Bulgaria and the IMF
Press Release: IMF Completes Fourth Review Under Stand-By Arrangement with Bulgaria, Approves US$39 Million Disbursement, Grants Waivers, and Extends Arrangement
February 04, 2004
Country's Policy Intentions Documents
Bulgaria—Letter of Intent and Supplementary Memorandum of Economic Policies
Mr. Horst Köhler
International Monetary Fund
Washington, D.C. 20431
Dear Mr. Köhler:
The attached Supplementary Memorandum of Economic Policies (SMEP) discusses our performance under the program supported by the Stand-By Arrangement (SBA) with the Fund and the policies that the government and the Bulgarian National Bank plan to implement in 2004. Our core policy objectives--laid out in the Memorandum of Economic Policies dated February 12, 2002 and updated in the SMEPs dated July 5, 2002, January 22, 2003, and June 18, 2003--remain to maintain macroeconomic stability and achieve higher living standards through rapid and sustainable growth.
During the last six months, macroeconomic developments have remained favorable and the program has been largely on track, as discussed in the SMEP. However, we request a waiver for the likely nonobservance of the end-December 2003 performance criterion (PC) on collection of tax arrears. This breach is due to the delay in privatizing a state-owned enterprise from which arrears payments were anticipated. But, revenue performance overall has been better than expected. In addition, as all end-December PCs are legally controlling for the purchase associated with this review, we request a waiver of applicability for the following PCs that we expect to be fully observed, but for which data are not yet available: (i) overall fiscal deficit of the general government; and (ii) ceiling on the growth of the wage bill for 60 monitored state-owned enterprises. We are taking measures to expedite implementation of those indicative targets and structural benchmarks that were missed, largely due to technical difficulties. To allow purchase of the last tranche of this SBA, which can take place after it has been ascertained that end-December 2003 PCs have been met, we request an extension of this program from February 26, 2004 to March 15, 2004.
The Government believes that the policies set forth in the attached SMEP are adequate to achieve the objectives of this program, but will take any further measures that may become appropriate for this purpose. Bulgaria will consult with the Fund on the adoption of these measures, and in advance of revisions to the policies contained in the SMEP, in accordance with Fund's policies on such consultation. We also believe that this program provides a solid basis for a successor precautionary SBA, which we subsequently intend to request. For now, we ask for the completion of the fourth review under this SBA.
Supplementary Memorandum of Economic Policies of the Government of Bulgaria and the Bulgarian National Bank
1. Bulgaria has continued to make progress toward sustained robust economic growth and higher living standards, which are key objectives of our economic program. To this end, we have maintained cautious fiscal and incomes policies in support of the currency board arrangement (CBA). Further, we are carrying out our structural reform agenda aimed at eliminating the remaining barriers to growth, while taking steps to reduce poverty and increase employment opportunities.
2. Our economic program--supported by a Stand-By Arrangement with the Fund--remains broadly on track. All end-June and end-September 2003 performance criteria (PCs) and indicative targets were observed, with the exception of the end-September PC on tax arrears collection by the General Tax Directorate (GTD) and the end-June and end-September indicative targets on arrears to the electricity company (NEK). Most structural benchmarks for end-June have been met as well, but several benchmarks for end-September and December were either missed or only partially observed. We are seeking to address these delays.
3. Macroeconomic developments in 2003 remained favorable.
4. Our strong economic performance has been supported by a sound fiscal policy. A significant overperformance in revenue collection allowed us to respond to the rapid rise in private sector demand and the widening of the external current account deficit while still meeting critical expenditure needs. By saving a significant portion of additional revenue, we expect to have achieved at least a balanced budget for the year. In addition, due to expenditure savings in some areas, we were able to undertake additional unbudgeted expenditures, including to fully fund central government-mandated municipal expenditures and clear overruns on medicine reimbursements and hospital arrears, and on wages and pensions. We are taking steps to limit hospital arrears in the future (see paragraph 13).
5. We have made further progress with public sector reforms aimed at keeping our fiscal policy on a sound footing over the medium term. We are pressing ahead with implementation of the National Revenue Agency (NRA). A draft Bulstat law, which regulates the use of the Bulstat number as the single key identification for all tax operations, has been submitted to Parliament. We intend this law to be passed by April, 2004, and to come into effect by mid-2004. We have improved the budget process, including by introducing program budgeting in three ministries. We are proceeding as well with our reform of intergovernmental finances, and to this end have passed the revised municipal budget act, and developed standards necessary for assessing the cost of government mandates.
6. Other structural reforms have advanced as well--notably with bank privatization and in the energy sector--but progress in some areas has proved more challenging. We sold the last large government-owned commercial bank (DSK). The sale of the telecommunication company (BTC) is at the final stage of implementation. Only technical problems impede the procedure's finalization, but we expect to conclude the transaction in the very near future, without canceling the current procedure. The sale of the tobacco holding (Bulgartabac), however, is taking considerably longer than initially envisaged. In the energy sector, we have raised electricity and district heating prices toward cost-recovery levels, passed a new Energy Law, and have started to evaluate bids for the majority shares in seven electricity distribution companies. Recent policies to strengthen the legal system and rationalize licensing regimes have improved the business climate. However, reforms to restructure the health sector have proved more difficult.
C. Economic Policies for 2004
7. We see economic prospects for 2004 and the medium term as favorable, but subject to significant risks. Our targeted real GDP growth of 4½ percent in 2003 was likely achieved, and with global economic prospects improving, we expect growth to rise to 5¼ percent in 2004. Inflation should remain subdued at about 4 percent. We expect growth in claims on the nongovernment sector to decline to about 20-25 percent in real terms by end-2004. Private consumption and investment should remain robust, and the extent of narrowing in the current account deficit would be commensurately limited, with the deficit projected to reach 7¼ percent of GDP by end-2004, from about 7¾ percent at end-2003. We anticipate net foreign direct investment (FDI) to cover some three quarters of the current account deficit. We are mindful, however, that our external position could worsen if private sector credit and import growth fail to moderate as expected, if recent gains in FDI are not sustained, or if other capital flows reverse. Further, while the banking system remains sound and financial oversight strong, we recognize that continued rapid credit growth presents new challenges for banking supervision.
8. Our policies will continue to be focused on limiting the economy's vulnerability to risks and on achieving sustained and rapid economic growth. Fiscal policy must remain cautious and flexible; the health of the financial sector safeguarded; and structural reforms pursued to remove remaining obstacles to growth and to allow the implementation of the government's medium-term fiscal strategy.
Fiscal Policy and Public Sector Reforms
9. The 2004 budget is aimed at containing external pressures while meeting key expenditure needs and continuing to reduce the tax burden. We have targeted a small deficit of 0.7 percent of GDP for 2004--a modestly expansionary fiscal stance compared with the 2003 outcome. In our view, this stance is consistent with macroeconomic stability, and will support a narrowing of the external current account deficit and allow a further modest decline in the external debt-to-GDP ratio. Key features of the budget are noted below. Passage of a budget targeting a deficit of 0.7 percent of GDP is a prior action for Board consideration of the review.
10. We are taking steps to ensure that fiscal policy remains sufficiently flexible to adjust to any adverse developments in our external position. We will continue our practice of proceeding cautiously with discretionary spending. We will limit spending to 93 percent of budgeted amounts in the first three quarters of the year, including from spending units' own revenues, and have built these limits explicitly into our Treasury Single Account (TSA). This provides us with the flexibility to adjust fiscal policy by up to one percent of GDP if the external position fails to improve. Such adjustments would be made in consultation with IMF staff. Additional flexibility is provided by budget contingencies equivalent to 0.6 percent of GDP. Finally, we view our revenue projection as conservative and will save most of the revenue overperformance in 2004, unless external conditions improve significantly, subject to the commitment in the budget that the first BGN 25 million of any revenue performance be directed to tobacco, agriculture, and railway subsidies.
11. We will strengthen our public sector reform effort, which is crucial to achieving our medium-term fiscal goals. First, we will implement measures to improve tax administration. We intend to have the NRA operational by January 1, 2005. Toward this end, we have established a pilot NRA project in Burgas, expect to have chosen revenue administration software for the NRA by end-February 2004, and plan to continue conducting joint National Social Security Institute (NSSI) and GTD audits. During 2004, we plan to develop integrated work processes of the tax administration and the NSSI for the purposes of the NRA. We anticipate receiving technical assistance from the Fund in this area in early 2004. We will continue to enhance our budgeting and expenditure management including by extending program budgeting to an additional four ministries in the 2005 budget process. Three out of five modules of the Financial Management Information System (FMIS) have been rolled out in the Ministry of Finance and all its second level spending units. The newly-established steering committee will decide on the next steps to make the system fully operational. The extension of the coverage of the TSA to all leva-denominated extrabudgetary funds has been delayed owing to technical problems, but we intend to complete this process by end-June 2004.
12. We are making major advances in our system of intergovernmental finances. First, in the 2004 budget, we have--in contrast to recent years--fully funded all mandated local government spending. In addition, we are preparing legislation pertaining to municipal and state properties and municipal debt. We are developing standards for assessing the costs of municipal mandates. With these measures implemented, we are well-placed to enforce hard budget constraints on municipalities and, in this context, will not clear any municipal arrears accumulated during 2004 and will strictly enforce the prompt payment of municipal obligations to public utilities.
13. We are determined to enhance efficiency in health spending. We aim to increase the share of hospital spending covered by the National Health Insurance Fund (NHIF) from 33 percent in 2003 to 45 percent in 2004. Municipal hospitals will receive additional financing from the Ministry of Health, also on a fee-for-service basis. These financing mechanisms will provide financial incentives for enhanced efficiency and quality of hospital care. To limit cost overruns on medicines we have established a positive list of medicines covered by the NHIF and introduced co-payment for selected medicines.
Financial Sector Policies and Debt and Asset Management
14. While the recent growth of financial intermediation in Bulgaria is a welcome development, we recognize that rapid credit growth presents new challenges for banking supervision. Bulgaria's banking sector remains sound, but credit growth at the current pace brings with it risks of a future deterioration of bank asset quality. In addition, the rapid rise in lending, including to households, is fueling the ongoing import boom, increasing Bulgaria's external vulnerability.
15. In response to these risks, the BNB has developed a comprehensive strategy consisting of a set of sequential measures, with its implementation dependent on observed developments in credit growth. As a first step, we have already conducted discussions with major banks to ensure that lending standards are not being relaxed in an effort to maintain or expand market share. We have also reduced the test period for classifying loans as loss from 180 to 120 days, and have postponed plans to reduce banks' reserve requirements toward EU norms. Although credit growth has already slowed down in the last few months--a trend we expect to persist--we continue to implement our strategy:
16. The government, in its asset management, will also remain cognizant of the need to contain credit growth within sustainable levels. In this context, the government will return the remaining deposits that were auctioned off to commercial banks in mid-2003 to the BNB as they mature, or more rapidly if necessary, and will not repeat similar operations in 2004. Moreover, any funds transferred to the state highway enterprise, as well as funds from the Bank Consolidation Company, will be deposited in the BNB. The Ministry of Finance and the BNB have agreed on draft amendments to the Organic Budget Law with the aim of improving coordination and transparency of the management of FRA resources.
17. We will carry on with our active public debt management, with a view to continuing to reduce external vulnerability and deepen the domestic securities market. In line with our debt management strategy adopted in March 2003, our objectives remain to achieve a more balanced interest and currency composition of the debt and increase the share of domestic debt, while continuing to lower the public debt-to-GDP ratio. A portion of the assets accumulated in the FRA could be utilized for prepayments and debt reduction operations.
18. We have also continued to make progress in implementing the measures recommended in the Safeguards Assessment report. We have established a risk-based methodology for the BNB's Internal Audit Department, ahead of schedule. We are also making good progress in developing an audit procedures manual for the internal audit function, which we intend to complete by the end-March 2004 deadline.
Other Structural Reforms
19. We are committed to stepping up our efforts to improve Bulgaria's business climate and attract higher FDI on a sustainable basis. We plan to improve administrative services for foreign and domestic investors through one-stop shops, and by enhancing the infrastructure available to large investors. With the assistance of the EU and World Bank, we have accelerated the reform of the judiciary and improved governance by amending the nation's constitution to limit the immunity of members of the judiciary, to provide for their replaceability in certain defined circumstances, and to limit their terms in office. With regard to Bulgartabac, our new strategy--focused on selling components of the company instead of the entire holding--was approved by parliament in December 2003, and we anticipate completing the sale of several Bulgartabac companies by mid-2004.
20. Reforms in the energy and railway sectors remain critical to our medium-term fiscal strategy and for removing remaining impediments to growth. Our new energy law provides a modern framework for the energy sector in Bulgaria. The sale of the electricity distribution companies is expected to be complete by mid-2004. We are continuing, with World Bank assistance, to reform the railways sector; we are committed to reaching our objective of a 10 percent reduction in personnel compared to 2001, and have raised intercity passenger tariffs to 76 percent of cost-recovery levels (compared to the benchmark of 70 percent agreed with World Bank). However, we recognize that a successful reform of the railways will require the government to make explicit decisions about the limited set of activities to be subsidized. Toward this end, we have separated the accounts for freight and passenger transport, and will sign purchase of service contracts for specific railway services in the context of the 2004 budget.
21. Our labor market policies are aimed at maintaining competitiveness and continuing to lower unemployment by reforming the labor code. We will seek to accelerate the dialogue among social partners on the proposed labor code amendments to reduce hiring and firing costs by abolishing the seniority premium, promoting flexibility in the duration of employment contracts, and increasing flexibility in employment during periods of production stoppage. We will maintain our incomes policy in regard of those state enterprises incurring the highest losses or overdue liabilities, receiving public subsidies or enjoying monopoly status. In this context, we have issued the 2004 incomes ordinance restricting the growth of the wage bill for the listed enterprises to a maximum of 4 percent for 2004, compared to the third quarter of 2003.
22. We met our objective to subscribe to the special data dissemination standards (SDDS) by end-2003.
The general government accounts are defined to comprise the consolidated budget (including the republican budget, the budgets of ministries and local governments, and the social security fund) as well as all extrabudgetary funds and accounts both at the central and local government levels.
The quarterly limits will be cumulative and will be monitored from the financing side as the sum of net credit from the banking system to the general government, including deposits and accounts abroad, net nonbank credit to the general government, privatization receipts of the budget, and receipts from external loans for direct budgetary support minus amortization paid. For calculating the performance against this ceiling, privatization receipts include the dividends the Bank Consolidation Company (BCC) distributed to the general government and taxes collected from BCC related to the sale of assets, and all the proceeds from the sale of GSM licenses. External drawings and repayments will be converted into leva at the BNB daily exchange rate. Valuation changes in deposits and accounts that are denominated in foreign currencies will be recorded daily and reported by the BNB and the Ministry of Finance at the end of each quarter, and such changes will be netted out.
The Fiscal Reserve Account (FRA) consists of (1) the balances in leva and in foreign exchange of the following accounts: all budgetary and deposit accounts in the banking system, including the central budget, ministries and agencies, central government extrabudgetary funds as defined in Annex No. 7 of the 2003 Budget Law, the National Social Security Institute, and the Health Insurance Fund, and (2) other highly liquid foreign assets of the central government.
The following assets qualify as highly liquid foreign assets:
(i) Foreign currency deposits with foreign financial institutions (or their branches) assigned a rating of AA- or higher;
(ii) Fixed income instruments issued by supranationals and foreign sovereigns (including financial institutions) that have a rating of AA- or higher, taken at market value;
(iii) Bulgarian Brady bonds and Eurobonds (acquired as treasury stock through market transactions) taken at 95 percent of market value.
In addition, the fixed income instruments (other than the Bulgarian Brady and Eurobonds) liquidity-wise have to satisfy the following conditions:
Finally, the modified duration of the entire portfolio of highly liquid assets should not be more than 4.5 years.
The limits will be monitored from the accounts of the banking system and marked-to-market data of other highly liquid foreign assets of the central government, to be provided monthly by the BNB and the Ministry of Finance. For the purposes of the program, deposit accounts and assets that are denominated in foreign currencies will be converted into leva at the December 31, 2002 exchange rates (1.88496 leva, and 0.73555 SDR per US dollar).
The Ministry of Finance will publish information on the level and composition of the FRA on the Ministry's website on a monthly basis. The information will include the overall balance of the FRA, the balance of the government deposit at the Bulgarian National Bank, and the total amount of foreign exchange denominated assets, including the highly liquid foreign assets.
The ceiling on the aggregate wage bill of the 60 state-owned enterprises closely monitored for their large losses or arrears, for receiving subsidies, or for being monopolies, is two percent above the level of their aggregate wage bill in the third quarter of 2002. The wage bill is defined to include wages and payroll taxes paid by the employer.
Those enterprises that have been privatized or ceased operations will be excluded from the list for the respective test dates. Those enterprises that register profits in each of the first two quarters of 2003 will also exit the list in the second half of 2003 unless they are monopolies, have arrears, or receive state subsidies. If an enterprise is excluded from the list, the wage bill ceiling will be adjusted down by the amount of that enterprise's wage bill in the third quarter of 2002 plus 2 percent. The 60 enterprises monitored (enterprises number 1 to 17 are considered monopolies):
These performance criteria are on the sum of changes in monitored arrears to the GTD and arrears to the NSSI. For the purpose of these performance criteria, arrears are defined to include interest and penalties. The enterprises monitored for arrears to the GTD:
The enterprises monitored for arrears to the NSSI:
For the purpose of assessing compliance with these performance criteria:
Other Performance Criteria1
1. The BNB will ensure that gross foreign reserves of the issue department are at least equal to the issue department's liabilities at all times. Issue department liabilities will comprise leva notes and coins in circulation, and deposits from the banking department, banks, government, and the nonfinancial sector with the BNB, excluding liabilities to the IMF. For the purpose of this performance criterion, issue department liabilities will be converted into foreign exchange using the official exchange rate. The BNB will exclude placements from other agencies under fund management contracts from the balance sheet of the issue department.
2. The BNB shall not increase credit to the government at any time during the period of the CBA, except as allowed under the Law of the BNB, nor shall it purchase Bulgarian government securities.
3. During the period of the arrangement, the government does not intend to impose new or intensify existing exchange restrictions on payments and transfers for current international transactions, or introduce or modify multiple currency practices, nor conclude any bilateral payments arrangements that are inconsistent with Article VIII of the IMF Articles, nor impose or intensify any import restrictions for balance of payments purposes, nor accumulate any external payments arrears except for amounts subject to rescheduling agreements.
1 All performance criteria listed in this annex are applicable on a continuous basis.