## 1. Spillovers Channels from the War in Ukraine ## Source details **Canonical URL:** [1. Spillovers Channels from the War in Ukraine](https://www.imf.org/-/media/files/publications/cr/2022/english/1bgrea2022001.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2022/english/1bgrea2022001.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2022/english/1bgrea2022001.pdf.json) --- ### Context: A succession of shocks - Health crisis: as of mid-May 2022, Bulgaria had the second highest cumulative death rate in the world. - April 2022: government lifted the “epidemiological emergency situation.” - Political stalemate in 2021 delayed policymaking (three parliamentary elections, caretaker government), delaying the Recovery and Resilience Plan (RRP), the 2022 budget, and the euro adoption changeover plan. - War in Ukraine effects: - April 27, 2022: Russia suspended gas delivery to Bulgaria; Bulgaria secured alternative supplies so far. - May 30, 2022: EU embargo on most oil from Russia exempted Bulgaria until December 2024. - The war affects the economy through multiple channels and complicates policy tradeoffs. ### A recovery before the war — key macroeconomic and fiscal facts - Real GDP growth: 4.2 percent in 2021 following a 4.4 percent contraction in 2020. - Wage growth: 11.5 percent in 2021. - Real GDP reached 2019Q4 level in 2021Q3 but remained almost 6¼ percent below its pre-pandemic trend in 2021. - Unemployment rate: 4.6 percent in 2021Q4. - Growth in 2022Q1: 1 percent Q/Q (flash); later revised to 0.8 percent q/q in supplementary information. - HICP inflation: 12.1 percent y-o-y in April 2022; core HICP inflation rose to 6.0 percent (core HICP defined by staff as HICP excluding energy, food, alcohol and tobacco). - Producer price index inflation: 49.8 percent y-o-y in April. - Government froze retail electricity, district heating, and water prices since December 2021. - Current account: deficit of 0.4 percent of GDP in 2021 (down from 0.1 percent of GDP in 2020). - SDR allocation equivalent: EUR 1.05bn. - Gross external debt: 59 percent of GDP in 2021 (declined in 2021). - COVID-related fiscal measures reached 5 percent of GDP in 2021 (initial plan about 2½ percent of GDP); fiscal deficit on a cash basis: 2.9 percent of GDP in 2021 (0.7 percentage points lower than targeted). Underspending in investment: 2 pp of GDP. Public debt: 23.8 percent of GDP. - Prudential measures phased out: private debt moratorium extended until March 2021 (payments deferred up to December 2021) has expired. BNB required full capitalization of banks’ 2019 and 2020 profits but removed dividend restrictions and discontinued the limit on banks’ foreign exposures effective April 1, 2022. - Selected COVID-related fiscal measures (share of GDP): - Household support: 1.0 (2020); 2.4 (2021); 0.5 (2022). - Corporate support: 0.2 (2020); 0.4 (2021); 0.3 (2022). - Job retention scheme: 0.8 (2020); 0.7 (2021); 0.3 (2022). - Health: 0.6 (2020); 1.3 (2021); 0.4 (2022). - Total: 3.2 (2020); 5.0 (2021); 1.5 (2022). - Banking sector: NPL ratio 5.1 percent in 2021Q3 (from 6.6 percent in 2019Q4). Return on equity: 8.7 percent in 2021Q3 (from 5.2 percent in 2020). Sovereign spreads widened by 39 basis points as of May 10, 2022 compared to three months earlier. - Euro accession: authorities aim to join the euro in January 2024; changeover action plan adopted in May 2022. ### Clouded outlook, heightened uncertainty, and downside risks - Staff tentative projection: Real GDP growth to slow to 2¾ percent in 2022. - Projection assumptions: - No new COVID-19 wave requiring mobility restrictions. - Natural gas from Russia fully replaced with alternative supplies. - Inflation projection: - Above 12 percent on average in 2022 and about 4 percent in 2023. - Average core inflation: above 8 percent in 2022 and about 6 percent in 2023. - Year-on-year inflation expected to peak over the summer before gradually abating, contingent on a decline in commodity prices. - Medium-term: - EU-funded public investment (about two-thirds of public investment) and NGEU grants estimated to amount to about 12 percent of 2019 GDP, need to be utilized by 2026. - Potential growth expected to decelerate to about 2¾ percent. - Staff projects Bulgaria’s real GDP could be about 4 percent below pre-COVID trend by 2027. - Risks highlighted: - War and sanctions spillovers could more severely affect trade, production, inflation, and financial stability than baseline. - Wider suspension of Russian gas deliveries could lead to EU-wide gas supply shortage. - Low COVID-19 vaccination increases risk of renewed waves. - Supply-chain disruptions and volatile commodity prices could entrench inflation and erode real incomes. - Second-round effects of higher production costs could increase headline and core inflation. - Higher energy prices may increase credit risks. - Faster-than-assumed tightening of financing conditions would increase borrowing costs. - Authorities’ view: - Broad agreement with outlook and risks. - Confident Bulgaria can secure alternative gas supplies despite Gazprom suspension. - Baseline inflation projections close to staff’s. - Authorities somewhat more pessimistic about 2022 growth and concerned about severe tail risks (e.g., impact on the season’s harvest). - Expect medium-term growth support from EU-funded public investment and domestic capital investment. ### Spillover channels from the war — Box 1 key findings - Main channels: higher commodity prices and lower trading partners’ demand; lower confidence affecting investment. Energy dependence on Russia is a significant vulnerability exposed by the gas shut-off. Financial sector has little exposure to Russia or Ukraine. - Trade exposure: - Exports to Russia and Ukraine are relatively small: 0.6 percent of GDP each. - EU accounts for two-thirds of Bulgaria’s exports. - Commodity supply links: Ukraine and Russia are key suppliers of grains and certain metals used by Bulgarian industry. - Tourism: pre-COVID tourism accounted for 3 percent of GDP and traditionally depended on Ukrainian and Russian visitors; proximity to the war may deter international tourists. - Contribution to inflation: surging commodity prices contributed 4.5 pp to inflation in the past 6 months; food and energy account for more than a third of the HICP basket. - Energy dependence: - Before the war, Russia supplied three-quarters of Bulgaria’s gas use and half of its oil/oil products use. - Bulgaria imports all its nuclear fuel from Russia (stocks worth several years of production). - Russia supplied 46 percent of Bulgaria’s energy mix (24 percent excluding nuclear fuel). - Financial exposures (BNB estimates): - Bulgarian resident banks’ exposure to Russian borrowers is less than 0.5 percent of total credits. - No Russian bank operates in Bulgaria. - No material withdrawal of funding from Bulgarian subsidiaries by parent banks exposed to Russia. - Direct investment: Russia and Ukraine each account for less than 2 percent of Bulgaria’s outward direct investment; they represent 5 percent and less than ½ percent of inward direct investment, respectively. - Portfolio investment exposure to Russia (asset side): less than ½ percent of total. - Refugees: about 85,000 at end May 2022 (number rose through mid-May then declined slightly; remains lower than in countries bordering Ukraine). - Bulgaria implements EU-level sanctions on Russia. ### Risks of gas or oil supply disruptions — Box 2 key findings - Energy mix shares: - Gas represents 13 percent and oil/oil products represent 24 percent of Bulgaria’s energy mix. - Bulgaria imports 99 percent of these resources, of which 75 percent of gas and 52 percent of oil/oil products are from Russia (2020). - Baseline assumption: no disruption because since Gazprom’s suspension, supplies have been provided from alternative sources including LNGs and Azeri gas through existing infrastructure via Greece and Turkey. - Infrastructure: - A new interconnector with Greece with capacity to carry more than Bulgaria’s entire consumption is close to completion and expected to be operational in 2022H2. - Risks: - A wider suspension of Russian gas deliveries to more EU countries, including the largest consumers, could lead to an EU-wide gas supply shortage that could affect Bulgaria, even though Bulgaria’s imports represent less than 1 percent of EU total gas imports. - Although Bulgaria was exempted until 2024 from the EU embargo on most oil imports from Russia adopted in May 2022, escalation of sanctions or countersanctions could cut supply of Russian oil to Bulgaria. This could result in a shortage of crude oil given technical difficulty to substitute all Russia’s oil used in Bulgaria’s only refinery in the short run. - Use concentration: district heating utilities consume about a third of gas supply; other industrial sectors account for another third; remaining consumption is for direct input to production (e.g., chemicals) and other sectors. Most crude oil is used by the refinery, majority owned by a Russian oil company; refined products are domestically consumed and exported. - Scenario analyses: partial equilibrium methodologies indicate the potential near-term impact of supply disruptions of oil is greater than that of gas. Simulations assume input substitution and likely underestimate short-run impact and ultimate GDP loss because they do not capture full demand impacts (e.g., lower external demand from EU partners and confidence effects). ### Gas supply risks and illustrative scenario (Box 2 concluded) - Gas storage as of mid-May was estimated to be sufficient to sustain consumption for 1½ months. - Illustrative scenario: a reduction of supply of about one fifth for a year would translate into a GDP decline of about 1 percent. - The heating sector would be the most severely affected by the gas shortage as district heating companies currently operate largely on gas. - Other sectors affected (reflecting gas-usage intensity) include Chemical, Non-metallic minerals, Transport, Oil refining, and Metal processing. - Together these sectors account for about 13½ percent of gross value added of intermediate consumption output (2014 data). ### Oil supply risks and illustrative scenario (Box 2 concluded) - Under an illustrative scenario of a 20 percent decline in oil supply, the forward-linkage model suggests an impact on GDP of about -6 percent per year. - The most affected sectors would be Transport, Agriculture, forestry and fishing, and Metallurgy. - These sectors account for some 12 percent of gross value added of intermediate consumption output. ### Sectoral impact (Three-Stage Forward Linkage Model) — affected sectors (20 percent decline scenarios) - 20 Percent Decline in Gas Supply to Bulgaria (percent change): Electricity & heating; Chemical; Non-metallic minerals; Transport; Oil refining; Metallurgy; Paper, pulp & printing; Food, beverages & tobacco; Other industry; Mining & quarrying; Agriculture, forestry & fishing; Commercial, institutional services & other. - 20 Percent Decline in Oil Supply to Bulgaria (percent change): Transport; Agriculture, forestry & fishing; Metallurgy; Oil refining; Other industry; Mining & quarrying; Electricity & heating; Food, beverages & tobacco; Non-metallic minerals; Chemical; Commercial, institutional services & other; Paper, pulp & printing. ### Monetary policy stance and credit conditions - Policy rate projection: "1.5 percent in 2023 from 0.5 percent currently." - Guidance: "Possible further increases will need to consider the strength of the recovery to ensure that credit to corporates remains sufficiently available to support private investment." - Considerations for additional measures: - Introduction of borrower-based measures "could also be considered if signs of overheating in the real estate market were to emerge." - Supervisory actions: "Supervisors should continue to ensure that banks monitor asset quality for possible deterioration and proactively resolve NPLs." - Credit risk drivers: - "Lagged impact of withdrawing COVID-19 related support" - "Impact of surging commodity prices and supply-chain disruptions on corporates" - "Rising interest rates" - "Emergence of imbalances in the housing market" ### Authorities’ views on supervision and macroprudential policy - Supervisory commitment: "The authorities are committed to a supervisory approach that ensures that banks maintain strong capital positions and proactively manage risks." - Assessment of moratorium expiry: "Bank supervisors noted no evidence so far of cliff effects from the expiration of the private debt moratorium, reflecting banks’ prudent approach." - Policy adjustments made by authorities: - "They lifted the ban on dividends, including from 2021 profits, and discontinued the limit of banks’ foreign exposures as they assessed that banks would preserve sufficient capital to maintain credit flows and absorb a possible deterioration in asset quality." - Concerns and preemptive stance: - "They saw the need to preempt a buildup of credit risks as the interest cycle could have a detrimental effect on credit quality." - Use of capital tools: "They considered that CCCB provide banks with an adequate tool to manage rising risks under the BNB’s conservative policy in implementing capital rules." - Stance on borrower-based macroprudential tools: - "They are not considering introducing borrower-based macroprudential tools that they see as having implementation challenges, being of limited efficiency, and distorting incentives." ### Housing market indicators (excerpted) - Chart labels and series: "House Price Index" and "Loans for House Purchase" showing "House Purchase Price and Housing Loans (Percent change, y-o-y)." - Data sources: "Sources: Eurostat; and IMF staff calculations." ### Structural reforms for competitiveness, inclusiveness, and green transition - Reform priority: "Structural reforms should accelerate to raise growth and enable the needed economic transformation." - Role of EU funds: "Investment and reforms supported by the EU funds can play a crucial role in this regard." - RRP objectives: "Bulgaria’s recovery and resilience plan (RRP) plan aims to strengthen the judicial and business environment, increase investment in digital infrastructure and in education, and accelerate the decarbonization of the energy sector (Box 4)." ### Judicial and anti-corruption reforms - Planned measures: "Reforming the office of the Prosecutor General and the Supreme Judicial Council, and establishing an anti-corruption commission with investigative powers and a commission for assets recovery." - Legislative action noted: "Parliament adopted a law to close specialized anti-corruption courts, which the government" (excerpt ends). ### Box 4 — Bulgaria: National Recovery and Resilience Plan (RRP) - Approval and purpose: "Bulgaria’s National Recovery and Resilience Plan was approved by the European Council in May 2022." - Funding accessed: - Access to an estimated EUR 6.3bn in grants (10 percent of GDP) over 2022–26 (amount subject to revision, based on GDP growth data for 2020-21). - Bulgaria decided not to request any of the EUR 4.5 bn (7 percent of GDP) loans that it is also eligible for under the RRF, focusing on the absorption of the large amount of grants. - Structure: RRP comprises four pillars (excerpt continues beyond the available text). ### National RRP allocation priorities (shares) - 25.3 percent: boost competitiveness and transformation into a knowledge-based economy through interventions in education, digital skills, science, innovation, and technologies. - 41.9 percent: Green Bulgaria — sustainable growth through accelerated adoption of renewables for power generation and promotion of energy efficiency and sustainable transport. - 18.3 percent: Connected Bulgaria — raise competitiveness and promote sustainable regional development via transport and digital connectivity and support for local development. - 14.6 percent: Fair Bulgaria — target disadvantaged people to achieve more inclusive growth through effective and efficient public institutions. ### Governance, AML/CFT, digitalization, and energy policy (high-level points) - Governance and rule of law: - Improving judicial effectiveness and independence and strengthening anti-corruption legal framework are vital. - Implementation requires clear strategy, timeline, and substantial resources. - Operational requirements: effective coordination of anti-corruption institutions; smooth transition of structures; transparency to build trust. - Continue aligning SOE governance with OECD guidelines (law on public enterprises adopted in 2019). - AML/CFT and financial integrity: - Continue improving AML/CFT framework and address issues from forthcoming MONEYVAL assessment. - Recommended measures: publish beneficial ownership information of public procurement contracts; conduct ex-post audits of pandemic-related spending. - Bulgaria’s termination of citizenship-by-investment program welcomed; concerns remain about residency-by-investment scheme. - Digitalization, skills, and innovation: - Priorities: bridge digital skill gaps; invest in digital infrastructure; promote digital start-ups and firm digital adoption. - Key statistics: - 29 percent of population aged 16-74 has at least basic digital skills. - 11 percent have above-basic skills. - ICT specialists account for 3.3 percent of total employment. - EU averages: basic digital skills roughly double Bulgaria’s; above-basic skills about three times Bulgaria’s; ICT specialists at 4.3 percent of total employment. - Energy policy and green transition: - Energy policy must balance near- and medium-term needs. - Bulgaria emits more GHG than other EU members when compared to economy size due to energy-intensive sectors, coal reliance, and inefficient buildings/transport. - Decarbonization strategy: shift electricity away from coal to low-carbon sources including nuclear and renewables; increase buildings and transport efficiency. - NGEU-financed investments in renewables and energy efficiency should be accelerated where possible. - When prices recede, consider maintaining incentives for energy saving and investment in renewables, and reduction of coal use through price-based mechanisms and fiscal tools while protecting vulnerable households. ### Authorities’ stated views on reforms and energy - Improving governance and fighting corruption is a key priority; authorities view closing specialized anti-corruption courts as improving judicial efficiency. - Committed to strengthening AML/CFT framework and following MONEYVAL. - Committed to accelerating digitalization and the green transition with NGEU support: - Accelerate e-government and increase digital skills. - Strengthen academia-business links to boost innovation. - Plan electricity sector reforms and investments in renewables and battery storage financed by NGEU. - Regulatory reforms and NGEU financing to improve energy efficiency in transportation and buildings. - Protect vulnerable households when prices are liberalized, based on a definition of “energy poverty” to be introduced. - See little room for tax tools to provide energy saving incentives because of already low overall taxation. ### Staff appraisal — outlook, risks, and fiscal policy advice - Macroeconomic environment: - War in Ukraine has clouded the outlook, heightened uncertainty, and increased downside risks. - War dampens growth and accelerates inflation; high energy dependence from Russia is a significant vulnerability. - Key risks: stronger spillovers from the war (including disruptions in energy supply), a resurgence of COVID-19, protracted supply-chain disruptions, faster-than-anticipated tightening of global financing conditions. - Fiscal policy recommendations: - Fiscal policy needs to be flexible given large uncertainty. - 2022 budget adopted in February strikes a reasonable balance between supporting incomplete recovery and not fueling inflation further. - Mid-year budget revision should be approached flexibly; potential measures include reprioritization of spending and possibly a looser fiscal stance if activity disappoints significantly. - Public spending composition: - Reorientation toward more public investment is welcome but planned increase may run against absorption capacity and requires phasing in new projects more gradually. - Nominal freeze of the wage bill is no longer desirable with inflation running high. - Mid-year budget revision should account for new needs emerging from the war, such as supporting refugees. - Existing subsidies to companies and price caps should be gradually shifted to direct support to vulnerable households to help cope with high energy prices. - Reduction in VAT rates should be discontinued as it is regressive and no longer needed. - Medium-term fiscal consolidation: - Planned consolidation is broadly appropriate and should be accompanied by expenditure and revenue-management reforms. - Prudence motivated by aging and shrinking population, the currency board arrangement, and need to preserve buffers. - Fiscal space could be expanded by increasing public spending efficiency and reviewing taxation to increase revenue and redistribution. - Recommend a holistic review of the pension system to target sustainability and adequate pension levels. - Financial sector vigilance: - Authorities should continue monitoring possible increases in credit risk. - Macroprudential measures during the pandemic strengthened banks’ balance sheets and helped maintain credit flows. - Authorities have recently tightened macroprudential policy in response to accelerating credit growth to households. - Banking sector remains well capitalized and liquid with very little direct exposure to Russia or Ukraine; systemic risks appear low. - Credit risk may rise because of surging commodity prices, supply-chain disruptions, rising interest rates, withdrawing COVID-19 support, or housing market imbalances. - Recommendation: continue monitoring asset quality and ensure banks proactively manage risks and maintain strong capital positions. - Structural reforms: - Accelerating structural reforms is crucial to raise living standards and promote a more competitive, inclusive, and green economy. - With euro area accession in sight, fostering income convergence with EU partners is important. - Government focus on strengthening governance and fighting corruption is welcome. - Steadfast efforts to improve judicial and anticorruption systems are essential. - Ongoing efforts to harness digital technologies and foster innovation are needed to raise productivity. - Effective implementation of planned investment in renewables and energy efficiency will strengthen energy security and reduce carbon footprints. - When energy prices decline, incentives for green transition could be supported by price-based mechanisms and fiscal tools. - NGEU funds have a key role to play to support efforts in these areas. - Procedural recommendation: - It is recommended that the next Article IV consultation be held on the standard 12-month cycle. ### Key statistics and projections (selected exact figures) - RRP allocation shares: - 25.3 percent (competitiveness / knowledge-based transformation) - 41.9 percent (Green Bulgaria) - 18.3 percent (Connected Bulgaria) - 14.6 percent (Fair Bulgaria) - Real GDP growth (Table 1 / Table 2 projections): - 2018: 2.7 - 2019: 4.0 - 2020: -4.4 - 2021: 4.2 - 2022: 2.8 - 2023: 4.0 - 2024: 4.1 - 2025: 2.9 - 2026: 2.8 - 2027: 2.8 - HICP (average): - 2018: 2.6 - 2019: 2.5 - 2020: 1.2 - 2021: 2.8 - 2022: 12.2 - 2023: 4.1 - 2024: 1.8 - 2025: 2.0 - 2026: 2.0 - 2027: 2.0 - General government gross debt (percent of GDP): - 2018: 20.1 - 2019: 18.3 - 2020: 23.3 - 2021: 23.8 - 2022: 23.1 - 2023: 25.5 - 2024: 27.3 - 2025: 29.1 - 2026: 28.1 - 2027: 26.8 - Current account balance (percent of GDP) projections: - 2018: 0.9 - 2019: 1.9 - 2020: -0.1 - 2021: -0.4 - 2022: -1.3 - 2023: -1.2 - 2024: -1.3 - 2025: -3.3 - 2026: -1.3 - 2027: -0.1 - Net international investment position (percent of GDP): - 2018: -37.0 - 2019: -30.2 - 2020: -27.1 - 2021: -19.7 - 2022: -16.3 - 2023: -13.9 - 2024: -12.2 - 2025: -13.2 - 2026: -12.0 - 2027: -10.2 - Fiscal figures (percent of GDP) — selected: - Revenue: 2018: 34.4; 2019: 34.9; 2020: 35.0; 2021: 37.5; 2022: 36.5; 2023: 37.3; 2024: 36.8; 2025: 35.5; 2026: 35.9; 2027: 35.7 - Expenditure: 2018: 34.3; 2019: 35.9; 2020: 38.0; 2021: 40.4; 2022: 39.4; 2023: 39.5; 2024: 38.4; 2025: 36.9; 2026: 36.0; 2027: 35.3 - Net lending/borrowing: 2018: 0.1; 2019: -1.0; 2020: -2.9; 2021: -2.9; 2022: -2.8; 2023: -2.2; 2024: -1.6; 2025: -1.3; 2026: -0.1; 2027: 0.3 - Monetary and financial sector indicators (selected): - Broad money (percent change): 2018: 8.8; 2019: 9.9; 2020: 10.9; 2021: 10.7 - Domestic private credit (percent change): 2018: 8.9; 2019: 9.7; 2020: 4.5; 2021: 8.8 - Capital to risk-weighted assets examples: 2016: 22.2; 2017: 22.1; 2018: 20.4; 2019: 20.2; 2020 Q1: 22.7; Q2: 22.5; Q3: 22.9; 2021: 22.4 - Nonperforming loans to total gross loans: 2016: 13.2; 2017: 10.4; 2018: 7.8; 2019: 6.6; 2020: 5.8; 2020 Q1: 5.6; Q2: 5.4; Q3: 5.1 ### Annex I — Public Debt Sustainability Analysis (selected) - Public debt increased to 23.8 percent of GDP in 2021, up from 23.3 percent of GDP in 2020 and 18.3 percent of GDP in 2019. - Public gross financing needs returned to their pre-pandemic average of 3.8 percent of GDP. - 2021 domestic bond issuance: BGN 3.8 billion (in line with domestic borrowing limit of BGN 4.5 billion). - Short-term projection (2022): - Staff projects fiscal deficit to decrease by 0.1 percent of GDP between 2021 and 2022. - Nominal deficit increases by BGR 0.5 billion or +13 percent in 2022, offset by nominal GDP growth of +17 percent reflecting an exceptionally high increase in the projected GDP deflator. - Public debt expected to decline to 23.1 percent of GDP in 2022 from 23.8 percent in 2021. - Gross financing needs projected to increase to 4.7 percent of GDP in 2022 from 3.8 percent of GDP in 2021. - Medium-term projections (2023–2027): - General government gross debt projected to peak at 29.1 percent in 2025 and decline to 26.8 percent of GDP in 2027. - Fiscal balance projected: deficit of 2.2 percent of GDP in 2023 and surplus of 0.3 percent of GDP in 2027. - Baseline scenario key indicators (selected nominal gross public debt percent of GDP series): - 2020 = 20.9; 2021 = 23.3; 2022 = 23.8; 2023 = 23.1; 2024 = 25.5; 2025 = 27.3; 2026 = 29.1; 2027 = 28.1; 2028 = 26.8. - Stress-test outcomes: - Under various single and combined shocks, public debt would not exceed 36 percent of GDP and gross financing needs would remain below 7 percent of GDP in the medium term. ### Annex III — Risk Assessment Matrix (selected risks and policy responses) - Global risks: - Russia’s invasion of Ukraine escalation: Likelihood: High; Impact if Realized: High. - Policy responses include accelerating regional cooperation on energy security; loosening fiscal stance to accommodate war-related spending; extending support to vulnerable households. - Rising and volatile food and energy prices: Likelihood: High; Impact if Realized: High. - Policy responses include accelerating structural reforms and extending support to vulnerable households. - Outbreaks of lethal COVID-19 variants: Likelihood: Medium; Impact if Realized: High. - Policy responses include allowing automatic stabilizers to operate and using fiscal space if needed. - De-anchoring of inflation expectations: Likelihood: Medium (U.S.) / Medium/Low (Euro area); Impact if Realized: Low/Medium. - Policy responses include faster consolidation and adjustment of macro-prudential rules. - Domestic risks: - Delays in policy development due to fragmented politics: Likelihood: High/Medium; Impact if Realized: High. - Policy response: accelerate reform implementation to build confidence and foster private investment. ### Annex IV — Digital Transition: Challenges and Policy Agenda (selected) - Digital skills and human capital: - 29 percent of population aged 16-74 has at least basic digital skills. - 11 percent have above-basic skills. - ICT specialists: 3.3 percent of total employment (EU average: 4.3 percent). - Connectivity: - Bulgaria scores 63 below the EU average in overall broadband take-up of households subscribing to internet 77. - Lagging in take-up of high-speed fixed broadband of at least 100 Mbps. - Policy priorities: improve high-speed internet access in less populated regions and secure connectivity to public institutions. - Enterprise digital adoption: - Bulgarian enterprises make low use of digital technology; e-commerce engagement remains limited. - Policy responses: support SME digitalization, Industry 4.0 technologies, and selection of European Digital Innovation Hubs. - eGovernment and digital public services: - Since 2018, institutions required to exchange documents via an electronic document exchange platform. - Unified model for electronic administrative services developed by SEGA. - In 2020, a private consortium received a 24-month EU grant to set up the first Bulgarian EBSI node and develop three use cases. - Digital public services for enterprises and open data use are now above EU average; users of e-government: 36 percent of internet users (EU average: 64 percent). Digital public services for citizens score 57/100 (EU average: 75). - Digital payments: - First six months of 2021: value of payments through RINGS increased by 30 percent y/y; value of payments in euro through TARGET2-BNB increased by 66 percent. - Authorities exploring digital currency payment options and aligning with ECB and EC initiatives (PISA, MiCA). ### Annex V — Main Recommendations of the 2020 Article IV and Authorities’ Actions (selected) - Fiscal policy recommendations and actions: - Continue fiscal support during COVID-19 and improve design/implementation (authorities expanded measures and improved targeting). - Shift policy post-pandemic to facilitate resource reallocation and transformation; use EU funds (RRP measures included). - Strengthen revenue mobilization and public investment efficiency (tax collection improved; no change to tax system). - Review public sector wages and pension system (government intends to rationalize public sector employment and review pensions in mid-2022 revision). - Structural reform recommendations and actions: - Strengthen active labor market policies, education quality, and social protection (public investment, education, and healthcare prioritized in 2022 budget; RRP measures included). - Strengthen governance (parliament adopted law to close specialized anti-corruption courts as first step). - Financial sector recommendations and actions: - Steer macroprudential policy to allow banks room to absorb asset quality deterioration while extending credit (BNB announced gradual increases in countercyclical capital buffers through 2023). - Encourage timely recognition and resolution of problem loans (banks proactively managing credit risks). - Supplementary developments since staff report (June 3, 2022): - GDP growth for 2022Q1 revised to 0.8 percent q/q from 1 percent flash estimate. - Political development: TISP left coalition on June 8, 2022; government continued as minority; policymaking and reform prospects dimmed. - Draft revised 2022 budget includes anti-inflation measures (lower VAT for bread, district heating and gas; exemption of electricity from excise; tax breaks for families with children; pension increases). - Staff estimates if revised budget fully implemented deficit and cyclically-adjusted deficit could be 0.4 percent of GDP larger than indicated in staff report. - Pensions: average pension would increase by about a third between June 2022 and October 2022 due to permanent incorporation of bonuses and changes in calculation; long-term sustainability requires holistic review. - Impact of Draft Revised Budget on Fiscal Projections (percent of GDP): - Revenue: Staff Report 36.5 — Revised Projections 36.9 - o/w Tax revenue (incl. social contributions): 28.1 — 27.8 - o/w Grants: 3.3 — 4.0 - Expenditure: 39.4 — 40.1 - o/w Compensation of employees: 6.7 — 6.7 - o/w Goods and Services: 5.6 — 5.8 - o/w Social spending: 16.3 — 16.7 - o/w Capital expenditure: 5.3 — 5.3 - Balance: -2.8 — -3.2 - Cyclically-adjusted balance: -2.6 — -3.0 *Source: International Monetary Fund staff report for the 2022 Article IV Consultation with Bulgaria (excerpts).* ### 1. Spillovers Channels from the War in Ukraine __________________________________________________ 9 ### 1. Spillovers Channels from the War in Ukraine ### Context: A succession of shocks - The health crisis from the pandemic was severe; as of mid-May 2022, Bulgaria had the second highest cumulative death rate in the world. - As of April 2022, the government lifted the “epidemiological emergency situation.” - Political stalemate in 2021 delayed policymaking (three parliamentary elections, caretaker government), delaying the Recovery and Resilience Plan (RRP), the 2022 budget, and the euro adoption changeover plan. - The war in Ukraine worsened Bulgaria’s external environment: on April 27, 2022, Russia suspended gas delivery to Bulgaria; Bulgaria secured alternative supplies so far. On May 30, 2022, the EU embargo on most oil from Russia exempted Bulgaria until December 2024. - The war affects the economy through multiple channels and complicates policy tradeoffs. ### A recovery before the war - Real GDP growth: 4.2 percent in 2021 following a 4.4 percent contraction in 2020. - Wage growth: 11.5 percent in 2021. - Real GDP reached 2019Q4 level in 2021Q3 but remained almost 6¼ percent below its pre-pandemic trend in 2021. - Unemployment rate: 4.6 percent in 2021Q4. - Growth in 2022Q1: 1 percent Q/Q. - HICP inflation reached 12.1 percent y-o-y in April 2022; core HICP inflation rose to 6.0 percent (core HICP defined by staff as HICP excluding energy, food, alcohol and tobacco). - Producer price index inflation: 49.8 percent y-o-y in April. - Government froze retail electricity, district heating, and water prices since December 2021. - Current account: deficit of 0.4 percent of GDP in 2021 (down from 0.1 percent of GDP in 2020). - SDR allocation equivalent: EUR 1.05bn. - Gross external debt: 59 percent of GDP in 2021 (declined in 2021). - Fiscal: COVID-related measures reached 5 percent of GDP in 2021 (initial plan about 2½ percent of GDP); fiscal deficit on a cash basis: 2.9 percent of GDP in 2021 (0.7 percentage points lower than targeted). Underspending in investment: 2 pp of GDP. Public debt: 23.8 percent of GDP. - Prudential measures phased out: private debt moratorium extended until March 2021 (payments deferred up to December 2021) has expired. BNB required full capitalization of banks’ 2019 and 2020 profits but removed dividend restrictions and discontinued the limit on banks’ foreign exposures effective April 1, 2022. - COVID-related fiscal measures (selected): household support share of GDP: 1.0 (2020), 2.4 (2021), 0.5 (2022); corporate support share of GDP: 0.2 (2020), 0.4 (2021), 0.3 (2022); job retention scheme share of GDP: 0.8 (2020), 0.7 (2021), 0.3 (2022); health share of GDP: 0.6 (2020), 1.3 (2021), 0.4 (2022). Total share of GDP: 3.2 (2020), 5.0 (2021), 1.5 (2022). - Banking sector: NPL ratio 5.1 percent in 2021Q3 (from 6.6 percent in 2019Q4). Return on equity: 8.7 percent in 2021Q3 (from 5.2 percent in 2020). Sovereign spreads widened by 39 basis points as of May 10, 2022 compared to three months earlier. - Euro accession: authorities aim to join the euro in January 2024; changeover action plan adopted in May 2022. ### Clouded outlook, heightened uncertainty, and downside risks - Staff tentative projection: Real GDP growth to slow to 2¾ percent in 2022. - Projection assumptions: no new COVID-19 wave requiring mobility restrictions; natural gas from Russia fully replaced with alternative supplies. - Inflation projection: above 12 percent on average in 2022 and about 4 percent in 2023. Average core inflation: above 8 percent in 2022 and about 6 percent in 2023. Year-on-year inflation expected to peak over the summer before gradually abating, contingent on a decline in commodity prices. - Medium-term: EU-funded public investment (about two-thirds of public investment) and NGEU grants estimated to amount to about 12 percent of 2019 GDP, need to be utilized by 2026. Potential growth expected to decelerate to about 2¾ percent. Staff projects Bulgaria’s real GDP could be about 4 percent below pre-COVID trend by 2027. - Risks: war and sanctions spillovers could more severely affect trade, production, inflation, and financial stability than baseline; wider suspension of Russian gas deliveries could lead to EU-wide gas supply shortage; low COVID-19 vaccination increases risk of renewed waves; supply-chain disruptions and volatile commodity prices could entrench inflation and erode real incomes; second-round effects of higher production costs could increase headline and core inflation; higher energy prices may increase credit risks; faster-than-assumed tightening of financing conditions would increase borrowing costs. - Authorities’ view: broadly agree with outlook and risks; confident Bulgaria can secure alternative gas supplies despite Gazprom suspension; baseline inflation projections close to staff’s; authorities somewhat more pessimistic about 2022 growth; concerned about severe tail risks (e.g., impact on the season’s harvest); expect medium-term growth support from EU-funded public investment and domestic capital investment. ### Spillover channels from the war (Box 1 key findings) - Main channels: higher commodity prices and lower trading partners’ demand; lower confidence affecting investment. Energy dependence on Russia is a significant vulnerability exposed by the gas shut-off. Financial sector has little exposure to Russia or Ukraine. - Trade exposure: Bulgaria’s exports to Russia and Ukraine are relatively small (0.6 percent of GDP each); EU accounts for two-thirds of Bulgaria’s exports. - Commodity supply links: Ukraine and Russia are key suppliers of grains and certain metals used by Bulgarian industry. - Tourism: pre-COVID tourism accounted for 3 percent of GDP and traditionally depended on Ukrainian and Russian visitors; proximity to the war may deter international tourists. - Contribution to inflation: surging commodity prices contributed 4.5 pp to inflation in the past 6 months; food and energy account for more than a third of the HICP basket. - Energy dependence: before the war, Russia supplied three-quarters of Bulgaria’s gas use and half of its oil/oil products use; Bulgaria imports all its nuclear fuel from Russia (stocks worth several years of production). Russia supplied 46 percent of Bulgaria’s energy mix (24 percent excluding nuclear fuel). - Financial exposures (BNB estimates): Bulgarian resident banks’ exposure to Russian borrowers is less than 0.5 percent of total credits. No Russian bank operates in Bulgaria. No material withdrawal of funding from Bulgarian subsidiaries by parent banks exposed to Russia. - Direct investment: Russia and Ukraine each account for less than 2 percent of Bulgaria’s outward direct investment; they represent 5 percent and less than ½ percent of inward direct investment, respectively. - Portfolio investment exposure to Russia (asset side): less than ½ percent of total. - Refugees: about 85,000 at end May 2022 (number rose through mid-May then declined slightly; remains lower than in countries bordering Ukraine). - Bulgaria implements EU-level sanctions on Russia. ### Risks of gas or oil supply disruptions (Box 2 key findings) - Energy mix shares: gas represents 13 percent and oil/oil products represent 24 percent of Bulgaria’s energy mix. Bulgaria imports 99 percent of these resources, of which 75 percent of gas and 52 percent of oil/oil products are from Russia (2020). - Baseline assumption: no disruption because since Gazprom’s suspension, supplies have been provided from alternative sources including LNGs and Azeri gas through existing infrastructure via Greece and Turkey. - Infrastructure: a new interconnector with Greece with capacity to carry more than Bulgaria’s entire consumption is close to completion and expected to be operational in 2022H2. - Risks: a wider suspension of Russian gas deliveries to more EU countries, including the largest consumers, could lead to an EU-wide gas supply shortage that could affect Bulgaria, even though Bulgaria’s imports represent less than 1 percent of EU total gas imports. Although Bulgaria was exempted until 2024 from the EU embargo on most oil imports from Russia adopted in May 2022, escalation of sanctions or countersanctions could cut supply of Russian oil to Bulgaria. This could result in a shortage of crude oil given technical difficulty to substitute all Russia’s oil used in Bulgaria’s only refinery in the short run. - Use concentration: district heating utilities consume about a third of gas supply; other industrial sectors account for another third; remaining consumption is for direct input to production (e.g., chemicals) and other sectors. Most crude oil is used by the refinery, majority owned by a Russian oil company; refined products are domestically consumed and exported. - Scenario analyses: partial equilibrium methodologies indicate the potential near-term impact of supply disruptions of oil is greater than that of gas. Simulations assume input substitution and likely underestimate short-run impact and ultimate GDP loss because they do not capture full demand impacts (e.g., lower external demand from EU partners and confidence effects). *Source: 1. Spillovers Channels from the War in Ukraine (IMF chapter).* ### Box 2. Bulgaria: Risks of Gas or Oil Supply Disruptions (Concluded) ### Box 2. Bulgaria: Risks of Gas or Oil Supply Disruptions (Concluded) ### Gas supply risks and scenario - Bulgaria’s gas storage as of mid-May was estimated to be sufficient to sustain consumption for 1½ months. - Illustrative scenario: a reduction of supply of about one fifth for a year would translate into a GDP decline of about 1 percent. - The heating sector would be the most severely affected by the gas shortage as district heating companies currently operate largely on gas. - Other sectors affected (reflecting gas-usage intensity) include Chemical, Non-metallic minerals, Transport, Oil refining, and Metal processing. - Together these sectors account for about 13½ percent of gross value added of intermediate consumption output (2014 data). ### Oil supply risks and scenario - Under an illustrative scenario of a 20 percent decline in oil supply, the forward-linkage model suggests an impact on GDP of about -6 percent per year. - The most affected sectors would be Transport, Agriculture, forestry and fishing, and Metallurgy. - These sectors account for some 12 percent of gross value added of intermediate consumption output. ### Sectoral impact (Three-Stage Forward Linkage Model) — key affected sectors - For a 20 Percent Decline in Gas Supply to Bulgaria (percent change): Electricity & heating; Chemical; Non-metallic minerals; Transport; Oil refining; Metallurgy; Paper, pulp & printing; Food, beverages & tobacco; Other industry; Mining & quarrying; Agriculture, forestry & fishing; Commercial, institutional services & other. - For a 20 Percent Decline in Oil Supply to Bulgaria (percent change): Transport; Agriculture, forestry & fishing; Metallurgy; Oil refining; Other industry; Mining & quarrying; Electricity & heating; Food, beverages & tobacco; Non-metallic minerals; Chemical; Commercial, institutional services & other; Paper, pulp & printing. _Source: IMF staff calculations._ ### 1.5 percent in 2023 from 0.5 percent currently. Possible further increases will need to consider the ### 1.5 percent in 2023 from 0.5 percent currently. Possible further increases will need to consider the ### Monetary policy stance and credit conditions - Policy rate projection: "1.5 percent in 2023 from 0.5 percent currently." - Guidance: "Possible further increases will need to consider the strength of the recovery to ensure that credit to corporates remains sufficiently available to support private investment." - Considerations for additional measures: - Introduction of borrower-based measures "could also be considered if signs of overheating in the real estate market were to emerge." - Supervisory actions: "Supervisors should continue to ensure that banks monitor asset quality for possible deterioration and proactively resolve NPLs." - Credit risk drivers highlighted: - "Lagged impact of withdrawing COVID-19 related support" - "Impact of surging commodity prices and supply-chain disruptions on corporates" - "Rising interest rates" - "Emergence of imbalances in the housing market" ### Authorities’ views on supervision and macroprudential policy - Supervisory commitment: "The authorities are committed to a supervisory approach that ensures that banks maintain strong capital positions and proactively manage risks." - Assessment of moratorium expiry: "Bank supervisors noted no evidence so far of cliff effects from the expiration of the private debt moratorium, reflecting banks’ prudent approach." - Policy adjustments made by authorities: - "They lifted the ban on dividends, including from 2021 profits, and discontinued the limit of banks’ foreign exposures as they assessed that banks would preserve sufficient capital to maintain credit flows and absorb a possible deterioration in asset quality." - Concerns and preemptive stance: - "They saw the need to preempt a buildup of credit risks as the interest cycle could have a detrimental effect on credit quality." - Use of capital tools: "They considered that CCCB provide banks with an adequate tool to manage rising risks under the BNB’s conservative policy in implementing capital rules." - Stance on borrower-based macroprudential tools: - "They are not considering introducing borrower-based macroprudential tools that they see as having implementation challenges, being of limited efficiency, and distorting incentives." ### Housing market indicators (as presented) - Chart labels and series: "House Price Index" and "Loans for House Purchase" showing "House Purchase Price and Housing Loans (Percent change, y-o-y)." - Data source attribution: "Sources: Eurostat; and IMF staff calculations." - (Note: specific chart values appear visually in the source; textual excerpt preserves the chart title and sources only.) ### Structural reforms for competitiveness, inclusiveness, and green transition - Reform priority: "Structural reforms should accelerate to raise growth and enable the needed economic transformation." - Role of EU funds: "Investment and reforms supported by the EU funds can play a crucial role in this regard." - Recovery and Resilience Plan (RRP) objectives: "Bulgaria’s recovery and resilience plan (RRP) plan aims to strengthen the judicial and business environment, increase investment in digital infrastructure and in education, and accelerate the decarbonization of the energy sector (Box 4)." ### Judicial and anti-corruption reforms - Planned measures: "Reforming the office of the Prosecutor General and the Supreme Judicial Council, and establishing an anti-corruption commission with investigative powers and a commission for assets recovery." - Legislative action noted: "Parliament adopted a law to close specialized anti-corruption courts, which the government" (text ends in source excerpt). ### Box 4 — Bulgaria: National Recovery and Resilience Plan (RRP) - Approval and purpose: "Bulgaria’s National Recovery and Resilience Plan was approved by the European Council in May 2022." - Funding accessed: "The RRP is a strategic document needed for EU member states to access EU’s Recovery and Resilience Facility (RRF)... Its approval gives Bulgaria access to an estimated EUR 6.3bn in grants (10 percent of GDP) over 2022–26 (amount subject to revision, based on GDP growth data for 2020-21)." - Loan decision: "Bulgaria decided not to request any of the EUR 4.5 bn (7 percent of GDP) loans that it is also eligible for under the RRF, focusing on the absorption of the large amount of grants." - Structure: "The RRP comprises four pillars: Innovative Bulgaria" (box text continues beyond the excerpt). *Source: IMF staff report excerpt (1bgrea2022001).* ### 25.3 percent of the RRP) will seek to boost competitiveness and transformation into a ### 1bgrea2022001 - 25.3 percent of the RRP) will seek to boost competitiveness and transformation into a ### National Recovery and Resilience Plan (RRP) priorities - 25.3 percent of the RRP will seek to boost competitiveness and transformation into a knowledge-based economy through interventions in education, digital skills, science, innovation, and technologies. - Green Bulgaria (41.9 percent) will focus on ensuring sustainable economic growth through accelerated adoption of renewables for power generation and promotion of energy efficiency and sustainable transport. - Connected Bulgaria (18.3 percent) will aim to raise competitiveness and promote sustainable regional development through enhancement of transport and digital connectivity as well as support for development based on local specificities. - Fair Bulgaria (14.6 percent) targets disadvantaged people to achieve a more inclusive growth through effective and efficient public institutions. ### Governance, rule of law, and anti-corruption - Improving the effectiveness of the judiciary and judicial independence, together with strengthening the anti-corruption legal framework, is highlighted as vital to raise ethical standards, enhance the rule of law, and promote a more inclusive economy. - Implementation will require a clear strategy and timeline to sequence reforms and substantial resources. - Key operational requirements: - Ensure effective coordination between the planned new anti-corruption institutions. - Ensure a smooth transition from one structure to another so that no case is left unaddressed. - Ensure transparency in anti-corruption efforts to build trust in the integrity of the public sector. - Reforms to continue aligning governance and oversight of state-owned enterprises with OECD guidelines, in line with the law on public enterprises adopted in 2019. ### AML/CFT and financial integrity - Continued efforts to improve the anti-money laundering and combating the financing of terrorism (AML/CFT) framework will help strengthen financial sector stability and integrity. - Addressing issues arising from the forthcoming MONEYVAL assessment is crucial. - Specific measures recommended: - Publishing the beneficial ownership information of public procurement contracts. - Conducting ex-post audits of pandemic-related spending. - Bulgaria’s recent termination of the citizenship-by-investment program is welcomed; concerns remain about the residency-by-investment scheme and potential financial integrity risks. ### Digitalization, skills, and innovation - Efforts to harness digital technologies will help raise economic potential and support income convergence (Annex IV). - Bulgaria lags EU peers in many dimensions of the digital economy, implying ample scope to accelerate digital transformation. - Priorities: - Bridging digital skill gaps. - Investing in digital infrastructure. - Promoting an ecosystem of digital start-ups to improve integration of digital technologies in firms’ business models and thereby productivity. - Authorities’ reform agenda builds on EU-wide initiatives such as the Digital Decade Compass. - Bulgaria is actively participating in the EU’s efforts to strengthen the oversight of digital payments. ### Energy policy and green transition - Energy policy needs to balance near- and medium-term needs. - Despite significant progress, Bulgaria still emits more greenhouse gas (GHG) emissions than all other EU member countries when compared to the size of the economy because: - The economy is skewed towards energy-intensive sectors. - Electricity generation heavily relies on coal. - Buildings and the transport sector remain energy inefficient. - Since Russia’s invasion of Ukraine, ensuring energy security through alternative supplies has become an immediate priority. - Authorities’ decarbonization strategy focuses on: - Gradually shifting electricity production away from coal to low-carbon sources, including nuclear and renewables. - Increasing buildings and transport efficiency. - Investment plans in renewables and energy efficiency, to be largely financed through the NGEU funds, are welcome and should be accelerated to the extent possible. - Once energy prices recede, consider maintaining incentives for energy saving and investment in renewables, and reduction of coal use through price-based mechanisms and fiscal tools while protecting vulnerable households. ### Authorities’ stated views - Improving governance and fighting corruption is a key priority. - Authorities consider that moving away from specialized anti-corruption courts will improve judicial efficiency. - Committed to further strengthening the AML/CFT framework and to follow up on assessments of the forthcoming MONEYVAL report. - Noted SOE reforms would continue, and audits of COVID-19 related spending would be undertaken. - Committed to accelerating digitalization and the green transition with NGEU support: - Accelerate e-government and increase digital skills. - Strengthen bridges between academia and businesses to boost innovation. - Plan electricity sector reforms and investment in renewables and battery storage financed by NGEU, along with envisaged decarbonization reforms, expected to lead to a further substantial decrease in GHG emissions in the medium term. - Regulatory reforms and NGEU financing to improve energy efficiency in transportation and buildings. - See need to protect vulnerable households when prices are gradually liberalized, based on a definition of “energy poverty” to be introduced. - See little room for tax tools to provide energy saving incentives because of already low overall taxation. ### Staff appraisal — outlook, risks, and fiscal policy advice - Macroeconomic environment: - The war in Ukraine has clouded the outlook, heightened uncertainty, and increased downside risks. - The war is dampening growth and accelerating inflation; high energy dependence from Russia is a significant vulnerability. - Key risks: stronger spillovers from the war (including disruptions in energy supply), a resurgence of COVID-19, protracted supply-chain disruptions, faster-than-anticipated tightening of global financing conditions. - Fiscal policy: - Fiscal policy needs to be flexible given large uncertainty. - The 2022 budget adopted in February strikes a reasonable balance between supporting the incomplete recovery and not fueling inflation further. - The planned mid-year budget revision should be approached flexibly; potential measures include reprioritization of spending and possibly a looser fiscal stance if activity disappoints significantly. - Public spending composition: - Reorientation toward more public investment is welcome but the magnitude of the planned increase may run against absorption capacity and requires phasing in new projects more gradually. - Nominal freeze of the wage bill is no longer desirable with inflation running high. - Mid-year budget revision should account for new needs emerging from the war, such as supporting refugees. - Existing subsidies to companies and price caps should be gradually shifted to direct support to vulnerable households to help cope with high energy prices. - Reduction in VAT rates should be discontinued as it is regressive and no longer needed. - Medium-term fiscal consolidation: - Planned medium-term consolidation is broadly appropriate and should be accompanied by expenditure and revenue-management reforms. - Factors motivating prudence: aging and shrinking population, the currency board arrangement, and the need to preserve buffers given uncertain external environment. - Fiscal space could be expanded by increasing public spending efficiency and reviewing taxation to increase revenue and redistribution. - A holistic review of the pension system is recommended to target sustainability and adequate pension levels. - Financial sector vigilance: - Authorities need to continue watching for possible increases in credit risk. - Macroprudential measures during the pandemic strengthened banks’ balance sheets and helped maintain credit flows. - Considering accelerating credit growth to households, authorities have recently tightened macroprudential policy. - Banking sector remains well capitalized and liquid with very little direct exposure to Russia or Ukraine; systemic risks appear low. - Credit risk may rise because of surging commodity prices, supply-chain disruptions, rising interest rates, the lagged impact of withdrawing COVID-19 support, or imbalances in the housing market. - Recommendation: continue monitoring asset quality and ensure banks proactively manage risks and maintain strong capital positions. - Structural reforms: - Accelerating structural reforms is crucial to raise living standards and promote a more competitive, inclusive, and green economy. - With euro area accession in sight, fostering income convergence with EU partners is important. - Government focus on strengthening governance and fighting corruption is welcome. - Steadfast efforts to improve the effectiveness of the judicial and anticorruption systems are essential. - Ongoing efforts to harness digital technologies and foster innovation are needed to raise productivity. - Effective implementation of planned investment in renewables and energy efficiency will strengthen energy security and reduce carbon footprints. - When energy prices decline, incentives for green transition could be usefully supported by price-based mechanism and fiscal tools. - NGEU funds have a key role to play to support efforts in these areas. - Procedural recommendation: - It is recommended that the next Article IV consultation be held on the standard 12-month cycle. ### Key statistics and projections (selected exact figures from tables and text) - RRP allocation shares: - 25.3 percent (competitiveness / knowledge-based transformation) - 41.9 percent (Green Bulgaria) - 18.3 percent (Connected Bulgaria) - 14.6 percent (Fair Bulgaria) - Real GDP growth (Table 1 / Table 2 projections): - 2018: 2.7 - 2019: 4.0 - 2020: -4.4 - 2021: 4.2 - 2022: 2.8 - 2023: 4.0 - 2024: 4.1 - 2025: 2.9 - 2026: 2.8 - 2027: 2.8 - Consumer price index (HICP, average): - 2018: 2.6 - 2019: 2.5 - 2020: 1.2 - 2021: 2.8 - 2022: 12.2 - 2023: 4.1 - 2024: 1.8 - 2025: 2.0 - 2026: 2.0 - 2027: 2.0 - General government gross debt (percent of GDP): - 2018: 20.1 - 2019: 18.3 - 2020: 23.3 - 2021: 23.8 - 2022: 23.1 - 2023: 25.5 - 2024: 27.3 - 2025: 29.1 - 2026: 28.1 - 2027: 26.8 - Current account balance (percent of GDP) projections (Table 2): - 2018: 0.9 - 2019: 1.9 - 2020: -0.1 - 2021: -0.4 - 2022: -1.3 - 2023: -1.2 - 2024: -1.3 - 2025: -3.3 - 2026: -1.3 - 2027: -0.1 - Net international investment position (percent of GDP): - 2018: -37.0 - 2019: -30.2 - 2020: -27.1 - 2021: -19.7 - 2022: -16.3 - 2023: -13.9 - 2024: -12.2 - 2025: -13.2 - 2026: -12.0 - 2027: -10.2 - Fiscal figures (Table 4b, percent of GDP): - Revenue: 2018: 34.4; 2019: 34.9; 2020: 35.0; 2021: 37.5; 2022: 36.5; 2023: 37.3; 2024: 36.8; 2025: 35.5; 2026: 35.9; 2027: 35.7 - Expenditure: 2018: 34.3; 2019: 35.9; 2020: 38.0; 2021: 40.4; 2022: 39.4; 2023: 39.5; 2024: 38.4; 2025: 36.9; 2026: 36.0; 2027: 35.3 - Net lending/borrowing: 2018: 0.1; 2019: -1.0; 2020: -2.9; 2021: -2.9; 2022: -2.8; 2023: -2.2; 2024: -1.6; 2025: -1.3; 2026: -0.1; 2027: 0.3 - Monetary and financial sector indicators (selected): - Broad money (percent change): 2018: 8.8; 2019: 9.9; 2020: 10.9; 2021: 10.7 - Domestic private credit (percent change): 2018: 8.9; 2019: 9.7; 2020: 4.5; 2021: 8.8 - Capital to risk-weighted assets (Table 6, 2016–Q3 2020 / 2021): examples include 2016: 22.2; 2017: 22.1; 2018: 20.4; 2019: 20.2; 2020 Q1: 22.7; Q2: 22.5; Q3: 22.9; 2021: 22.4 - Nonperforming loans to total gross loans (Table 6): 2016: 13.2; 2017: 10.4; 2018: 7.8; 2019: 6.6; 2020: 5.8; 2020 Q1: 5.6; Q2: 5.4; Q3: 5.1 *International Monetary Fund staff report for the 2022 Article IV Consultation with Bulgaria (excerpts).* ### Annex I. Public Debt Sustainability Analysis ### Annex I. Public Debt Sustainability Analysis ### 2021 outcomes and recent developments - Public debt increased to 23.8 percent of GDP in 2021, up from 23.3 percent of GDP in 2020 and 18.3 percent of GDP in 2019. - Public gross financing needs returned to their pre-pandemic average of 3.8 percent of GDP. - In 2021, the authorities issued domestic bonds worth BGN 3.8 billion; this was in line with the domestic borrowing limit of BGN 4.5 billion of new domestic debt for the year. ### Short-term projection (2022) - Staff projects the fiscal deficit to decrease by 0.1 percent of GDP between 2021 and 2022. - Nominal deficit increases by BGR 0.5 billion or +13 percent in 2022, offset by nominal GDP growth of +17 percent reflecting an exceptionally high increase in the projected GDP deflator. - Despite a 14 percent increase in nominal euros terms, public debt is expected to decline as a share of GDP to 23.1 percent in 2022 from 23.8 percent in 2021. - Gross financing needs are projected to increase to 4.7 percent of GDP in 2022 from 3.8 percent of GDP in 2021. ### Medium-term projections (2023–2027) - General government gross debt is projected to decline over the medium term. - Fiscal balance projected path: - Deficit of 2.2 percent of GDP in 2023. - Surplus of 0.3 percent of GDP in 2027. - Consolidation driver: gradual reduction in expenditure in percent of GDP. - Public debt-to-GDP ratio projected to: - Peak at 29.1 percent in 2025. - Decline to 26.8 percent of GDP in 2027. - Alternative scenarios indicate: - Public debt would not exceed 36 percent of GDP under various shocks in the medium term. - Gross financing needs would remain below 7 percent of GDP under those scenarios. ### Baseline scenario key indicators (selected, as reported) - Nominal gross public debt: 2020 = 20.9; 2021 = 23.3; 2022 = 23.8; 2023 = 23.1; 2024 = 25.5; 2025 = 27.3; 2026 = 29.1; 2027 = 28.1; 2028 = 26.8 (percent of GDP). - Public gross financing needs: 2020 = 3.8; 2021 = 4.1; 2022 = 3.8; 2023 = 4.8; 2024 = 4.0; 2025 = 3.5; 2026 = 3.1; 2027 = 1.2; 2028 = 0.5 (percent of GDP). - Real GDP growth (in percent): 2020 = 2.1; 2021 = -4.4; 2022 = 4.2; 2023 = 2.8; 2024 = 4.0; 2025 = 4.0; 2026 = 2.9; 2027 = 2.8; 2028 = 2.8. - Inflation (GDP deflator, in percent): 2020 = 3.2; 2021 = 4.2; 2022 = 6.2; 2023 = 13.9; 2024 = 4.1; 2025 = 1.9; 2026 = 2.3; 2027 = 2.1; 2028 = 2.2. - Nominal GDP growth (in percent): 2020 = 5.5; 2021 = -0.4; 2022 = 10.7; 2023 = 17.1; 2024 = 8.4; 2025 = 6.1; 2026 = 5.3; 2027 = 5.0; 2028 = 5.1. - Effective interest rate (in percent): 2020 = 3.8; 2021 = 2.8; 2022 = 2.2; 2023 = 2.1; 2024 = 2.2; 2025 = 2.6; 2026 = 2.7; 2027 = 2.4; 2028 = 2.5. ### Contributions to changes in gross public sector debt (selected) - Change in gross public sector debt (cumulative): 2020 = 0.5; 2021 = 5.0; 2022 = 0.5; 2023 = -0.7; 2024 = 2.4; 2025 = 1.8; 2026 = 1.8; 2027 = -1.0; 2028 = -1.3; cumulative through projection horizon = 3.0 (percent of GDP). - Identified debt-creating flows (annual): 2020 = 0.8; 2021 = 5.4; 2022 = 0.9; 2023 = -0.4; 2024 = 2.8; 2025 = 2.2; 2026 = 2.2; 2027 = -0.6; 2028 = -0.9; cumulative = 5.2. - Primary deficit (annual): 2020 = 0.7; 2021 = 2.8; 2022 = 2.9; 2023 = 2.8; 2024 = 2.1; 2025 = 1.3; 2026 = 1.0; 2027 = -0.2; 2028 = -0.6; cumulative = 6.4. - Primary (noninterest) revenue and grants (percent of GDP): 2020 = 32.9; 2021 = 34.6; 2022 = 37.1; 2023 = 36.2; 2024 = 36.9; 2025 = 36.4; 2026 = 35.2; 2027 = 35.5; 2028 = 35.3; cumulative = 215.5. - Primary (noninterest) expenditure (percent of GDP): 2020 = 33.7; 2021 = 37.5; 2022 = 39.9; 2023 = 38.9; 2024 = 39.0; 2025 = 37.8; 2026 = 36.2; 2027 = 35.3; 2028 = 34.7; cumulative = 221.9. - Automatic debt dynamics (interest rate/growth differential) contributions (percent of GDP): 2020 = -0.4; 2021 = 0.6; 2022 = -1.8; 2023 = -3.0; 2024 = -1.3; 2025 = -0.8; 2026 = -0.7; 2027 = -0.7; 2028 = -0.7; cumulative = -7.3. - Residual, including asset changes (annual): 2020 = -0.3; 2021 = -0.4; 2022 = -0.4; 2023 = -0.4; 2024 = -0.4; 2025 = -0.4; 2026 = -0.4; 2027 = -0.4; 2028 = -0.4; cumulative = -2.2. ### Alternative scenarios and stress tests - Alternative scenario projections include: - Baseline, Historical, and Constant Primary Balance scenario projections for key variables (examples shown for Real GDP growth, Inflation, Primary Balance, Effective interest rate). - Constant Primary Balance scenario: Primary Balance = -2.8 for 2022–2027; Effective interest rate series provided. - Stress tests considered: - Real GDP growth shock: real GDP growth reduced by 1 standard deviation for 2020–21 with accompanying model assumptions. - Primary balance shock: primary balance for 2020–21 below baseline by 50 percent of the 10-year historical standard deviation; additional borrowing increases interest rates by 25 bp per 1 percent of GDP worsening of the primary balance. - Real interest rate shock: nominal interest rate increases by the difference between the maximum real interest rate over history (last 10 years) and the average real interest rate over the projection. - Combined macro-fiscal shock and additional scenario-specific shocks (including a one-time real depreciation of 30 percent in 2023 in a specified scenario). - Stress-test outcomes (summary): - Under various single and combined shocks, projections show increases in gross nominal public debt and public gross financing needs, but alternative scenarios indicate public debt would not exceed 36 percent of GDP and gross financing needs would remain below 7 percent of GDP in the medium term. - Predictive density plots and percentile bands indicate distributional uncertainty around baseline debt paths. ### Key methodological notes and assumptions - Public sector defined as general government. - Effective interest rate defined as interest payments divided by debt stock (excluding guarantees) at the end of previous year. - Automatic debt dynamics derived as [(r - π(1+g) - g + ae(1+r)]/(1+g+π+gπ)) times previous period debt ratio, with r = interest rate; π = growth rate of GDP deflator; g = real GDP growth rate; a = share of foreign-currency denominated debt; and e = nominal exchange rate depreciation. - Real interest rate contribution derived from numerator in footnote 5 as r - π (1+g) and real GDP growth contribution as -g. - Exchange rate contribution derived from numerator in footnote 5 as ae(1+r). - Residual includes asset changes and interest revenues (if any); for projections, includes exchange rate changes during the projection period. - Scenario "assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year" for tail-risk fan chart. *Source: IMF staff.* ### Annex III. Risk Assessment Matrix ### Annex III. Risk Assessment Matrix ### Global Risks: summary of risks, likelihood, impact, and policy response - Russia’s invasion of Ukraine leads to escalation of sanctions and other disruptions. Sanctions on Russia are broadened to include oil, gas, and food sectors. - Likelihood: High - Impact if Realized: High - Policy Response: - Russian countersanctions and secondary sanctions on countries and companies that continue business with Russia leads to even higher commodity prices, tighter financial conditions, and other adverse spillovers. - Accelerate the cooperation with regional partners to improve energy security. - Loosen the fiscal stance to accommodate additional spending needs related to the war. - Extend the support to the most vulnerable to protect from increases in food and energy prices. - Rising and volatile food and energy prices. Commodity prices are volatile and trend up amid supply constraints, war in Ukraine, export restrictions, and currency depreciations. - Likelihood: High - Impact if Realized: High - Policy Response: - Bouts of price and real sector volatility, including in the energy and food, affect household disposable income and confidence. - Accelerate structural reform efforts to boost productivity and to improve social protection. - Extend the support to the most vulnerable to protect from increases in food and energy prices. - Outbreaks of lethal and highly contagious COVID-19 variants. Rapidly increasing hospitalizations and deaths due to low vaccine protection or vaccine-resistant variants force more social distancing and/or new lockdowns. - Likelihood: Medium - Impact if Realized: High - Policy Response: - Low vaccination increases Bulgaria’s vulnerability to this risk. Economic activity would be disrupted leading to a contraction of domestic demand and of exports notably through tourism and investment. Supply chain disruptions result in growth slowdowns and price surges. - Allow automatic stabilizers to operate. Use fiscal space to provide adequate support and, if needed, further stimulus. - De-anchoring of inflation expectations in the U.S. and/or advanced European economies. Worsening supply-demand imbalances, higher commodity prices (in part due to war in Ukraine), and higher nominal wage growth lead to persistently higher inflation and/or inflation expectations, prompting central banks to tighten policies faster than anticipated. - Likelihood: Medium (for U.S.) / Medium/Low (for Euro area) - Impact if Realized: Low/Medium - Policy Response: - A tightening of global financing conditions may increase the cost of borrowing and, ultimately, affect lending. - Consider a more rapid consolidation path to limit the cost of rollover of public debt and adjust the macro-prudential rules if needed. ### Domestic Risks: summary of risks, likelihood, impact, and policy response - Delays in developing and implementing economic policies. Fragmented political landscape delays policy design and the structural reform agenda. - Likelihood: High/Medium - Impact if Realized: High - Policy Response: - Delays in preparing the revised 2022 budget may delay the implementation of large public investment. - Slow progress in structural reforms would reduce potential growth and employment, stalls real convergence, and increases fiscal risks. - Accelerate the implementation of the reform agenda to build confidence and foster private investment. --- ### Annex IV. Digital Transition: Challenges and Policy Agenda ### Overview and opportunities - Bulgaria can increase its productivity, deepen its European integration, and raise its economic potential by embracing the digital transition. - Authorities’ broad reform agenda builds on two initiatives: the Recovery and Resilience Facility and the Digital Decade Compass. ### Human capital and digital skills - Key findings: - Only 29 percent of the population aged 16-74 has at least basic digital skills. - Only 11 percent have above-basic skills. - ICT specialists account for 3.3 percent of total employment. - EU averages: basic digital skills roughly double Bulgaria’s (implied), above-basic skills about three times Bulgaria’s, and ICT specialists at 4.3 percent of total employment. - Risks and context: - Bulgaria continues to report a net loss of skilled labor to emigration. - Competition for frontier digital skills in Europe is expected to intensify. - Policy actions underway: - Targeted measures for digital education are part of the broader 2021-30 strategic framework for the development of education, training and learning. - An EU-funded ‘Digital Skills Development’ initiative aims to provide a framework to increase workers’ digital skills. - During the pandemic, domestic budget and EU structural funds were used to purchase digital equipment to support continuity of education and training for remote work. ### Connectivity - Key findings: - Bulgaria scores 63 below the EU average in the overall broadband take-up of households subscribing to internet 77. - Bulgaria lags further behind in the take-up of high-speed fixed broadband of at least 100 Mbps. - Constraints: - Entry barriers and high capital investment requirements have slowed deployment of advanced network technologies. - Policy priorities: - Improve access to high-speed internet in less populated regions. - Secure connectivity to all public institutions. - The RRP aims to step up connectivity networks throughout the country, with a focus on underserved regions and European interconnection. ### Enterprise digital adoption - Key findings: - Bulgarian enterprises make low use of digital technology. - Firms’ engagement in e-commerce remains limited, lagging strongly behind EU averages. - Inadequate investment in innovation by small and medium enterprises (SMEs) contributes to low digital uptake. - Policy responses: - Policies to support the digitalization of SMEs are crucial. - Authorities’ agenda includes development and introduction of Industry 4.0 technologies and selection of potential European Digital Innovation Hubs under the Digital Europe Program. - Noted programs and strategies: - “Digital Transformation of Bulgaria for the period 2020-2030” - “The 2027 national strategy for SMEs” - 2021-27 “Competitiveness and Innovation in Enterprises” Program (funded by the European Regional Development Fund) ### eGovernment and digital public services - Progress and usage: - Since 2018, all administrative institutions have been required to exchange documents using an electronic document exchange platform. - A unified model for requesting and delivering electronic administrative services was developed by the State e-Government Agency SEGA with support of EU Structural Funds. - In 2020, a private consortium received a 24-month EU grant to set up, deploy and maintain the first Bulgarian EBSI node and to develop three use cases: ESSI (European Self Sovereign Identity), notarization, and diplomas. - Digital public services for enterprises and the use of open data by public administrations are now above the EU average. - Remaining gaps: - Users of e-government represent only 36 percent of internet users (EU average: 64 percent). - Digital public services for citizens score 57 out of 100 (EU average: 75). - An outdated legal framework, lack of skills, and internet usage remain major obstacles. ### Digital payments and oversight - Payment system developments: - In the first six months of 2021, the value of payments made through the BNB-operated Real-time Gross Settlement System in BGN (RINGS) increased by 30 percent y/y. - In the first six months of 2021, the value of payments in euro through the national component system of the large-value payment system (TARGET2-BNB) increased by 66 percent. - Policy and regulatory context: - Payment services are evolving with a focus on new technologies and cybersecurity: instant payments, open banking, and mobile technologies. - Authorities explore viability of digital currency payment options. - As national regulator, the BNB aims to leverage technology to achieve cheaper, safer, and more accessible and integrated payment solutions—in line with the policies of the European Commission and the European Central Bank. - European-level initiatives noted: - ECB’s single Eurosystem oversight framework for electronic payment instruments, schemes and arrangements (PISA). - A proposal for a Regulation on Markets in Crypto-assets (MiCA) is under discussion at EC level. *Source: Annex III. Risk Assessment Matrix; Annex IV. Digital Transition: Challenges and Policy Agenda (excerpts).* ### Annex V. Main Recommendations of the 2020 Article IV ### Annex V. Main Recommendations of the 2020 Article IV Consultation and Authorities’ Actions ### Fiscal Policy - Recommendation: Continue proving fiscal support aimed at mitigating the impact of the COVID-19 crisis. Improve the implementation and design of some support measures. - Authorities’ actions: The authorities expanded the size of COVID-19 related fiscal measures in 2021 more than budgeted. The design of the several measures was improved including by increasing the targeting of the job retention scheme. - Recommendation: Once the pandemic abates, shift the policy to facilitate resource reallocation and economic transformation. Use EU funds effectively. - Authorities’ actions: The government decided to phase out the job retention scheme in 2022. The Resilience and Recovery Plan, to be supported by NGEU funds, includes measures to promote green transition and digital transformation. - Recommendation: Strengthen revenue mobilization and improve efficiency of public investment to finance reforms while to consolidate the fiscal stance over the medium-term. - Authorities’ actions: Tax collection improved thanks to improved administration, but there was no change to the taxation system. Significant room for improving spending efficiency remains. - Recommendation: Review public sector wages and pension system. - Authorities’ actions: No change yet but the government intends to rationalize public sector employment and review the pension system in the context of the announced mid-2022 budget revision. ### Structural Reforms - Recommendation: Strengthen active labor market policies to ease labor shortages, raise the quality of education to raise human capital, and improve the social protection system and access to education to alleviate inequality and poverty. - Authorities’ actions: Public investment, education, and healthcare are the 3 main priorities of the 2022 budget and the Resilience and Recovery Plan includes measures aimed at raising the quality and coverage of education, enhancing worker skills, and improving social protection. - Recommendation: Continue efforts to strengthen governance. - Authorities’ actions: As a first step toward broader judicial reforms that the authorities intend to implement to increase the efficiency and effectiveness of the anti-corruption framework, parliament adopted a law to close specialized anti-corruption courts that it deemed ineffective. ### Financial Sector Policies - Recommendation: Steer macroprudential policy to continue allowing banks room to absorb the deterioration of asset quality while extending credit. - Authorities’ actions: The authorities maintained macroprudential measures that were introduced in response to the COVID-19 crisis through 2021. The BNB announced gradual increases in the countercyclical capital buffers through 2023. - Recommendation: Continue encouraging banks timely recognition of problem loans. Once recovery takes hold, encourage proactive resolution of non-performing loans. - Authorities’ actions: Banks have continued proactively managing credit risks. The banking sector overall remains well-capitalized and liquid. ### Supplementary information and recent staff observations (since the staff report issued June 3, 2022) - GDP growth revision: - GDP growth for 2022Q1 was revised down. It is now estimated at 0.8 percent q/q, instead of 1 percent in the flash estimate, implying a lower carry over effect for the year as whole. - Political developments: - One of the parties in government left the coalition, heightening political uncertainty. On June 8, 2022, the leader of There Is Such People Party (TISP) announced that its party was withdrawing from the coalition. Without TISP’s 25 deputies, the government no longer holds a majority in parliament. The three remaining parties vowed to continue as a minority government, but snap elections may eventually need to be called. Policymaking will likely be hampered, and prospects for reforms have dimmed. - Draft revised 2022 budget and staff assessment: - A revised 2022 budget including anti-inflation measures was submitted to parliament. The draft revised budget is based on an updated macroeconomic framework, includes revised estimates of EU grants, and incorporates new measures to mitigate the impact of inflation in addition to those included in the initial budget. These measures include lower VAT rates for bread, district heating and gas, an exemption of electricity from excise payment, tax breaks for family with children, and pension increases. - Fiscal impact assessment: While the proposed revised budget leaves the fiscal balance target unchanged at 4.1 percent of GDP, staff estimates that the deficit and the cyclically-adjusted deficit could be 0.4 percent of GDP larger than indicated in the staff report if the revised budget is fully implemented. However, with no reduction in public investment, capacity constraints may slow the implementation of projects and limit the increase in the deficit. - Staff view on budget composition: Staff’s recommendations to improve the budget composition largely stand. Notably, the draft revised budget leaves unchanged planned investment, the wage bill, and the contingency reserve. VAT and excise rate cuts are untargeted and regressive. Other measures, such as the additional support to families with children and pensioners are also insufficiently targeted. - Pensions: The average pension would increase by about a third between June 2022 and October 2022 owing to: (i) a greater increase than in the initial budget, (ii) the permanent incorporation in the pensions of the bonuses that were initially introduced as a temporary response to the pandemic, and (iii) changes in pension calculation. While these measures will improve the adequacy of pensions, their long-term implication for the sustainability of the pension system remains to be assessed. This reinforces the need for a holistic review of the pension system. - Staff appraisal: The thrust of the staff appraisal remains unchanged. - Impact of the Draft Revised Budget on Fiscal Projections (percent of GDP): - Staff Report — Revised Projections - Revenue 36.5 — 36.9 - o/w Tax revenue (incl. social contributions) 28.1 — 27.8 - o/w Grants 3.3 — 4.0 - Expenditure 39.4 — 40.1 - o/w Compensation of employees 6.7 — 6.7 - o/w Goods and Services 5.6 — 5.8 - o/w Social spending 16.3 — 16.7 - o/w Capital expenditure 5.3 — 5.3 - Balance -2.8 — -3.2 - Cyclically-adjusted balance -2.6 — -3.0 *Annex V. Main Recommendations of the 2020 Article IV Consultation and Authorities’ Actions — IMF staff compilation* --- _Source: https://www.imf.org/-/media/files/publications/cr/2022/english/1bgrea2022001.pdf_