Public Information Notice: IMF Executive Board Concludes 2006 Article IV Consultation with Bulgaria

August 4, 2006

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.

Public Information Notice (PIN) No. 06/87
August 4, 2006

On August 2, 2006, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Bulgaria and completed the Third Review under the Stand-By Arrangement.1


Bulgaria's successful transition from crisis a decade ago to steady growth has helped the country reach the doorstep of the European Union accession. A policy strategy anchored by the currency board arrangement and supported by prudent fiscal policy, strict incomes policy for state-owned enterprises, tight supervision of the banking sector, and structural reforms has resulted in average real GDP growth of 5½ percent since the last Article IV consultation in 2004. The unemployment rate has continued to drop and wage pressures remain contained. Inflation has been trending up since early 2005, but should begin to taper off during the second half of 2006. In response to rapidly rising current account deficits, fiscal policy have been prudent during the past few years, and the growth of bank lending to the nongovernment sector was brought down from almost 50 percent during 2003-04 to 32 percent in 2005.

Despite generally favorable macroeconomic developments, Bulgaria's vulnerability has increased with the sharp widening of the current account deficit. The current account deficit deteriorated from under 6 percent of GDP in 2003 and 2004 to around 12 percent of GDP in 2005, rising further to 14.6 percent by April 2006. Although one-off factors and rising oil prices have contributed, much of the increase of the deficit can be traced to the buoyancy of domestic demand, notably investment but also consumption. Competitiveness indicators remain favorable. Foreign direct investment financed more than two thirds of the current account deficit and contributed to a rising investment to GDP ratio. Gross reserves at 140 percent of short-term debt, low public debt, and a well-capitalized banking sector suggest low risk exposure. Still, with the growth of private debt out-pacing the decline in public debt, Bulgaria's external debt has increased substantially since 2003, increasing the country's vulnerability to shocks. Close monitoring is warranted as liquidity and solvency risk could change quickly.

The structural reform momentum has weakened, adversely affecting Bulgaria's growth potential. An impressive privatization program made substantial progress but recent transactions have been mired in the courts. Reform of the education sector, critical to Bulgaria's future competitiveness, has been stalled. Health sector reforms have been equally inert, yet are crucial to releasing scarce public resources for higher priority spending. The business climate and governance indicators have ceased to improve, and greater labor market flexibility is needed notably in view of the projected decline of Bulgaria's population of labor force age.

For 2006, given the large and growing current account deficit, the authorities target of at least 3 percent of GDP in 2006 and around 2 percent in 2007 after taking account of EU accession effects. Fiscal policy is the main short-term macroeconomic policy instrument as credit controls have largely lost their effectiveness. In order to enhance Bulgaria's medium term supply potential, the authorities are implementing measures to improve governance and the business climate.

Executive Board Assessment

Executive Directors commended the Bulgarian authorities for implementing sound economic policies in recent years that have resulted in robust growth and falling unemployment. These achievements have enhanced confidence in the economy and prepared the ground for accession to the European Union. Directors noted, however, that external imbalances have increased, credit growth is rapid, and inflation has risen, giving rise to sizeable risks. They stressed that policies need to aim to contain the underlying vulnerabilities and increase the resilience of the economy.

Directors noted that buoyant domestic demand has contributed to a sharp widening of the external current account deficit and higher inflation. Although competitiveness appears to be satisfactory, the high and rising ratio of gross external debt to GDP is of concern, despite the sharp reduction in public external debt. Directors therefore called for maintaining cautious macroeconomic policies to moderate the growth of domestic demand and reduce debt, for prudent incomes policies to help safeguard competitiveness, and for a revitalized structural reform effort to boost output and export potential. Directors supported the authorities' strategy of retaining the currency board at the present parity through to euro adoption.

Directors saw fiscal policy as the key macroeconomic policy tool, and commended the authorities for the progressive fiscal tightening in recent years. In view of the further deterioration of the current account balance, Directors welcomed the government's commitment to a fiscal surplus of 3 percent of GDP in 2006. They noted that, with revenue performance expected to exceed earlier projections, and with the authorities' commitment to save half of this overperformance, achieving a larger surplus is appropriate and feasible.

As the current account deficit is projected to decline only slowly, Directors welcomed the authorities' commitment to caution in relaxing the fiscal stance over the medium term. Directors endorsed the fiscal surplus target of 2 percent of GDP for 2007, seeing the slight reduction in the surplus from that of 2006 as balancing appropriately the need to absorb EU accession-related financial flows with the need to contain domestic demand. Directors stressed that for EU-financed projects to boost Bulgaria's productive potential, stronger administrative capacity is needed to ensure both high quality projects and effective use of the inflows. Directors called for improvements in public procurement and expenditure management and, more broadly, for greater fiscal transparency, notably by providing parliament with realistic revenue and expenditure projections at the time of budget submission.

Directors concurred with the authorities' plans to maintain low tax rates and to limit exemptions in the context of a continued shift away from direct taxation. In light of macroeconomic developments, however, they welcomed the authorities' intention to postpone further tax cuts until there is clear evidence of their affordability. They also agreed that future rate cuts should give priority to reducing the payroll tax, which remains relatively high even after the welcome reduction in 2006.

Directors supported the authorities' intention to phase out the bank credit growth limits, noting that their effectiveness has faded over time due to increasing circumvention and the expanding availability of nonbank credit. While financial soundness indicators are satisfactory and stress tests indicate that the banking system is resilient to a significant adverse shock, supervisors need to scrutinize nonperforming loans closely and ensure the adequacy of banks' risk management frameworks. Directors underlined the importance of supervising closely the growing non-bank financial sector.

Directors underscored the urgency of enhancing the flexibility of the economy to enable it to handle better external shocks. They encouraged the authorities to revitalize the structural reform effort to reduce vulnerabilities, help sustain competitiveness, and boost growth potential, thereby accelerating the convergence of Bulgarian living standards to those of Western Europe. Efforts to increase labor market flexibility and minimize disincentives to labor market participation will be critical, especially in light of demographic prospects. Directors stressed the need to improve the business climate to sustain foreign direct investment, including by strengthening the judicial system, reducing red tape, and combating corruption forcefully.

Directors welcomed the authorities' intention to privatize several remaining state assets—including in the energy sector—and to reform the health and education sectors.

Bulgaria: Selected Economic Indicators

  2002 2003 2004 2005 20061

Real economy

Percent change

Real GDP

4.9 4.5 5.7 5.5 5.6

Consumer price index (end of period)

3.8 5.6 4.0 6.5 6.2

Registered Unemployment

17.4 14.3 12.7 11.5 ...

Public finance

(In percent of GDP)

General government balance

-0.8 -0.4 1.8 2.3 3.2

Public debt (end of period)

56.3 48.2 40.7 31.9 28.6

Money and credit

(Annual Percent change)

Broad money (nominal, end of period)

11.9 20.9 21.6 27.7 17.5

Credit to nongovernment sector (nominal, end of period)

44.0 48.3 48.7 32.3 17.5

Interest rates (annualized)

(In percent annualized)

BNB basic rate

3.4 2.7 2.4 2.1 ...

Time deposit (leva)

3.2 3.2 3.0 3.4 ...

Balance of payments

(In millions of euro)

Gross official reserves (end of period)

4,575 5,405 6,854 7,370 8,473

(In months of prospective imports of GNFS)

4.9 4.8 5.0 4.3 4.3

Current account (percent of GDP)

-2.4 -5.5 -5.8 -11.8 -12.4

Trade balance (percent of GDP)

-11.4 -13.7 -15.1 -20.4 -20.9

Exchange rates


Exchange rate regime

Currency Board since July 19972

Leva per dollar (end of period)

1.885 1.591 1.459 1.658 ...

Nominal effective exchange rate (2000=100)3

105.5 110.8 113.0 111.8 ...

Real effective exchange rate (2000=100)3, 4

109.6 114.0 119.8 120.5 ...

Sources: Bulgarian authorities; and IMF staff estimates.


2The Currency Board arrangement fixed the exchange rate at 1,000 leva = 1 DM through end-1998 and 1,955.83 leva = 1. Euro since January 1, 1999. On July 5, 1999, the lev was redenominated by removing three zeroes.

3Annual average level.


1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.


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