Press Information Notice: IMF Concludes Article IV Consultation with Bulgaria

July 29, 1997

Public Information Notices (PINs) are issued, (i) at the request of a member country, following the conclusion of the Article IV consultation for countries seeking to make known the views of the IMF to the public. This action is intended to strengthen IMF surveillance over the economic policies of member countries by increasing the transparency of the IMF's assessment of these policies; and (ii) following policy discussions in the Executive Board at the decision of the Board.

The IMF Executive Board on July 23, 1997 concluded the 1997 Article IV consultation1 with Bulgaria.


The severe financial crisis from which Bulgaria is emerging was rooted in the slow pace of structural reform and financial indiscipline in the enterprise and banking sectors. After a promising start in 1991-92 when prices, the exchange rate, and interest rates were liberalized, structural reforms stalled and left most of industrial production and the banking system in state hands, allowing loss making enterprises to be kept afloat by bank credit. Public indebtedness grew as the losses in state enterprises and banks spilled onto the budget, compounding an already heavy external debt burden and leaving the economy vulnerable to currency crises. Periodic attempts to stabilize the economy succeeded temporarily but were eventually undone by the failure to follow through with structural reforms.

The 1996 crisis hit Bulgaria with unexpected virulence as confidence in the banking system and the currency collapsed. By late 1995, the public had become increasingly aware of the ill health of banks and began to withdraw deposits and shift into foreign currency. Pressures for depreciation were initially resisted and foreign exchange reserves fell rapidly. This raised doubts about Bulgaria's ability to service its large external debt and triggered large withdrawals of foreign exchange deposits, further weakening the liquidity of banks.

A stabilization and reform program adopted in mid-1996 failed to restore confidence owing to policy slippages, particularly in the implementation of structural reforms. As a result, real GDP fell by 11 percent; the lev depreciated from 71 per U.S. dollar at end-1995 to 487 per U.S. dollar at end 1996; 12-month inflation accelerated sharply to 311 percent; and foreign exchange reserves fell to US$0.5 billion, equivalent to less than one month of imports (Table 1). Nonetheless, the sharp compression of non-interest expenditures in the budget enabled Bulgaria to remain current on its external debt service obligations, and by end-year the worst banks, representing almost one-third of total deposits, had been closed.

A political crisis in late 1996 led to the resignation of the government, and the heightened political uncertainty culminated in hyperinflation in February 1997, with monthly inflation reaching 243 percent. To resolve the crisis, early elections were called and a caretaker government adopted a comprehensive economic program centered on the prospective introduction of a currency board arrangement (CBA). The program accelerated and deepened structural reforms, emphasizing the rapid privatization of enterprises and banks and the liberalization of trade and prices, especially in the agricultural sector. With the rapid implementation of the program, confidence returned, the lev rebounded from around leva 3,000 per U.S. dollar in early February to leva 1,500 per U.S. dollar in March, inflation decelerated to 12.7 percent in March and then to rates averaging less than 2 percent per month in the period April through June.

The newly elected government, which took office in May, strongly reaffirmed its commitment to the CBA-centered program; the CBA was established on July 1 with the lev pegged at 1,000 per DM; and Parliament adopted a budget consistent with the CBA. By mid-July, foreign exchange reserves had increased to US$1.5 billion and yields on three-month government securities had fallen to 6.3 percent per annum.

Executive Board Assessment

Executive Directors observed that, after very costly delays in its transition process, Bulgaria now had an excellent opportunity to reinvigorate and complete the reforms needed to provide the basis for sustained growth and improved living standards. Directors commended the authorities' commitment to reform and were encouraged by their efforts to stabilize the economy, including the implementation of the currency board arrangement (CBA). Directors noted that markets had responded favorably to those efforts with stronger than expected declines in interest rates and inflation. Those measures, along with steps taken to improve the soundness of the banking system and the passage of a budget consistent with the demands of a CBA, provided a firm foundation to consolidate the stabilization developments thus far. Directors strongly encouraged the authorities to take full advantage of the confidence in their policies to press forward with their program of broadly based structural reforms. They underscored that there was no room for slippage or complacency, as significant risks remained. Any weakening of resolve could easily erode credibility and confidence and jeopardize macroeconomic stabilization.

The swift adoption of the CBA was viewed by Directors as a strong signal of the authorities' commitment to enforce financial discipline. Initial results of the CBA were clearly encouraging, but Directors emphasized that its durability would depend upon the strict adherence to the new Law of the Bulgarian National Bank and would require sustained discipline and vigilance across the full range of economic policies, including the budget, incomes policy, and strengthened performance and governance in the banking and enterprise sectors. Failure to implement effective policies in those areas would eventually be reflected in a loss of competitiveness, rising interest rates, and economic slowdown.

Although expressing concern that the 1997 budget passed by parliament was weaker than initially programmed, Directors noted that it remained consistent with the objectives of no central bank or banking system financing. Directors emphasized the importance of strict adherence to the budget so as to make progress toward a broadly-balanced budget in 1998. In that regard, several Directors noted that interest rates and payments were already lower than programmed and that those savings should be used to reduce the overall deficit rather than to increase spending. Given Bulgaria's high external public indebtedness and the deep loss of confidence from which Bulgaria was emerging, Directors agreed that an ambitious target for the Fiscal Reserve Account (FRA) was essential to maintain confidence, and that the target should be achieved without excessive borrowing.

Directors considered poor revenue performance to be a key risk to the budget, and therefore urged the authorities to step up their efforts to improve tax administration and strengthen the tax system by broadening its base and increasing its efficiency. Directors cautioned that, without sustained efforts to improve revenue performance, the government would increasingly lack the resources needed to carry out its basic functions and achieve its social goals. They therefore welcomed the planned review of the tax system, which would provide the opportunity to put in place comprehensive tax measures in the context of the 1998 budget. In that regard, they underscored the need to improve the taxation of the private sector and strengthen collection of tax arrears. Since it would take time to improve revenue performance, Directors stressed the need for continued expenditure restraint. They therefore welcomed the plans to improve the targeting of the social safety net and the efforts to streamline public administration. They also stressed the importance of timely adjustments to administered prices to keep subsidies within budgeted limits. Several Directors also questioned whether adequate account had been taken of the likely fiscal impact of banking sector problems. A few Directors also advocated a reduction in nonproductive expenditures to release resources for spending on operations and maintenance, on infrastructure, and on the social sectors.

Directors observed that maintaining cost competitiveness would be crucial to the attraction of foreign investment and to support export-led growth. They stressed that the authorities would need to implement strictly the incomes policy applying to state-owned enterprises (SOEs). Wages in SOEs had recovered quickly from the very low levels of early 1997. Further increases should be limited to profitable enterprises that were increasing productivity. A few Directors expressed concern about the already serious unemployment situation. They called for early actions to address that issue; in particular, through measures to improve education and training. Over the medium term, policies should be directed toward maintaining and enhancing labor market flexibility, which would be a key ingredient for promoting employment, encouraging high productivity growth, and facilitating adjustment to shocks under the CBA.

Directors underlined that Bulgaria's transition history showed that enterprise and banking sector reform was essential for durable stabilization. It was therefore crucially important that the authorities implement fully the panoply of structural reforms supported by the Stand-By Arrangement and the World Bank Financial and Enterprise Structural Adjustment Loan. The authorities' commitment to privatize all state banks, commercial state enterprises, and half of the utilities within the next two years was in that regard viewed as both necessary and encouraging. A few Directors accorded particular urgency to the privatization or liquidation of loss-making enterprises, and suggested that privatization of the remaining utilities could be accelerated. Directors commended the authorities on the privatization results achieved so far, and strongly advised that privatization continue in as transparent a manner and with as high a regard for governance and efficiency as possible. They stressed that the establishment of an effective legal and regulatory framework and improvement in business practices would be essential to that end.

In the meantime, strict financial discipline on banks and state enterprises and effectively restructuring the financial system were essential to avoid the re-emergence of quasi-fiscal deficits, as well as to ensure the effective functioning of the CBA. A fundamental turnaround in the governance of banks was required to prevent the recurrence of the problem of bad loans. Directors viewed passage of the amendments to the Law of Banks, which strengthened the central bank's supervisory powers, as an important step in that direction. They considered it of utmost importance that the strengthened supervisory framework be implemented fully so that the reflow of resources into the banking system was used wisely. The further liberalization of financial markets, including the removal of obstacles to overseas investment, would also be important in preventing the accumulation of excess liquidity in the banking system. A few Directors raised the possibility of increasing reserve requirements for prudential purposes while prudential standards were being strengthened.

Directors encouraged the authorities to pursue vigorously their goal of fighting corruption and organized crime. Respect for the law and effective institutions were crucial for both the development of civil society and the proper functioning of a market economy.

Directors commended the authorities on the maintenance of a liberal trade and exchange regime and the steps taken to further liberalize trade and prices in the energy and agricultural sectors, including the lifting of export bans on agricultural products. They encouraged the authorities to phase out both the temporary export tax on cereals and the import surcharge as soon as possible. Directors welcomed the removal of the restriction on profit remittances by small enterprises, the limit on foreign exchange purchases for tourism, and the maturity restriction on inward portfolio investments. They urged the authorities to complete the liberalization of the exchange and trade system.

In conclusion, Directors urged steadfast implementation of the authorities' policy program in order to unlock the economic potential of Bulgaria and to continue to establish a strong track record. They welcomed the interest of the new government in a successor extended arrangement to support a deepening of structural reforms.

Bulgaria: Selected Economic Indicators

  1993 1994 1995 19961 19972

  In percent
Domestic Economy
  Change in real GDP -1.5 1.8 2.1 -10.9 -7.4
  Unemployment rate (end of period) 16.4 12.8 11.6 12.5 . . .
  Change in consumer prices (end of period) 63.8 121.9 32.9 310.8 566
  In millions of U.S. dollars3
External Economy
  Exports, f.o.b. 3727 3935 5345 4881 5046
  Imports, f.o.b. 4612 3952 5224 4673 4841
  Current account balance -1386 -203 -59 117 74
  Direct investment 40 105 82 100 430
  Capital account balance -180 29 253 -944 375
  Foreign exchange reserves 655 1002 1236 483 1638
  Current account balance (in percent of GDP) -12.8 2.1 -0.5 1.3 0.8
  Change in real effective exchange rate (in percent)4 33.7 -0.3 14.7 -37.7 . . .
  In percent of GDP3
Financial Variables
  General government balance -10.9 -5.8 -6.4 -13.4 -6.3
  Change in broad money (in percent) 47.6 78.6 39.6 124.5 245.4
  Interest rate (in percent)5 53.6 72.3 25.3 211.8 . . .

2IMF staff estimates.
3Unless otherwise noted.
4(+) = appreciation.
5One-month time deposits.

1Under Article IV of the IMF's Article 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 directors, and this summary is transmitted to the country's authorities. In this PIN, the main features of the Board's discussion are described.


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