IMF Executive Board Concludes 2007 Article IV Consultation with Bulgaria

Public Information Notice (PIN) No. 07/142
December 19, 2007

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. The staff report (use the free Adobe Acrobat Reader to view this pdf file) for the 2007 Article IV Consultation with Bulgaria is also available.

On December 14, 2007, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Bulgaria.1


Bulgaria's large external imbalance has continued to widen. Driven by massive capital inflows, particularly foreign direct investment (FDI) inflows, the current account deficit could reach a record level of 20 percent of GDP in 2007. While the present level of the current account deficit is clearly above sustainable levels, external competitiveness has remained adequate. But, underscoring growing external vulnerabilities, the net international investment position is projected to deteriorate to about 65 percent of GDP, while gross external debt could soar to about 88 percent of GDP. At the same time, accumulation of international reserves has continued at a rapid clip, with reserves likely to top 40 percent of GDP by end-2007.

Real GDP growth in 2007 is likely to remain relatively steady at just over 6 percent, but underlying inflation pressures are building up. Investment spending has continued to boom, likely reflecting a one-off re-assessment of Bulgaria as an investment location. While FDI inflows have been mainly absorbed by nontradables sectors, the tradeables sectors share in real investment has held up well during the investment boom. Private consumption growth has remained relatively subdued over recent years, in part reflecting restrained fiscal and income policies. Labor market conditions have tightened: unemployment declined sharply and wage pressures have picked up. In this setting, headline HICP inflation has increased sharply to over 10 percent, mainly owing to food and energy price shocks. While underlying core inflation has also risen in response to higher labor cost, it has done so at a much slower pace than headline inflation.

Since 2004, fiscal policy has achieved progressively larger fiscal surpluses, mainly as the result of unspent revenue windfalls associated with the domestic demand boom. The 2007 fiscal surplus is projected to reach at least 3½ percent of GDP, while the underlying fiscal surplus position is significantly more moderate. Reflecting the prudent fiscal policy stance, the government's balance sheet is strong, with gross public debt (about 20 percent of GDP) and other liabilities more than offset by a growing fiscal reserve and other assets.

Bank credit has again started to expand rapidly after the administrative credit limits imposed during 2005-06 lapsed. With hindsight, the limits helped stimulate nonbank financial flows and did not much constrain overall private-sector credit. Banks remain well capitalized, partly reflecting the highest minimum capital adequacy ratio among the EU New Member States. Credit quality has been stable, as indicated by low nonperforming loan ratios, but this may partly reflect rapid loan portfolio growth.

Bulgaria's progress on structural reforms is at par in areas where EU legislation tends to enforce regulatory homogeneity. However, where EU accession has provided only a weak reform anchor, progress has been slow, including on raising the public sector's low efficiency, reducing costly administrative burdens on businesses, and increasing labor market flexibility.

Executive Board Assessment

Executive Directors commended the authorities for their strong record of stability-oriented macroeconomic policies, which have contributed to steady GDP growth, progress in income convergence with other EU countries, and falling unemployment. In particular, Directors considered that fiscal and incomes policies have responded prudently so far to the widening current account deficit and the investment boom, which is being driven by large foreign direct investment inflows related to Bulgaria's EU accession. Directors emphasized nevertheless that the current account deficit is unsustainable and will need to be reduced significantly over the medium term in order to contain external vulnerabilities. They also noted that, although competitiveness appears not to have been affected, domestic price pressures are rising, in large part because of region-wide increases in food and energy prices, but also because of accelerating wage increases as the labor market tightens.

Directors considered that, assuming that a strong policy framework is sustained and the requirements of the currency board arrangement continue to be met, the current account deficit will gradually normalize to a more sustainable level over the medium term. In that connection, there was strong support for the authorities' strategy of maintaining the exchange rate peg until euro adoption. Directors advised the authorities to guard against a loss of external competitiveness, which could likely entail a severe external adjustment or a prolonged period of slow growth.

Against this background, Directors commended the authorities for their commitment to maintain a fiscal framework that avoids procyclical fiscal impulses and supports sustainable convergence to EU income levels. They welcomed in particular the authorities' intention to target a large budget surplus in 2008 consistent with avoiding a loosening of the fiscal stance. Several Directors observed that an even more restrictive fiscal policy may be needed to contain demand pressures effectively and limit downside risks. It will also be important to maintain wage discipline in the public sector by keeping wage increases in line with productivity growth. Directors welcomed the planned further reductions in public sector employment, which will also help mitigate labor market overheating. They called on the authorities to review carefully spending priorities in key budget sectors, notably education and health care, with external technical assistance, if needed. They concurred with the authorities' plans to increase fiscal transparency, including by discontinuing across-the-board spending sequestration.

Directors agreed that Bulgaria's banking sector remains well supervised and regulated and that, with buffers against a possible credit cycle downturn being well maintained, the adverse spillovers from the recent tremors in global credit markets have been moderate. They nevertheless encouraged the authorities to monitor banks' risk management mechanisms closely, as bank credit growth has surged following the lapsing of administrative credit limits at the beginning of 2007. Directors considered that the predominance of subsidiaries of foreign banks in Bulgaria's financial system calls for a further strengthening of cooperation with the supervisory authorities of the parent banks. They therefore welcomed the authorities' participation in efforts to improve the EU's cross-border crisis management arrangement. Directors looked forward to the update in 2008 of Bulgaria's FSAP.

Directors encouraged the authorities to move forward decisively with much-needed structural reforms, in particular to raise public sector efficiency. They supported measures to promote labor market participation and adaptability, including by giving the social partners additional legal leeway to negotiate flexible work contracts. They welcomed the plans to activate the electronic commercial register on January 1, 2008 and to further simplify the licensing and permit systems, which would help lower the cost of doing business.

Directors concluded that Bulgaria's statistical data are broadly adequate for surveillance. Nevertheless, they encouraged further enhancements in employment, wage, and trade data. Moreover, compiling flow of funds for households and nonfinancial corporations would help deepen the understanding of sectoral vulnerabilities.

Bulgaria: Selected Economic Indicators, 2002-07
  2002 2003 2004 2005 2006 2007 1/

Output, prices, and labor market

(Annual percentage change)

Real GDP

4.5 5.0 6.6 6.2 6.1 6.4

Consumer price index (average)

5.8 2.3 6.1 6.0 7.4 7.2

Consumer price index (end of period)

3.8 5.6 4.0 7.4 6.1 9.5


0.2 3.0 2.6 2.7 2.4 2.6

Public Finance

(In percent of GDP)

General government overall balance

-0.8 -0.2 1.7 2.3 3.5 3.5

Gross public debt

56.2 48.1 40.1 31.3 24.7 21.3

Financial net worth

-10.4 6.1 8.8 9.3 11.8 13.8

Money and credit

(Annual percentage change)

Broad money (M3)

11.9 19.6 23.1 23.9 26.9 28.5

Credit claims on

non-government sector

44.0 48.3 48.7 32.4 24.6 52.5

Balance of payments

(In percent of GDP)

Merchandise trade balance

-11.3 -13.7 -14.9 -20.2 -22.2 -26.2

Current account balance

-2.4 -5.5 -6.6 -12.0 -15.7 -20.2

Gross international reserves

27.6 30.5 34.5 33.7 35.6 40.5

Exchange rates


Exchange rate regime

Currency board arrangement

Leva per euro

Lev 1.956 per Euro

Sources: Bulgarian authorities; and IMF staff estimates.

1/ Projection.

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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