Abstract
This 2015 Article IV Consultation highlights that Bulgaria achieved modest economic growth in 2014, which is expected to continue in 2015, albeit at a lower rate. Consumer prices declined by an average 1.6 percent in 2014, among the sharpest contractions in the European Union, but are projected to turn positive late in the year. The banking system has shown substantial resilience to the damage to confidence resulting from the bank failure. The budget targets a 3 percent of GDP deficit in 2015, and a further 0.5 percentage point reduction per year in coming years. Measures to improve the composition and quality of expenditure and mitigate contingent liabilities arising from state-owned enterprises remain the key.
The Bulgarian authorities highly appreciate the constructive policy dialogue with the mission during the 2015 Article IV consultation, and thank staff for their appraisal. They also welcome the staff analyses in the Selected Issues paper. The authorities remain committed to prudent macroeconomic policies which promote sustainable growth, and broadly share the staff’s policy advice as presented in the staff report.
The Currency Board Arrangement (CBA) continues to be the cornerstone for domestic policymaking amid the uncertainty. Along with this, the authorities use every window of opportunity to reinforce macroeconomic stability. The Bulgarian National Bank (BNB) took decisive actions to increase bank liquidity and support depositor confidence following the closure of the ailing Corporate Commercial Bank (KTB). In March 2015, Bulgaria successfully issued a €3.1 billion Eurobond which not only covers the 2015 external financing needs, but serves as an additional buffer. In April 2015, a new Law on the Fiscal Council was adopted, which establishes the Fiscal Council to serve as an independent consultative body to the Bulgarian Parliament.
Bulgaria has experienced significant political instability and financial distress since the last Article IV consultation. The minority coalition government elected last fall faces a difficult domestic and external environment. This situation further limits the policy options to preserve macroeconomic and financial stability, rebuild buffers against shocks, and advance with the already delayed structural reforms. With the local elections planned for later this year, every aspect of government activity is placed under deep scrutiny, which could make immediate policy steps even more difficult. A new impetus for structural reforms could only come from improving public confidence in the reform process and further strengthening of the EU fund’s utilization.
The new government keeps focusing on social issues, while its near-term plan includes three main pillars: (1) gradual fiscal consolidation and enhanced revenue administration; (2) rebuilding confidence in the financial sector through system-wide legal amendments and institutional enhancements; and (3) structural reforms.
Recent Macroeconomic Developments
The authorities generally share staff’s view on the macroeconomic developments and outlook. Since the last Article IV consultation, net export has not contributed positively to economic growth. The recently released 2015 government Spring Forecast has taken into account the published reporting data for 2014, the most recent developments in the external environment, and the more favorable expectations for the domestic economy from the beginning of 2015. The business climate and employment in the main sectors of the economy have slightly improved which has led to an upward revision of 2015 growth by 0.6 percentage points, to 1.4 percent. Driven by domestic demand, in the period 2016–18, growth is expected to gradually speed up and reach 2.3 percent, but it will remain insufficient for income convergence with the European levels.
The subdued growth in 2015 reflects still cautious recovery of the private sector demand and lower contribution of the public sector. Some improvement in the external environment, expressed in slightly higher growth of the European and world economies, will lead to an increase in the real export of goods and services by 2.8 percent y-o-y, but the contribution of net export to growth will remain negative. The 2015 current account balance, however, will be slightly positive.
The authorities welcome staff’s analysis on inflation determinants. They are fully aware that sustained deflation represents an important risk for the economic recovery and public finances given the limitations of the current fiscal stance and lack of independent monetary policy in a small open economy. Against this background, the authorities are committed to exercise tight control over the nominal wages in the public sector in the short term and keep closer alignment of utility tariffs with the cost structure. In line with staff’s advice, these measures will be accompanied by enhanced protection of the poor and proactive management of the inflationary expectations to avoid a deflationary spiral.
Fiscal Sustainability
After the parliamentary elections in October 2014, the new parliamentary majority has clearly recognized the need to reduce budget deficits following earlier slippages. However, striking the right balance between the pace of fiscal consolidation and support for economic growth remains a daunting task for the authorities. The new minority government has consolidated around the strategy for gradual fiscal consolidation. Within the recently revised medium-term budgetary framework, the government envisages a nominal reduction of the fiscal deficit on cash basis by 0.5 percent per year until 2018. Respectively, the return to a structurally balanced budget by 2019 would allow the automatic stabilizers to work while the government builds up liquidity buffers in good times and contains debt accumulation.
The 2015 budget fully demonstrates the fiscal responsibility of the new government as well as its commitment to restore confidence in the management of the public finances. The budget envisages a deficit of 3 percent of GDP on cash basis and a reduction in the structural deficit by approximately 0.5 percent, mainly through improving the efficiency of spending. In addition, the budget lays down taut and ambitious reforms in the public finance management, while restraining administrative and operational expenditures. In the first quarter of 2015, the revenue administration has been strengthened, resulting in higher revenues compared with last year. The authorities are also committed to save much of the revenue overperformance.
The recently adopted Law on Fiscal Council stipulates that the members will be accountable to the Parliament, which aims to increase transparency of fiscal indicators and policies. The authorities are fully committed to immediately implement the law in order to get better understanding of fiscal risks and their attribution.
The Banking System
The authorities are fully aware that it is of utmost importance to restore confidence and credibility in the financial system. Since the KTB failure, they have implemented policy measures at various levels to stabilize the banking sector. First and foremost, the goal to avoid a spillover effect has been successfully achieved through the immediate adoption of a state liquidity support framework for the banking sector, in compliance with the EU state aid rules, and smooth repayment of the insured deposits in KTB. Second, the BNB has enhanced oversight over the individual bank liquidity management, and has strengthened liquidity requirements. Third, the CRD IV has been fully implemented to banks, additional capital buffers have been created, and the NPLs are continuously reported in a very conservative manner. In addition to the good provisioning, the banks have strengthened their internal strategies to handle the NPLs with encouraging preliminary results. These measures have supported depositors’ confidence and assured system-wide stability.
Going forward, the authorities agree with staff that a clear strategy and additional measures will be needed to restore credibility in the financial system. In August 2014 the authorities requested a full FSAP. Since then, they have coordinated with the IMF on the next steps. An assessment of compliance with the Basle Core Principles for effective banking supervision was recently conducted by the IMF/WB team and the report will be published in the second quarter of 2015. Furthermore, the authorities have just announced in the National Reform Program Update a comprehensive action plan to: (1) finalize the assessment of compliance of the BNB supervisory practices with the Basel Core Principles, (2) establish a framework of the recovery and resolution of credit institutions, and (3) conduct an asset quality review (AQR) and stress test of the entire banking sector. The AQR and stress-test will be based on methodologies fully compliant with those of the European Central Bank and European Banking Authority. The authorities are open to the recommendations and will consider a more systematic approach toward the NPLs reduction, if it fits the country specifics. Given the uncertain low growth environment, the BNB stands ready to sustain and further develop the capacity of the banking system and individual credit institutions to withstand shocks.
Bulgaria remains fully engaged in the financial sector reform at the European level. The new domestic legislation transposing requirements of the EU Directives on Deposit Guarantee Schemes and Recovery and Resolution of Credit Institutions and Investment Firms is in the final stage of preparation and will be adopted by mid-2015. Accordingly, consistent mechanisms to recapitalize the Bulgarian Deposit Insurance Fund and to achieve a reasonable burden sharing will be steadily implemented. The authorities also envisage closer cooperation with the Single Supervisory Mechanism (SSM). At the same time, they mind the asymmetric treatment of non-euro area participants in the SSM because of the absence of liquidity and capital support as well as the lack of voting rights in the Governing Council of the ECB for these members. The preparations to join the SSM, however, will serve as a useful anchor for structural reforms on the road to the euro adoption.
Structural Reforms
The authorities recognize the importance of improving public confidence in the reforms. They are well aware that the near-term challenges should not prevent them from addressing the critical impediments to long-term economic growth. The reform priorities are stipulated in the updated National Reform Program, which will be submitted to the European Commission by the end of April. In 2015, the main focus of the reforms will be to reach a political consensus on the necessary amendments in the Constitution which would open the door to deep reforms in justice and intelligence. One of the priorities of the new government is also a fast development of electronic services of the administration. In addition, amendments to the Law on Access to Public Information will be adopted by June 2015 to increase the transparency of public information and assure full compliance with EU legislation.
Following recent amendments to the Energy Act, the Parliament appointed, last April, a new independent energy regulator. The energy tariff structure is under review. The government has also negotiated a more favorable long-term price with some of the key electricity suppliers, and at the same time has negotiated a schedule for settlement of the existing arrears.
Being aware of the widespread discontent among the population about the perceived unfairness of the existing pension package, last month, the authorities published a pension reform proposal. The proposal aims at reaching an agreement in 2015 on the augmented package to overturn the long-run deficit in the pension system.