in January-October (2.8 percent of GDP). It has been improving (in yoy terms) in most of the 2013 months, mainly resulting from stronger export of goods. The cumulative trade deficit narrowed by 39.5 percent (yoy) in January-October. The current and capital account was positive for the same period, amounting to €1.43 billion, and at the end of 2013 international reserves reached €14.4 billion which covers more than 7 months of the import.
Since the global crisis, the authorities have been facing the daunting task of striking the right balance between fiscal consolidation and supporting economic growth. The protracted slowdown and uncertainty in the Euro Area and the domestic discord in early 2013 necessitated a swift and firm political and policy response. While fully observing the restrictions set by the new Fiscal Compact and domestic fiscal rules, in April 2013 the caretaker government passed a small social assistance package of 0.05 percent of GDP. Given the uncertainty it also proposed a marginal relaxation of the medium-term balance target, and the 2013–2016 Convergence Program extended the path of fiscal consolidation toward achieving Bulgaria’s MTO of a 0.5 percent structural deficit by one year, to 2017.
After the parliamentary elections in May 2013, the newly established parliamentary majority has taken power with the firm ambition to spur growth, while preserving the sound underlying fiscal position. Within the revised medium-term budgetary framework, in June, the new government passed a second small social assistance package of additional 0.03 percent of GDP, and in August the Parliament revised the 2013 Budget Law which provided an additional fiscal impulse of 0.7 percent of GDP. As a result, the fiscal deficit was set to reach 2.0 percent of GDP. The budget implementation parameters as of end-November and operational data for December outline an achievement of the revised fiscal targets for the year. At the end of 2013 the fiscal reserve also remained well above the minimum threshold set by the 2013 Budget Law.
The 2014 budget fully demonstrates the fiscal responsibility of the new government as well as continuity in the fiscal policy. It remains consistent with national fiscal rules and the Fiscal Compact. The budget envisages a deficit of 1.8 percent of GDP and a further decline to a deficit of 1.1 percent of GDP by 2016. In structural terms the deficit in 2016 is expected to be reduced to 1 percent of GDP which is in line with the MTO. Implementation of the new Public Finance Law is underway, and the 2014 budgetary execution will be the first to fully comply with the new rules. This year, however, the budget lays down taut and ambitious reforms in the public finance management, while restraining administrative and operational expenditures.
Within the budget envelop, the authorities aim at increasing the efficiency of capital spending in small municipalities with otherwise low administrative capacity through the establishment of a new special purpose investment fund (0.6 percent of GDP). A competitive bidding process will be implemented under the direct control of the Council of Ministers. Concise amendments in the existing administrative regulations have been adopted to increase efficiency of the active labor market policies at both the national and regional levels. In line with the staff advice, the authorities work on regulations to extend the coverage of the targeted social assistance, and to implement more flexible eligibility thresholds.
To increase the predictability of the government finances and better anchor market expectations, the new government continues to issue debt by priority denominated in domestic currency and at fixed interest rates, as proposed by the Government Debt Management Strategy for the period 2012–2014. The government also set more stringent limitations to public sector enterprises and municipalities on taking new contingent liabilities. In addition, the management of public enterprises has been recently strengthened, while the government works on a new and more transparent framework for monitoring and control of management’s appointment and performance.
The Banking System
The Central Bank of Bulgaria (BNB) remains committed to sustain and further develop the capacity of the banking system and individual credit institutions to withstand shocks. The authorities are vigilant and aware that since the global crisis has erupted the Bulgarian banking system has been operating in a challenging low growth environment. The process of deleveraging as seen in many EU banking systems did not affect the Bulgarian banking system due to the on-going strong growth of local savings. The BNB continues its policy from the pre-crisis period towards maintaining the accumulated capital and liquidity buffers during the implementation of the new European CRD IV. The available opportunities under the pillar 2 of the Basel Accord will also be explored in a flexible manner, by imposing the maximum capital conservation and systemic capital buffers on all banks. Despite a cyclical compression of profitability, the banking system remains stable, well capitalized and highly liquid, and the same applies to individual banks. NPLs are reported in a conservative manner and covered with an additionally created capital buffer.
The authorities remain committed to further develop the domestic insolvency framework in line with the best international practices. As underlined by staff, the design and implementation of an effective strategy for addressing the existing NPL stock in Bulgaria remain seriously constrained by prevailing uncertainty and the current low stage of asset market development. The authorities, however, focus on the good provisioning of NPLs and acknowledge the benefits banks see in a “wait and see approach”. In the interim period, the authorities will rely on conservative banking supervision. The BNB will continue to play a supportive role to encourage a steady but gradual process of reducing distressed assets and releasing the associated collateral that avoids unduly disturbing markets.
The authorities do not intend to participate in the close cooperation framework of the Single Supervisory Mechanism, noting the absence of liquidity and solvency support as well as the lack of voting rights in the Governing Council of the ECB for non euro area participants. Meanwhile, Bulgaria remains fully engaged in the financial sector reform at the European level.
The authorities remain committed to structural reforms. In compliance with the recommendations from the European Commission and the IMF to strengthen education and narrow skills mismatches, a new National Strategy for Lifelong Education has been adopted at the beginning of 2014. The implementation of pension reforms has been postponed for one year given the widespread discontent among the population about the perceived unfairness of the existing package, but has not been reversed. The authorities have enhanced cooperation with the interested stakeholders to reach an agreement in 2014 on the augmented package to overturn the long-run deficit in the pension system.