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—Concluding Statement of 2012 Article IV ConsultationSofia, October 2 2012
Strong buffers and steadfast policy implementation have allowed Bulgaria to maintain stability in a challenging environment. However, growth remains weak, unemployment high, and the economy is exposed to external risks from the on-going euro area crisis. Bulgaria's prudent fiscal and financial supervisory policies need to be accompanied by accelerated structural reforms to preserve resilience and boost growth. Priorities include re-orientating the composition of fiscal spending to better support growth, improving the corporate insolvency framework, and promoting skills development and a better, more predictable, business environment.
Stability amid low growth and downside risks
Ongoing and steadfast commitment to prudent macroeconomic policies has preserved stability in a difficult environment. Substantial adjustment has been undertaken to lower the fiscal deficit, which combined with the use of the fiscal reserve buffer have kept public debt low. Conservative supervisory policies created capital cushions in good times that banks utilized as the domestic demand boom unwound. These policies, along with a substantial pension reform, created a favorable environment for the return of foreign direct investment, a successful eurobond issue, and declining yields on government debt. Nonetheless, growth since the crisis has left unemployment high.
Sustained external headwinds are impeding the recovery. There was little contribution to growth from exports in the first half of 2012, but domestic demand gained some traction on improved EU funds absorption and private consumption. We now project real GDP growth of 1 percent in 2012, rising to 1½ percent in 2013 aided by increased EU fund inflows and exports. Headline inflation is expected to rise to 2½ percent on average in 2012 due to higher food and fuel prices. The current account is projected to move back to a small deficit as imports outpace exports. Over the medium-term, growth is projected to gradually rise towards the 4 percent range by 2016 provided external conditions improve.
Downside risks continue to loom. Strong trade and financial linkages leave Bulgaria exposed to external risks under a scenario involving a possible intensification of the euro area crisis that could push the Bulgarian economy into recession, causing unemployment, non-performing loans and the fiscal deficit to deteriorate. Clearly, a resolution to the euro-area crisis would benefit Bulgaria through greater external demand and stronger domestic confidence. Bulgaria’s high reliance on oil imports also exposes it to the risk of a sharp rise in oil prices. Domestically, the longer unemployment and remaining structural bottlenecks persist, the greater the risk to growth potential and income convergence, particularly given the already aging population and income levels that are still well below EU comparators.
Policies to promote growth and preserve stability
Boosting growth in a highly uncertain external environment will require bolder structural reform while maintaining the prudent policy stance. The currency board, supported by conservative policies, remains a successful anchor with competitiveness unimpaired. The need to preserve the ability to respond to shocks precludes looser fiscal and financial policies, leaving structural reforms and higher EU funds absorption as the main levers to revive growth. Improving the composition of fiscal policy, addressing non-performing assets and tackling skills and infrastructure gaps with the aid of EU funds, would support domestic demand and spur growth.
Marrying fiscal prudence with the need for growth
The objective to return the budget to balance by 2015 appropriately supports Bulgaria’s policy framework. A small and declining deficit over the next few years would keep public debt low and create fiscal space to use in the event of potential shocks. The trade-off with short-term growth would be limited given the little adjustment that remains to be done—just under a ½ percent of GDP in structural measures over 3 years. However, if growth were to slow significantly relative to projections, automatic stabilizers should be allowed to work if adequate financing is available.
The fiscal cash deficit is on track to fall to 1¼ percent of GDP in 2012 and make a substantial down payment towards the 2015 target. Spending has been contained while improved tax administration and higher imports are boosting tax collections. The cash deficit could be lower still if more than projected EU funds reimbursements occur before the year end.
The fiscal adjustment achieved so far should be preserved and spending pressures firmly resisted to safeguard the hard-earned credibility demonstrated in lower yields on government debt. Within a tight budget envelope that already accommodates a pension increase, it will be necessary to resist pressures for generalized wage increases. Reflecting the 2011 pension reform, future pension increases should not however exceed inflation. Public sector arrears need to be avoided as they hurt the recovery and worsen the business climate.
The way fiscal policy can help growth is by changing the composition of the budget and improving the quality of spending. Higher capital spending—for example on basic infrastructure—financed by EU funds absorption, as well as better tax compliance and reductions in untargeted subsidies and transfers, have the most potential to stimulate growth. Limiting early retirement options, linking the retirement age to life expectancy, and increasing the retirement age of women to match men’s would help boost labor force participation and counter the drag from aging on growth. While a public administration reform has already been carried out, spending effectiveness could be enhanced by a bold health reform to rationalize hospitals, promote primary care, and enforce transparency.
To safeguard the integrity of the pension system, social security contribution collections should continue to flow to the relevant funds under new streamlined collection procedures. At the same time, proposals to reduce fees and strengthen the governance structure of mandatory private pension funds are welcome given the need to improve these funds’ performance.
Readying the financial sector to support the recovery
The financial system is stable but operating in a challenging low-growth environment. Reflecting prudent supervisory policies, the overall capital adequacy ratio (16.7 percent in June 2012) is comfortably exceeding the 12 percent regulatory minimum, with a high level of Tier 1 capital. Non-performing loans (NPLs) have reached 16.9 percent of total loans on a gross basis and are on an upward trend although at a slower pace. The coverage of IFRS provisions is about 45 percent while additional capital cushions are also available in form of specific provisions amounting to 22 percent of NPLs. Strong deposit growth and subdued credit demand created space for the system to boost liquidity buffers and reduce external funding. Profitability remained positive system-wide, but was reduced by large impairments.
A comprehensive strategy to address problem assets may allow banks to play a more supportive role in the recovery. Banks should actively address non-performing assets by loan restructuring, asset disposals, or write-downs. The process should be closely monitored by the Bulgarian National Bank (BNB), which should continue to press for conservative provisioning and prudent recognition of interest on NPLs. Furthermore, introducing a fast track court approval procedure for pre-agreed reorganization plans would facilitate faster and more cost effective debt resolution.
Continued vigilance, contingency planning, and stronger safety nets are a priority in the present environment. The BNB is closely monitoring banks and co-operates actively with home supervisors. It has required additional capital and liquidity buffers where needed, policies which should be sustained as long as necessary. Strengthening the BNB’s bank resolution powers and tool-kit by introducing “purchase and assumption” and “bridge bank” options should proceed in line with the proposed EU directive on bank resolution frameworks.
Strengthening the legal framework for debt resolution
A more efficient insolvency framework would help reduce the burden of non-performing debts in the corporate and financial sectors. Problems in the insolvency process related to back-dating as well as delays in court processes have contributed to a situation where businesses rarely write-down non-performing loans.
The problem of back-dating insolvencies needs to be urgently addressed. The possibility of backdating insolvencies that triggers automatic invalidation of a wide range of transactions is raising credit and operational risks, undermines the predictability of private contract enforcement, creates moral hazard in borrowers and therefore discourages bank lending. Changing the law to disallow backdating and to have “avoidance rules” which could, but do not automatically, void certain transactions would largely address this problem.
More generally, a comprehensive review of frameworks and practices for insolvency and creditor rights is needed. Such a review could identify ways to address weaknesses in insolvency processes and put forward appropriate amendments to the relevant legislation.
Reinforcing the policy framework to deal with prolonged uncertainty
As demonstrated since 2009, the fiscal reserve plays a vital role in Bulgaria’s policy framework, complementing prudent policies with buffers to counter shocks. In a highly uncertain environment and within the policies set by the currency board, the benefit of such a reserve is enhanced and complements other crisis management tools. The July eurobond secured resources for upcoming debt repayments and temporarily boosted the reserve. Saving any overperformance with respect to the 2012 fiscal deficit target, proceeding with budgetary plans of domestic debt issuance, and saving privatization proceeds would bolster the reserve without raising net debt. A more comprehensive approach that includes assets as well as debt would make public debt management more effective. The debt management strategy should be complemented with a review of how the fiscal reserve is structured and funded to meet the need for a liquidity buffer, and how it functions with respect to a savings vehicle for aging, which would allow the benefits and costs of the reserve to be better tailored to changing economic conditions.
Reforms to aid job creation and income convergence
The crisis has left unemployment high, especially amongst the young and less skilled. Since 2009, increases in private sector average real wages have surpassed productivity gains. The increase in wages reflects compositional changes in employment and, particularly, the impact of rising minimum social security thresholds. While effective in combating the grey economy, social security thresholds have raised the costs of employing lower skilled workers. The upcoming review of the system should identify the adjustments necessary to alleviate these costs. Looking forward, wage increases need to be anchored in productivity gains to preserve Bulgaria’s competitiveness while making progress towards better living standards. As identified in the National Reform Program, this puts the onus on active labor market policies, better education, and training to raise productivity.
Boosting EU funds absorption is critical to improve Bulgaria's productivity and growth prospects. Reforms implemented over the course of 2011 have resulted in higher EU funds absorption, especially in the priority areas of infrastructure and human resource development. Further reforms, which also would prepare the ground for the new program period, could include enhancement of municipal capacity, introduction of a framework law to govern the procedures and process for EU funds’ management, and more use of external project evaluators.
The mission would like to thank the authorities and other interlocutors for productive and collaborative discussions.