Statement by Anthony De Lannoy, Executive Director for Bulgaria and Tsvetan Manchev, Advisor to Executive Director, November 4, 2016

The Bulgarian economy has shown resilience since the last Article IV consultation. Growth over the last 4 quarters exceeded expectations. The authorities took concrete steps to correct the fiscal slippage in 2014 and efforts are underway to strengthen confidence in the health of the financial system. Looking ahead, risks to the outlook are broadly balanced. Downside risks stem mostly from weak external demand, possible regional tension, and reversal in domestic policy reforms.


The Bulgarian economy has shown resilience since the last Article IV consultation. Growth over the last 4 quarters exceeded expectations. The authorities took concrete steps to correct the fiscal slippage in 2014 and efforts are underway to strengthen confidence in the health of the financial system. Looking ahead, risks to the outlook are broadly balanced. Downside risks stem mostly from weak external demand, possible regional tension, and reversal in domestic policy reforms.

The Bulgarian authorities had a constructive dialogue with the mission during the 2016 Article IV consultation, and thank staff for the papers. Since the authorities broadly agree with staff that they should continue their policies aimed at increasing resilience against ongoing domestic and external challenges, we would like to make the following points for emphasis.

Amid the high global and regional uncertainty, the authorities continue to build their policies around the currency board monetary regime, which remains the cornerstone for anchoring macroeconomic, monetary and financial stability. The authorities maintain macroeconomic stability, and aim to strengthen the medium term growth prospects of the economy. The 2016 fiscal consolidation is ahead of schedule, mainly thanks to the higher-than-initially expected growth and comprehensive administrative revenue measures. The coalition government also works hard to reduce contingent liabilities, improve public confidence in the reform process, and further strengthen the EU funds’ utilization. The Bulgarian National Bank (BNB) continues with the decisive actions to further strengthen confidence in the banking system through implementing its comprehensive plan for strengthening the banking supervision, and addressing issues identified by the recent asset quality review (AQR) and stress test.

Recent Macroeconomic Developments and Outlook

The authorities generally share staff’s view on the macroeconomic developments and remain cautious in their outlook given the high uncertainty in the external environment. As highlighted by staff, Bulgaria’s recent economic performance has been by far stronger than initially anticipated. Going forward, the authorities will implement an action plan to improve the business environment and advance the anti-corruption agenda in order to attract more private investment.

The deflationary pressures are related to the impact of international prices and they are gradually easing. The labor market continues to tighten. Active labor market policies will continue to stimulate labor force participation and mitigate the effect from emigration. In line with staff’s advice, these measures will encompass better protection of the poor. In this regard, staff’s analysis on the fiscal implications stemming from demographic changes is very helpful.

Financial Stability

Since the last Article IV Consultation the central bank has focused on improving banking supervision, implementing the institutional framework for bank resolution and conducting AQR and stress tests in the banking sector. Progress in all three areas has been significant.

In 2015, the IMF and the WB, together with the central bank, undertook an assessment of compliance of supervisory regulations and practices with the Basel Core Principles (BCP). Following the BCP assessment, the BNB adopted a detailed Plan on Reforms and Development of Banking Supervision in October 2015. This plan envisages coordinated actions in three areas - governance and organization of banking supervision, regulatory framework and supervisory processes, and crisis management and preparedness. So far, the legal framework and governance of banking supervision have been strengthened, and the Supervisory Review and Evaluation Process Manual has been created in line with the decisions of the European Banking Authority on common procedures and methodologies.

The authorities have taken steps to strengthen crisis resolution management by transposing the European Bank Recovery and Resolution Directive (BRRD) into Bulgarian law in mid-August 2015. The BNB swiftly established a new directorate on bank resolution. In August 2016, as mandated and scheduled under the 2015 Law on Recovery and Resolution of Credit Institutions and Investment Firms, the BNB concluded an AQR and stress test of the banking system. The AQR has confirmed the comfortable position of banks’ balance sheets as of end-2015, as only minor adjustments have appeared necessary to be reflected in the banks’ 2016 financial statements (BGN 665 million, or 1.3% of the total risk-weighted assets). The impact of these adjustments has already been mitigated, after taking into consideration the amount of realized net income and additional impairments in the banks performed until mid-2016, as well as relevant capital-related developments and measures by banks throughout 2016. The results of the stress test confirmed the strong capital position and resilience to shocks of the banking system. The AQR and stress test and their results were positively reflected by the international financial institutions, markets, credit rating agencies, and professional analysts.

Since the last Article IV Consultation, several other policies have been implemented to strengthen financial stability. In 2015, the BNB successfully contained the spillovers from Greece and the domestic banking system remained stable. The BNB measures focused on close monitoring and oversight over the individual bank liquidity management and ex-ante steps to forestall spillovers and strengthen liquidity requirements. In the first half of 2016, the Bulgarian Deposit Insurance Fund (BDIF) signed agreements with the WB and the EBRD for two government-guaranteed loans that will be used to repay the BDIF loan from the Ministry of Finance. With regard to the non-banking financial system, the Financial Supervision Commission intends to complete an AQR of the pension funds and insurance companies and a stress test of the insurance and re-insurance industry by the end-2016. In the second half of the 2016, an IMF/WB FSAP started and its results will be presented to the IMF Board in May 2017.

Fiscal Sustainability

In the highly uncertain and volatile external environment, the government remains committed to a conservative medium-term fiscal consolidation strategy. The 2016 fiscal consolidation is proceeding faster than expected due to inter alia the unanticipated acceleration of the economic activity, better revenue collection, and a slower start of the implementation of the 2014-2020 EU budgetary framework. The authorities are committed to save the 2016 revenue over performance in order to strengthen fiscal buffers and contain cyclicality of the private demand. 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 further debt accumulation.

The preparation of the 2017 budget is at an advanced stage. The consolidated government deficit is projected at 1.4 percent of GDP on cash basis, and the structural deficit will further decline and reach 0.5 percent to GDP. In line with the long-standing public consensus, Bulgaria maintains a predictable tax system, and the 2017 tax policy and tax-to-GDP ratio will remain broadly unchanged. Given that Bulgaria’s public pension system has relatively low contribution collection and income replacement rates, the social security contributions will be increased by one percentage point in the next two years. As described in the staff report, the next steps in the public education and health care reforms will be implemented to achieve a more targeted and efficient public expenditure and to enhance the productivity of public investment. The recently-enacted Public Procurement Act in line with the well-established European practices will help reducing public procurement deficiencies. In 2017, Bulgaria does not plan to tap into international financial markets, and domestic debt operations will be limited to the refinancing of the matured securities.

The authorities are fully aware of the increasing medium- and long-term fiscal pressures stemming from the adverse demographic trends, contingent liabilities of the state-owned enterprises (SOEs) and subnational governments, and other structural rigidities. The budget procedure has already been amended to include the state-owned enterprises in the General Government sector and ensure better monitoring of their impact on the budgetary balance and government debt position. In line with the international practices, a mechanism for financial recovery of the municipalities has been introduced through amendments in the Public Finance Law. In 2016, the members of the Fiscal Council were appointed, and the Parliament set up conditions for its functioning in order to get a better and deeper understanding of various fiscal risks and attribution. Going forward, the authorities also remain open to discuss and implement best international practices in the corporate governance, output quality, and financial performance of the SOEs.

Structural Reforms

Emigration of young people and skilled labor, continues to be a key challenge. It will be comprehensively addressed by promoting child care support, enhancing vocational training and skill development to improve the employability of workers, and rationalizing administrative procedures. In the same vein, legislative amendments will be launched to enhance synergy between social services and health care system, and the authorities will proceed with a gradual increase of the statutory retirement ages.

In late 2015, the widespread discontent among the population about the perceived unfairness of the public pension system was addressed by a reform package creating an automatic link between the statutory retirement ages and the life expectancy once the statutory retirement age reaches 65 years. To reduce the deficit in the public pension system, however, the authorities will continue active labor market policies to ensure old-age employment, while striking the right balance between ensuring fiscal sustainability and preventing old-age poverty.

The government is also committed to boosting productivity by further improvements in the EU funds’ absorption during the existing program period. The implementation of the new Public Procurement Act adopted in April 2016 will enhance the ex-ante control and e-procurement procedures. A comprehensive set of measures to strengthen the administrative capacity and to broaden the electronic public services is also underway. In June 2016 the Law on Electronic Governance was adopted, and in September the government created an independent state agency with a mandate to oversee other governmental structures in charge of e-government development.