Describes the preliminary findings of IMF staff at the conclusion of certain missions (official staff visits, in most cases to member countries). Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, and as part of other staff reviews of economic developments.

Bulgaria—2011 Article IV Concluding Statement

May 20, 2011

The Bulgarian economy has adjusted swiftly following the recent crisis. The ability to preserve macroeconomic stability was testimony to the benefits of long-standing conservative policies and prompt policy action. Growth is gradually recovering, fiscal consolidation is being front-loaded, and the banking system remains well capitalized and stable. The challenge going forward will be to accelerate on-going reforms to regain growth potential, create jobs, raise incomes, and address aging-related pressures. Given the uncertain global environment, rebuilding the fiscal and maintaining the financial buffers that played a key stabilizing role in the recent crisis would enhance economic resilience against shocks.

Outlook: Recovery Facing Headwinds

1. The export-led recovery continues but is facing headwinds from rising inflation and uncertainty. Exports have rebounded above pre-crisis levels and are expected to propel real GDP growth to 3 percent in 2011. However, the recovery in consumption is held back by increases in inflation and precautionary savings amid heightened regional uncertainty. As a result, imports remain subdued and the current account deficit is expected to move closer to balance. Higher food and fuel prices are projected to increase headline inflation to 4¼ percent in 2011, before easing to 3 percent in 2012. Given the moderate speed of recovery, and ongoing shift away from non-tradeables to tradeable sectors, a quick reduction in unemployment is unlikely.

2. Medium-term growth is expected to be broader-based but more moderate than before the crisis. Growth is rebalancing between the domestic and external sectors, building on gains in export market share and improved competitiveness. Real GDP growth is expected to converge to an average rate of about 4 percent over the medium term. In the longer run, absent reforms structural bottlenecks and population aging could constrain growth potential.

3. While there is scope for better-than-expected outcomes, risks are tilted to the downside. Growth would be higher if exports surprise, confidence improves to allow consumption to revive strongly, or if the absorption of EU funds exceeds expectations. Such a strengthening in demand, if accompanied by a return of large scale capital inflows, could test the correction in the current account. However, at this juncture, downside risks—largely related to the external environment—dominate and have a greater potential impact. Growth would be lower and the recovery more protracted if world oil prices were to rise further or if growth in Western Europe were to falter and reduce export demand. Tensions in the financial and sovereign debt markets of the euro area periphery could also impact Bulgaria, but its international and fiscal reserves constitute critical buffers to counter such a tail risk.

Policy Agenda: Reinvigorating Growth and Convergence Prospects

4. The policy challenge is to bolster longer-term growth prospects while also sustaining Bulgaria’s resilience to address potential shocks. Progress on both these fronts would reinforce the already strong currency board arrangement as the bridge to eventual euro adoption and calls for:

• Bold structural reforms to raise productivity and jump-start job creation.

• Making fiscal adjustment and spending more growth-friendly and effective.

• Steps to maintain financial sector resilience.

• Rebuilding fiscal buffers to counter potential shocks.

Structural Reforms: Reigniting the Reform Momentum

5. The National Reform Program rightly recognizes that strong growth requires reforms to increase labor productivity. The Program appropriately identifies the greatest potential for productivity gains in low skilled young workers. This group experienced the largest increase in unemployment during the crisis. Given that a skills mismatch prevents their hiring for new vacancies, strengthened job placement services and targeted training programs would help reduce unemployment in the near-term. To achieve this, the government is currently scaling-up utilization of EU social funds. The measures envisaged to better align education to employer needs will also increase productivity over the long run. Social security contributions also need to be made compatible with more flexible working arrangements to encourage participation.

6. The government continues to reduce barriers in product markets but more action is needed to strengthen institutions. The government is set to achieve its 2012 goal of reducing the administrative burden on firms by 20 percent. However, weakness in contract enforcement, governance, and judicial shortcomings still need to be addressed to reduce the cost of business and enhance Bulgaria’s attractiveness to foreign investment.

7. Increasing EU funds absorption is essential to close the infrastructure gap where reforms to remove obstacles are bearing fruit. With the assistance of the World Bank, EBRD and EIB, project preparation capacity is strengthening. Controls have been streamlined, verification and audit processes strengthened, while barriers to coordination across the various levels of government are being tackled. The proposed amendments to the Public Procurement Act will be key to streamline the tendering process for EU-funded projects. These reforms will help unleash funding for infrastructure and improve its predictability. The proposed restructuring of the railway sector, supported by the World Bank, can modernize Bulgaria’s outdated rail network and enhance regional connectivity to facilitate trade.

Fiscal Policy: Growth Enhancing Adjustment

8. The proposed Financial Stability Pact will send a strong signal of Bulgaria’s commitment to prudent fiscal policies. The ceilings on the deficit and spending provide backing to Bulgaria’s fiscal commitments under the Enhanced Stability and Growth Pact. The recent crisis, however, underscored the fact that the key challenge is not only to contain the deficit, but also to restrain expenditure during upswings. To complement the Pact, a simple and transparent rule that links fiscal policy to a prudent estimate of potential growth, incorporates mechanisms to correct deviations, and create savings in upswings should be included in the organic budget law. Flexibility is also an important criterion to ensure the viability of any rules-based framework, making difficult trade-offs necessary in a currency board, when fiscal policy is the major policy tool to address shocks.

9. Bulgaria is poised to exit the excessive deficit procedure as long as strict control over spending is maintained in 2011. The strong action taken to rationalize public administration, freeze pension and wage outlays, and offset revenue shortfalls contributed to a better than projected fiscal outturn in 2010. The 2011 deficit target provides an ample cushion relative to the Maastricht deficit ceiling that also counters inflationary pressures. Nonetheless, with growth and direct tax revenues showing weakness in the first quarter, it will be important to sustain ongoing efforts to counter tax and social security evasion while avoiding pressures from new or supplementary spending increases. This should not preclude the clearance of remaining municipal arrears. Should expenditure cuts prove necessary during the year, every effort should be made to protect growth enhancing capital outlays. In case of a better than expected revenue outturn, the additional funds should be saved.

10. The new medium-term objective provides an appropriate goal to guide the consolidation effort. Reaching the 0.6 percent of GDP deficit target by 2014 as envisaged in the Convergence Program will entail a total adjustment of about 2 percent of GDP between 2012 and 2014, although under more conservative assumptions the adjustment could be higher. Aiming for some safety margin with respect to reaching the consolidation target would address this risk. The pace of adjustment serves to safeguard the fiscal reserve without placing an undue drag on the recovery. Depending on the pace of recovery after 2014, fiscal policy should aim for a more ambitious objective of a small surplus. This would provide a greater cyclical cushion relative to the proposed deficit ceiling.

11. The consolidation hinges on continued expenditure restraint. The current plan appropriately envisages the continued real contraction of spending in line with the lower levels of post-boom revenues. This contraction is largely achieved through the imposition of tight spending ceilings, including the extension of the wage and pension bill freezes through end-2012. In this context, the new ceilings on government liabilities will help ensure the tight spending envelopes translate into strengthened control of spending commitments.

12. Measures to further increase spending efficiency would improve the quality and durability of the consolidation effort. The top-down ceilings on spending have resulted in commendable efficiency gains. Going forward, strong spending control should be accompanied by reforms that create space within the tighter budget envelope to improve spending effectiveness, enhance service quality, and free resources for growth-enhancing education, and capital outlays. The priorities include:

• Health Care: Initial steps towards improving efficiency and cost-effectiveness need to be complemented by rationalization of the structure of the hospital sector, improved performance controls, and reform in the supply and pricing of pharmaceuticals to ensure health outcomes improve.

• Public administration: Continued streamlining of government functions and the introduction of transparent performance-based pay would create space to redirect resources to priority areas and attract more skilled staff. While much has been achieved at the central government level, the reform effort needs to include autonomous spending units, in particular municipalities.

• Pensions: Recent reforms made an important contribution to closing the near-term gap in the system, but more needs to be done to ensure its long-term sustainability. Further increases in the retirement age and service period, linking them to life expectancy, and a closer link between benefits to contributions are recommended.

13. The fiscal financing strategy should rely on privatization and increased debt issuance given the need to safeguard the fiscal reserve. The renewed push for privatization would not only enlarge the role of the private sector, it also yields resources to replenish the fiscal reserve account. Increased debt issuance would also boost the reserve. The government’s debt management strategy would benefit from a regular issuance calendar, the establishment of larger benchmarks, and the streamlining of the primary dealership system.

Financial Sector: Maintaining Resilience

14. Reported indicators of financial banking soundness remain strong, but—as in other countries—the crisis has impacted asset quality. At end-March, the average capital adequacy ratio was 17.7 percent, much higher than the 12 percent mandatory ratio and more than double the minimum ratio required by EU countries. It reflects conservative regulatory standards and the commitment of parent banks. NPLs have, however, risen to 12.9 percent, and the increase in loan-loss provisions and funding costs has reduced profitability. NPLs are expected to peak in the second half of 2011, although a more protracted recovery could delay this. Stress tests conducted by the Bulgarian National Bank show that current profits, existing provisions, collateral, and capital appear adequate to absorb potential losses. Still, in the unlikely event of a new significant shock or a much delayed recovery, asset quality would remain a concern.

15. Improvements in the debt resolution framework would strengthen credit growth. High legal fees, uncertainty about the legal process and questionable outcomes from loan recovery are slowing asset workout and inhibit banks from resuming lending. Clarifying the criterion for the initiation of insolvency proceedings, expedited court approval of pre-packaged restructuring plans, and assigning priority status to creditors who inject new capital to the rehabilitation process would improve the resolution process. 

16. As the economy recovers, regulatory requirements should remain tight to maintain the buffers in the banking system. Provisioning requirements and certain capital risk weights were appropriately eased during the crisis to allow banks to utilize some of their buffers to absorb losses. With the recovery still not firmly established and real estate prices yet to fully stabilize, restructured loans should be closely monitored to ensure appropriate provisioning and collateral valuation. The still conservative Bulgarian regulatory and supervisory regime will facilitate the implementation of the new Basel III requirements. As the recovery gathers pace, the regulatory easing implemented in the crisis should be gradually reversed.

17. Contingency planning remains essential given the uncertainty in financial markets. The authorities are actively participating in discussions on the design of a new European-level bank resolution framework and continuously developing their stress testing methodologies. The Bulgarian National Bank and the Ministry of Finance are working together within the existing contingency planning framework to prepare for the envisaged EU-wide changes.

Fiscal Reserves: Strengthening Defenses

18. Rebuilding the fiscal reserve would make the economy more resilient to new shocks and enhance confidence.  The fiscal reserve played a critical role in allowing Bulgaria to weather the recent crisis so well, serving both to finance the deficit and underpin confidence in the currency board arrangement. The cost of maintaining these higher reserves has paid off well. The fiscal reserve should now be preserved and rebuilt through privatization receipts and more proactive debt issuance. High reserve buffers provide Bulgaria extra resources to address unforeseen shocks and ensures it is comfortably placed to meet the upcoming bond amortization payments.


We wish to thank the authorities for their hospitality and for the open and constructive discussions.


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