## 1. Income Tax Reform to Raise Revenues and Introduce Progressivity

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### Context and Near-Term Environment
- Euro adoption expected in January 2026; near-term benefits include lower risk premia, enhanced investor confidence, and loosening of financial conditions contingent on reform momentum and policy continuity.
- Political environment: October 2024 election was the seventh vote in four years, resulting in a minority government coalition.
- Rising incomes increase demands for welfare and equitable policies; expenditure likely to surpass revenue-generating capacity of the flat-tax regime.

### Recent Economic Developments
- Growth and demand:
  - Real GDP: grew by 3.4 percent in 2024 and by 3.2 percent in H1 2025.
  - Expansion driven by private consumption (strong credit growth and fiscal easing); investment recovering; real exports subdued in 2024 and decelerated in H1 2025.
- Labor market and wages:
  - Unemployment rate: record low of 3.5 percent.
  - Real wages: growing by about 9 percent.
  - Minimum wage: increased by 15 percent in January (linked to formula pegging it to average wage growth).
- Inflation:
  - Headline inflation: 2.1 percent at end-2024; 3.4 percent in H1 2025 (YoY).
  - Core inflation: reached 3 percent in H1 2025.
  - Acceleration linked to reinstatement of standard VAT on bread, flour, and restaurant services and administered price increases in early 2025; services are main driver.
- Fiscal developments:
  - 2024: neutral fiscal stance overall due to strong revenue collection and investment underspending.
  - 2025 preliminary cash through August: revenue growth 13 percent y-o-y; expenditure growth 20 percent y-o-y.
  - Government debt increase largely due to issuance of EUR 7.2 billion (about 6 percent of GDP) in Eurobonds.
- Banking and credit:
  - Credit to non-financial private sector: grew 14 percent (August, y-o-y).
  - Household credit: 21 percent y-o-y; corporate credit: 8 percent y-o-y.
  - Mortgage loans: grew 30 percent; mortgages represent more than half of household credit.
  - BNB borrower-based measures (BBMs) (Oct 2024): LTV limit 85 percent; DSTI limit 50 percent; maturity limit 30 years.
- External sector:
  - 2024 current account deficit: widened to 1.6 percent of GDP.
  - Net exports of services surplus: 7.3 percent of GDP; net exports of goods contracted 4.8 percent of GDP.
  - Real effective exchange rate (deflated by ULCs): appreciated by around 3 percent in 2024 and 17 percent since 2020.

### Outlook and Risks
- Growth and financing:
  - Growth projected: around 3 percent in 2025 and 2026, supported by domestic consumption and RRP-funded public investment.
  - Current account: projected to weaken to -3.8 percent in 2025 before narrowing over the medium term.
  - Planned reduction in reserve requirements expected to ease financial conditions and sustain double-digit private credit growth in 2026.
- Inflation and wages:
  - Average inflation expected at around 3½ percent in 2025 and 2026, declining gradually thereafter.
  - Wage dynamics: labor costs rising faster than productivity, squeezing profit margins and reinforcing passthrough to prices.
- Risks (tilted to the downside):
  - Domestic: overheating from strong domestic demand and expansionary fiscal policy; rapid credit expansion and mortgage exposure could create financial vulnerabilities; fading reform momentum post-euro adoption could limit benefits.
  - External: subdued activity in Europe, heightened geopolitical tensions, tighter global financial conditions; downside scenario calibrated to the April 2025 WEO (Box 1.1, Scenario A) could reduce growth by 0.1–0.2 percentage points, on average per year, over 2025–30.
  - Additional downside: tightening of sanctions on Russian energy companies operating in Bulgaria.

### Authorities’ stance
- Broad concurrence with staff on cyclical assessment and inflationary pressures from minimum and public wage indexations; authorities stressed importance of political stability.
- Authorities disagree with moving to a progressive tax regime or removing the cap on maximum insurable income; emphasized recapitalization needs for SOEs and BDB.

---

### Fiscal Outlook and Key Figures (select)
- Table highlights (percent of GDP):
  - Total revenues: 33.3 (2024); 38.3 (2025 Budget); 35.6 (IMF staff 2025); 36.3 (IMF staff 2026).
  - Tax and social-security revenues: 26.8; 29.5; 28.4; 28.3.
  - Total expenditure: 36.3; 41.2; 39.0; 39.8.
  - Capital expenditures: 3.3; 6.1; 3.9; 4.5.
  - Overall balance: -3.0; -2.9; -3.4; -3.5.
  - CAPB excluding EU grants: -3.7; -5.0; -4.4; -5.5.
- Memo: Projected RRP grants: 0.4; 2.2.
- Projection: fiscal deficit projected to increase further in 2026–27 before gradually declining, remaining above 3 percent of GDP in the medium term.

### Staff Recommendation on Fiscal Stance and Near-Term Consolidation
- Recommended stance: neutral, given demand strength and cyclical position.
- Required adjustment: about 1 percent of GDP relative to staff baseline, achievable via a mix of expenditure and revenue measures.
- Estimated yields of consolidation measures (Percent of GDP, relative to staff baseline):
  - Revenue measures:
    - Increase Social Security Contribution rate by 1 percent: 0.2
    - Increase property tax revenues: 0.2
    - Further strengthen revenue administration: 0.2
    - Accelerate excise tax increases: 0.05
  - Expenditure measures:
    - Reduce spending on goods and services: 0.2
    - Restrain public sector wage growth: 0.1
    - De-link social payments from minimum wage increase: 0.1
    - Freeze subsidies at 2025 level in nominal terms: 0.1
  - Total estimated yield: 1.2
- Additional recommendations:
  - Moderate public sector wage growth and de-link benefit indexation from average and minimum wage increases.
  - Replace untargeted subsidies with targeted transfers; improve VAT compliance.
  - Increase property taxation revenues and consider revisiting property valuations.
  - Increase excise taxes on tobacco faster.
  - Advance increase of social security contributions by one percent (planned for 2027).
  - Prioritize grant-based EU-funded investment.

### Fiscal Risks and SOE Issues
- Planned gross debt issuance: 8.2 percent of GDP; 3.2 percent of GDP to be used for capital injections into BDB and BEH (outside general government).
- BDB expected to finance municipal capital spending: 0.4 percent of GDP.
- BEH expected to pay 100 percent of 2024 dividends and a 2025 interim dividend: 0.7 percent of GDP in 2025.
- Policy note: requiring SOEs to pay dividends while recapitalizing them sends conflicting signals; greater transparency on selection, funding, and execution of municipal projects and the role of BDB is needed.

---

### Revenue Policy, Income Tax Reform Simulation (Box 1)
- Assessment: Flat-tax revenue-generating capacity appears insufficient for rising demands; medium-term options include raising personal and corporate income tax rates and moving to progressive PIT.
- Hypothetical PIT reform (implementation assumed in 2026, illustrative):
  - Reform design: progressive system with a basic deduction and three brackets taxed at 10, 14, and 20 percent.
  - Potential revenue and distribution outcomes:
    - Revenue (percent of GDP): Current regime 3.70; Reform scenario 4.72.
    - Change in tax revenue (percent of GDP): Current regime 0.00; Reform scenario 1.02.
    - Average tax rate: Current regime 10.00; Reform scenario 12.77.
    - Post-tax Gini coefficient: Current regime 55.03; Reform scenario 51.86.
    - Redistributive capacity: Current regime 0.00; Reform scenario 3.17.
    - Share paying tax: Current regime 99.97; Reform scenario 79.58.
- Complementary measures:
  - Strengthen tax administration (operational audits, enhanced audit and control procedures).
  - Consider raising corporate income tax (example noted: from 10 to 15 percent) to align with top PIT rate.

---

### Pension System: Challenges and Reform Priorities
- Current status:
  - Pay-as-you-go pension scheme deficit is widening; population aging will further increase shortfall.
  - Pensions have grown faster than implied by pension rule, including measures to ensure adequacy.
- Recommended reforms:
  - Increase contribution revenues; remove cap on insurable income.
  - Strengthen link between contributions and payments; remove ceiling on pensions and phase out pandemic-related benefits.
  - Improve pension adequacy to reduce old-age poverty.
  - Continue Roadmap for Improving the Pension System; strengthen second and third pillars and offer more flexible risk-return profiles.
- Reference: 2024 SIP “The Bulgarian Pension System: Caught Between Adequacy and Sustainability”.

---

### Financial Sector Soundness and Housing Market Risks
- Banking sector indicators (select):
  - Capital adequacy (CAR): 23 percent.
  - Mandatory capital buffers: systemic risk buffer 3 percent; countercyclical capital buffer 2 percent.
  - Return on assets: 2.3 percent.
  - Liquidity Coverage Ratio: 254 percent.
  - NPL ratio: 3.2 percent; consumer loan NPLs 3.7 percent.
  - Non-bank lenders NPL ratio: 8 percent.
- Credit and housing market:
  - Housing loans growth: 27 percent y/y; close to 60 percent of household credit.
  - House prices: grew 15.1 percent y/y in Q1 2025 (from 18.3 percent in Q4 2024).
  - Model-based overvaluation: 10–15 percent.
  - Owner occupancy: about 85 percent.
  - Vacancy rates: around one third nationally and over 25 percent in Sofia.
  - Housing cost overburden rate: declined from 20.7 percent in 2016 to 8.0 percent in 2024.
  - Affordability concerns concentrated for low-income households (30.7 percent), tenants renting at market rates (27.8 percent), and single-person households (17.6 percent).
- Policy notes:
  - Monitor household debt and mortgage growth.
  - Address supply-side constraints and target measures to preserve affordability for vulnerable groups.

---

### Euro Adoption, Liquidity, and Macroprudential Policy
- Reserve requirement change:
  - Reserve requirements lowered from 12 percent to ECB uniform rate of 1 percent in January 2026 will free excess liquidity.
  - Banks expected to redirect excess liquidity to the ECB deposit facility or to additional lending.
- Macroprudential role post-euro adoption:
  - Macroprudential policy will be primary tool for systemic risk management; BNB will no longer control bank liquidity via reserve requirements.
  - BBMs empirical effects (reported by BNB): annual mortgage growth slowed by 2 percentage points on impact; share of newly originated mortgages above DSTI limit fell from 25 to 3 percent at year-end.
  - DSTI limit of 50 percent is high regionally and may need tightening if house price growth persists.
  - Recommended frequent reassessment of BBMs, DSTI and LTV settings, and macroprudential capital buffers (Systemic Risk Buffer, Countercyclical Capital Buffer); use Pillar 2/SREP for bank-specific risks.

---

### Structural Policies and RRP Implementation
- Structural constraints:
  - Working-age population expected to decline by as much as 20 percent in the next 25 years.
  - Bulgaria ranks lowest in the EU in academic achievement and has a substantial digital skills gap.
- Priority reforms:
  - Invest in human capital, expand digital and AI-related skills, foster innovation.
  - Incentivize inactive workers (youth and minority groups) and facilitate employment of foreign workers.
  - Improve governance, competition, and innovation to boost non-price competitiveness.
- Staff estimate:
  - Closing half of structural policy gaps could raise level of GDP by 5–10 percent over the medium term (Budina et al., 2025).
- RRP implementation:
  - Full EU fund absorption could boost GDP by 1 percent in 2030; with efficiency gains, up to 2.3 percent.
  - As of end-September 2025: 22 percent (EUR 1.4 bn) of RRP grants disbursed.
  - Revised plan foresees four additional installments totaling EUR 4.9 bn before expiry in August 2026; staff baseline projects about three quarters of RRP grants will be disbursed.

---

### Governance, Rule of Law, AML/CFT, and Energy Sector
- Governance and rule of law:
  - Persistent challenges in rule of law, public procurement, and SOE governance; trust in public institutions relatively low.
  - Anti-corruption reform agenda unfinished; EC concerns could lead to suspension of RRP funding linked to these reforms.
  - Public procurement issues: prevalence of single bidder and negotiated outcomes.
- AML/CFT:
  - May 2025 MONEYVAL: upgraded technical compliance with five FATF recommendations; partial compliance in eight areas.
  - June: Parliament approved amendments to the Law on Measures Against the Financing of Terrorism.
  - To exit FATF grey list, must address remaining FATF action plan items focusing on effective implementation.
- Energy sector:
  - Challenges: significant fossil fuel reliance, highest energy intensity in the EU, untargeted subsidies, preserved regulated household tariffs, and reliance on coal-fired generation.
  - Planned actions: expand renewables, enhance grid connection and storage, add nuclear capacity, boost energy efficiency (building renovations), and implement targeted support for energy-poor households.
  - Governance reforms: reduce financial interdependence within BEH and strengthen its governance.

---

### Staff Appraisal: Key Policy Messages
- Macroeconomic stance:
  - Economic momentum strong, labor market tight, inflation elevated; wage growth driving income convergence but productivity lagging.
  - External demand subdued; external position broadly in line with fundamentals in 2024; current account projected negative near term.
- Fiscal policy:
  - Recommend fiscal tightening in 2026 to cool the economy; neutral stance in 2025–26 achievable via combined expenditure and revenue measures.
  - Moderating public wage growth and benefit indexation would generate fiscal savings and ease inflationary pressures.
  - Greater transparency needed around substantial SOE recapitalizations.
  - In medium term, raise revenue by increasing personal and corporate income tax rates and moving to progressive PIT.
- Pensions:
  - Strengthen sustainability by increasing contribution revenues, notably removing cap on insurable income; improve adequacy to reduce old-age poverty; strengthen second and third pillars.
- Macroprudential:
  - Remain nimble; rapid consumer and mortgage credit growth increases systemic risks; BBMs and capital buffers need active management post-euro adoption.
- Structural reform imperative:
  - Durably raising living standards requires reforms, governance improvements, and strategic investments in human and physical capital; RRP implementation and governance improvements are central to unlocking growth dividends.

*Source: IMF staff analysis as presented in the chapter "1. Income Tax Reform to Raise Revenues and Introduce Progressivity" (excerpts).*

### 1. Income Tax Reform to Raise Revenues and Introduce Progressivity _________________________13

### 1. Income Tax Reform to Raise Revenues and Introduce Progressivity

### Context
- Bulgaria is approaching euro adoption in January 2026.
- Political environment: the October 2024 election was the seventh vote in four years and resulted in a minority government coalition.
- Euro adoption expected near-term benefits: lower risk premia, enhanced investor confidence, and loosening of financial conditions; full benefits depend on maintaining reform momentum and policy continuity.
- As incomes rise, demands for welfare and more equitable policies are mounting, with expenditure likely surpassing the revenue-generating capacity of the flat-tax regime.

### Recent Economic Developments
- GDP and demand:
  - Real GDP grew by 3.4 percent in 2024 and by 3.2 percent in the first half of 2025.
  - Expansion driven by private consumption underpinned by strong credit growth and fiscal easing; investment is growing again.
  - Real exports subdued in 2024 and decelerated further in H1 2025.
- Labor market and wages:
  - Unemployment rate reached a record low of 3.5 percent.
  - Labor market tight with reported labor shortages despite positive net migration and increased employment of foreign workers.
  - Real wages are growing rapidly by about 9 percent.
  - Minimum wage increased by 15 percent in January (linked to the formula pegging it to average wage growth).
- Inflation:
  - Headline inflation closed 2024 at 2.1 percent; rose to 3.4 percent in the first half of 2025 (YoY).
  - Core inflation reached 3 percent in H1 2025.
  - Inflation acceleration linked to reinstatement of standard VAT on bread, flour, and restaurant services, and increases in administered prices in early 2025; services are the main driver.
- Fiscal developments:
  - 2024: neutral fiscal stance overall due to strong revenue collection and investment underspending; composition of adjustment differed from staff recommendations.
  - 2025 preliminary cash through August: revenue growth 13 percent y-o-y; expenditure growth 20 percent y-o-y.
  - Government debt increased significantly, largely due to issuance of EUR 7.2 billion (about 6 percent of GDP) in Eurobonds.
- Banking and credit:
  - Credit to the non-financial private sector grew 14 percent (August, y-o-y).
  - Household credit 21 percent vs. corporate credit 8 percent (y-o-y).
  - Mortgage loans grew 30 percent (mortgages represent more than half of household credit).
  - BNB introduced borrower-based measures (BBMs) in October 2024: Loan-to-Value (LTV) limit of 85 percent, Debt-Service-to-Income (DSTI) limit of 50 percent, and a maturity limit of 30 years.
- External sector:
  - 2024 current account deficit widened to 1.6 percent of GDP.
  - Net exports of services surplus 7.3 percent of GDP; net exports of goods contracted 4.8 percent of GDP.
  - Real effective exchange rate, deflated by ULCs, appreciated by around 3 percent in 2024 and 17 percent since 2020.

### Outlook and Risks
- Growth and financing:
  - Growth projected to remain robust at around 3 percent in 2025 and 2026, supported by domestic consumption and RRP-funded public investment.
  - Euro adoption expected to lower sovereign risk premia and enhance investor confidence; planned reduction in reserve requirements expected to ease financial conditions and keep private credit growing at double digits in 2026.
  - Current account projected to weaken to -3.8 percent in 2025 before narrowing over the medium term.
- Inflation and wages:
  - Average inflation expected at around 3½ percent in 2025 and 2026, declining gradually thereafter.
  - Wage dynamics are a key driver; labor costs are rising faster than productivity, squeezing profit margins and reinforcing passthrough to prices.
  - Concerns about potential menu price adjustments around currency changeover; measures such as dual pricing and retail price monitoring are being implemented.
- Risks (tilted to the downside):
  - Domestic risks: overheating from persistently strong domestic demand and expansionary fiscal policy; rapid credit expansion and bank exposure to mortgages could create financial vulnerabilities; fading reform momentum post-euro adoption could limit benefits.
  - External risks: subdued activity in Europe, heightened geopolitical tensions, tighter global financial conditions; downside scenario calibrated to the April 2025 WEO (Box 1.1, Scenario A) could reduce growth by 0.1–0.2 percentage points, on average per year, over 2025–30.
  - Additional downside: tightening of sanctions on Russian energy companies operating in Bulgaria.
- Authorities broadly concurred with staff on cyclical assessment and inflationary pressures from minimum and public wage indexations; stressed importance of political stability to realize euro adoption benefits.

### Policy Discussions and Recommendations
- Overarching policy priorities linked to euro adoption:
  - Tighten and reorient fiscal policy from short-term demand support towards investment.
  - In the medium term, raise more revenue to respond to rising demands, including by moving to progressive income taxation.
  - Closely monitor credit and liquidity risks during the transition and be ready to adjust macroprudential policies.
  - Accelerate structural reforms to lift productivity, benefit from the EU single market, and secure RRP disbursements (including infrastructure and human capital investments, energy sector liberalization, and improved governance).
  - Ensure a predictable and consistent policy environment to support reforms.
- A. Fiscal Policy to Anchor Macroeconomic Stability — near-term details:
  - 2025 projected expansionary fiscal stance with a fiscal impulse of 0.7 percent of GDP (staff projection), somewhat smaller than envisaged in the 2025 budget.
  - The fiscal impulse reflects substantially lower projected revenues (2.7 percent of GDP) and large under-execution of capital expenditure, shifting composition toward consumption support.
  - Discretionary current expenditure increases in 2025 driven by a substantial increase in the public sector wage bill, notably a large pay rise in the defense and security sector.
  - Budgetary revenue measures include: increase in maximum insurable income for Social Security Contributions (SSC), reversal of reduced VAT rates, increase in excise rates, and large dividend payments from SOEs; profit tax payments from commercial banks for 2026 were frontloaded into 2025.
  - SOE recapitalization and fiscal transparency concerns:
    - Planned gross debt issuance 8.2 percent of GDP; 3.2 percent of GDP to be used for capital injections into the Bulgarian Development Bank (BDB) and Bulgarian Energy Holding (BEH), entities outside general government.
    - BDB expected to finance municipal capital spending (0.4 percent of GDP).
    - BEH expected to pay the government 100 percent of 2024 dividends and a 2025 interim dividend (0.7 percent of GDP) in 2025.
    - Policy note: requiring SOEs to pay regular and interim dividends while recapitalizing them sends conflicting signals and can constrain their ability to reinvest; greater transparency on selection, funding, execution of municipal projects, and the role of the BDB is needed.

*Source: IMF staff analysis as presented in the chapter "1. Income Tax Reform to Raise Revenues and Introduce Progressivity" (excerpts).*

### 14.      Under unchanged policies, fiscal policy

### 14.      Under unchanged policies, fiscal policy will remain expansionary in 2026.

### Fiscal outlook and key fiscal figures (2024–26)
- Table of selected fiscal aggregates (percent of GDP) — columns correspond to 2024; 2025 Budget; IMF staff 2025; IMF staff 2026:
  - Total revenues, of which: 33.3; 38.3; 35.6; 36.3
  - Tax and social-security revenues: 26.8; 29.5; 28.4; 28.3
  - Nontax revenues: 4.7; 5.4; 4.9; 4.3
  - Grants: 1.8; 3.4; 2.3; 3.7
  - Total expenditure, of which: 36.3; 41.2; 39.0; 39.8
  - Compensation: 7.9; 7.9; 8.3; 8.1
  - Use of goods and services: 3.7; 4.2; 3.8; 3.7
  - Subsidies: 3.0; 3.1; 3.0; 3.3
  - Social expenditures, including pensions: 16.8; 18.1; 18.1; 18.0
  - Capital expenditures: 3.3; 6.1; 3.9; 4.5
  - Overall balance: -3.0; -2.9; -3.4; -3.5
  - CAPB excluding EU grants: -3.7; -5.0; -4.4; -5.5
- Memo: Projected RRP grants: 0.4; 2.2
- Note: 1/ Different from the budget presentation, social insurance contributions paid for government employees are excluded from both revenue and expenditure.
- Projections: The fiscal deficit is projected to increase further in 2026–27 before gradually declining, but would still stay above 3 percent of GDP in the medium term.

### Fiscal stance recommendation and near-term consolidation options
- Staff recommendation:
  - Given underlying demand strength and the economy’s cyclical position, a neutral stance is recommended.
  - This would require an adjustment of about 1 percent of GDP, relative to staff’s baseline projections, achievable through a combination of expenditure and revenue measures.
- IMF staff estimated yields of possible fiscal consolidation measures (Percent of GDP, relative to staff's baseline projections):
  - Revenue:
    - Increase Social Security Contribution rate by 1 percent: 0.2
    - Increase property tax revenues: 0.2
    - Further strengthen revenue administration: 0.2
    - Accelerate excise tax increases: 0.05
  - Expenditure:
    - Reduce spending on goods and services: 0.2
    - Restrain public sector wage growth: 0.1
    - De-link social payments from minimum wage increase: 0.1
    - Freeze subsidies at 2025 level in nominal terms: 0.1
  - Total: 1.2

- Additional near-term recommendations (text):
  - Moderate public sector wage growth and de-link benefit indexation from average and minimum wage increases to generate fiscal savings and ease inflationary pressures.
  - Reduce expenditure on goods and services and replace untargeted subsidies (e.g., electricity subsidies to businesses) with targeted transfers to enhance spending efficiency.
  - Improve VAT compliance.
  - Increase property taxation revenues (e.g., revisit property valuations for tax purposes) to raise revenue and help cool the housing market.
  - Increase excise taxes on tobacco faster to secure additional resources.
  - Advance the increase of social security contributions by one percent (planned for 2027) to strengthen pension system finances.
  - Prioritize EU-funded investment that is grant-based to support growth without substantially adding to fiscal pressures.

### Medium-term fiscal outlook and debt risks
- Debt trends and risks:
  - Debt is on an upward trend from low levels, owing to sustained deficits and sizeable recapitalizations of SOEs.
  - Recent deterioration in fiscal outcomes adds to rising fiscal risks.
  - Addressing spending pressures from aging, defense, infrastructure, and the energy transition will require fiscal space.
  - The highest income inequality and child poverty rates in the EU, combined with migration-driven regional disparities, increase demands for equitable access to infrastructure and public goods.
- EU context:
  - The European Commission (EC) assessed in June 2025 that a deviation from the recommended net expenditure growth in 2025 could be within the flexibility provided by the escape clause.
  - Bulgaria received an allocation of Euro 3.3 billion under the EU’s SAFE instrument which, once disbursed, will increase government debt. The disbursement schedule and modalities are yet to be finalized.

### Revenue policy and tax reform (Box 1)
- Assessment:
  - The revenue-generating capacity of the flat-tax regime appears insufficient to meet increasing demands for quality services.
  - Medium-term options include increasing tax rates for personal and corporate income and moving to progressive income taxation to reduce income inequality.
  - Continued strengthening of tax administration (enhanced audit and control procedures and compliance risk management) would support revenue collection.
- Simulation of a hypothetical PIT reform (implementation assumed in 2026 for illustrative purposes):
  - Reform scenario: progressive system with a basic deduction and three brackets taxed at 10, 14, and 20 percent.
  - Potential outcomes: could generate about 1 percent of GDP in additional revenues and reduce the post-tax Gini coefficient by around 3 points.
- Bulgaria: Current PIT System and Reform Scenario Estimates for 2026 (all values in percent except otherwise indicated):
  - Revenue (in percent of GDP): Current regime 3.70; Reform scenario 4.72
  - Change in tax revenue (in percent of GDP): Current regime 0.00; Reform scenario 1.02
  - Average tax rate: Current regime 10.00; Reform scenario 12.77
  - Post-tax Gini coefficient: Current regime 55.03; Reform scenario 51.86
  - Redistributive capacity: Current regime 0.00; Reform scenario 3.17
  - Share paying tax: Current regime 99.97; Reform scenario 79.58
- Complementary measures:
  - Strengthen administration with better use of operational audits to estimate the PIT gap and enhanced tax control and auditing processes.
  - Consider a concomitant increase in the corporate income tax rate (example noted: moving from 10 to 15 percent) to align with the top PIT rate under the reform scenario.

### Pension system challenges and reform priorities
- Pension system status:
  - The deficit of the pay-as-you-go pension scheme is widening; population aging will further increase the shortfall.
  - Pensions have grown much faster than implied by the pension rule, including to ensure pension adequacy.
- Recommended reforms:
  - Strengthen financial sustainability by increasing contribution revenues; a key measure is removing the cap on insurable income (which has not kept up with wage growth).
  - Strengthen the link between contributions and payments, including by removing the ceiling on pensions and phasing out pandemic-related benefits.
  - Improve pension adequacy to reduce old-age poverty risk.
  - Continue efforts under the Roadmap for Improving the Pension System to strengthen the system's second and third pillars, beginning with offering more flexible risk-return profiles.
- Background references:
  - For background, see 2024 SIP “The Bulgarian Pension System: Caught Between Adequacy and Sustainability”.

### Financial sector soundness and housing market risks
- Banking sector metrics and risks:
  - Capital adequacy: CAR of 23 percent.
  - Mandatory capital buffers include systemic risk capital buffer of 3 percent and countercyclical capital buffer of 2 percent.
  - Profitability: return on assets 2.3 percent.
  - Liquidity: Liquidity Coverage Ratio of 254 percent.
  - Non-performing loans (NPL): NPL ratio 3.2 percent; consumer loan NPLs 3.7 percent.
  - Non-bank lenders: NPL ratio 8 percent (sector still small); risk from credit diversion to less-regulated non-bank lenders.
  - Euroization of loans and deposits has accelerated in anticipation of euro adoption.
- Credit and housing market:
  - Rapid growth of consumer credit, particularly mortgage loans, raises systemic risks.
  - Housing loans growth: 27 percent y/y and now account for close to 60 percent of household credit.
  - House prices: grew 15.1 percent y/y in Q1 2025, moderating from 18.3 percent in Q4 2024.
  - Model-based estimates suggest house prices are overvalued by 10–15 percent.
  - Owner occupancy: about 85 percent.
  - Vacancy rates: around one third nationally and over 25 percent in Sofia.
  - Housing cost overburden rate: declined from 20.7 percent in 2016 to 8.0 percent in 2024.
  - Affordability concerns concentrated for low-income households (30.7 percent), tenants renting at market rates (27.8 percent), and single-person households (17.6 percent).
  - Supply constraints: limited dwellings stock, modest supply response, higher construction costs, labor shortages, title disputes.
  - Risks: potential housing market correction could arise from a substantial economic slowdown or long-term population decline, leading to higher non-performing household loans and increased personal insolvencies.
- Policy notes:
  - Monitor household debt and mortgage growth.
  - Address supply-side constraints and target measures to preserve affordability for vulnerable groups.

### Euro adoption and liquidity management implications
- Reserve requirements and liquidity:
  - Minimum reserve requirements were increased to keep excess liquidity constrained.
  - Excess liquidity will increase once reserve requirements are lowered from 12 percent to the ECB’s uniform rate of 1 percent in January 2026.
  - After euro adoption, banks are expected to redirect excess reserves to the ECB; in the long run this could strengthen monetary transmission as lending and deposit rates become more responsive to policy rate changes and the ECB’s standing facility provides a remunerated floor.
  - Short-term caveat: competition in the dynamic mortgage market may prevent banks from raising rates immediately, limiting monetary transmission effectiveness.

### Authorities’ views
- Areas of agreement with staff:
  - Authorities agree with many recommendations, including the need to improve efficiency of current spending—particularly in health and education—and of public investment and better targeting transfers.
  - Authorities agree that wage indexations in the public sector have put a large burden on the budget and that current indexation mechanisms may not be fiscally sustainable.
  - The Roadmap for Improving the Pension System is expected to be finalized by end-2025.
- Areas of disagreement or caution:
  - Authorities do not support moving to a progressive tax regime or removing the cap on maximum insurable income.
  - They noted recent political instability has weighed on public finances and that the 2025 budget was adopted with substantial delay.
  - Authorities emphasized concerns that progressive taxation could increase tax evasion and reiterated that the flat-tax regime has served the country well.
  - They indicated the need to recapitalize SOEs and the BDB due to their role in investing in the energy sector and financing other priority investment projects.

*Sources: Authorities and IMF staff calculations.*

### 23.      Following euro adoption, macroprudential policy will become the primary tool for

### 1bgrea2025001-source-pdf - 23.      Following euro adoption, macroprudential policy will become the primary tool for

### Euro adoption and macroprudential policy
- Following euro adoption, macroprudential policy will become the primary tool for systemic risk management and will need to proactively manage credit market risks.
- The BNB will no longer be able to control accessible bank liquidity by adjusting the minimum reserve requirement.
- Most banks are not expecting an immediate impact on credit supply and are likely to hold excess liquidity in the ECB’s deposit facility, though some may channel it to additional lending, potentially compounding credit market pressures, including in housing (Annex VI).
- Empirical effects of BBMs (as reported by the BNB):
  - The annual growth rate of mortgage loans slowed by 2 percentage points on impact.
  - The share of newly originated mortgage loans above the DSTI limit dropped from 25 to 3 percent at year-end.
- The DSTI limit of 50 percent is noted as high in regional comparison and may need to be tightened should house price growth not abate.
- Policy implication: The BNB may have to nimbly adjust macroprudential instruments, particularly BBMs, to ensure credit expansion remains aligned with household incomes and to prevent the buildup of housing market imbalances.

### Authorities’ views on financial risks and BBMs
- Authorities emphasized the BNB is closely monitoring financial sector risks and agreed risks could emerge if credit expansion accelerates.
- They assessed that the BBMs are well designed and calibrated for the current situation and have been successful in containing risks, while the BNB stands ready to make adjustments as needed.
- Regarding additional liquidity release after euro adoption, the authorities consider accelerated credit expansion as unlikely, noting banks have had excess liquidity for some time.

### Monetary and banking sector developments (high-level)
- Mortgage rates kept declining, while interest (and deposit) rates for NFIs have inched up.
- Bank profitability is at historical highs; the banking sector remains well capitalized and liquid.
- NPLs remain comparatively high but continue to decline.
- Sources cited: BNB; Haver; and IMF FSI.

### Structural policies to raise medium-term growth
- Major headwinds: low productivity and a shrinking population.
  - The working-age population is expected to decline by as much as 20 percent in the next 25 years.
  - Bulgaria ranks the lowest in the EU in academic achievement and has a substantial digital skills gap (2024 Article IV Staff Report).
- Priority areas:
  - Sustained investment in human capital: enhance education outcomes, expand digital and AI-related skills, foster innovation.
  - Incentivize inactive workers—particularly youth and minority groups—to enter the labor force; facilitate employment of foreign workers.
  - Improve non-price competitiveness and close structural policy gaps, notably in governance and innovation.
- Staff estimate on structural gaps:
  - Closing half of the structural policy gaps could lead to an increase in the level of GDP in the range of 5–10 percent over medium-term (Budina et al., 2025).

### Scaling up quality public investment and RRP implementation
- Growth dividends from scaling up quality public investment:
  - Full absorption of EU funds would boost GDP by 1 percent in 2030.
  - If paired with efficiency improvements, the gain could reach 2.3 percent.
- Revised RRP:
  - Only 22 percent (EUR 1.4 bn) of the grants under the RRP were disbursed as of end-September 2025.
  - The revised plan foresees four additional installments totaling EUR 4.9 bn before funds expire in August 2026.
  - Staff baseline projects that only about three quarters of RRP grants will be disbursed.
- Implementation challenges: politically challenging reforms and ambitious investment projects mean RRP disbursement and reform milestones require immediate priority.

### Governance, rule of law, and AML/CFT
- Persistent challenges: rule of law, public procurement, and SOE governance limit reform effectiveness and public trust.
  - Trust in public institutions is relatively low; quality of justice remains a challenge; corruption is perceived as a major problem.
  - Anti-corruption reform agenda remains unfinished; critical gaps persist in ensuring transparent, merit-based, and impartial appointment procedures and securing operational independence of the new Anti-Corruption Commission.
  - Shortcomings have prompted EC concerns, possibly leading to suspension of RRP funding related to this reform.
  - In public procurement, single bidder and negotiated outcomes remain too prevalent (EC 2025 Country Report).
- AML/CFT framework:
  - The May 2025 MONEYVAL report upgraded technical compliance with five FATF recommendations; Bulgaria remains only partially compliant in eight areas.
  - In June, Parliament approved amendments to the Law on Measures Against the Financing of Terrorism.
  - To exit the FATF grey list, Bulgaria needs to address the remaining items from the FATF action plan which mainly focus on the effective implementation of the legal framework.
- Policy priorities: advance reforms to boost competition in procurement, strengthen anti-corruption enforcement, improve judicial integrity, and implement AML/CFT measures to strengthen governance and procurement transparency.

### Energy sector reforms
- Objectives: transition to a more resilient, more efficient, and cleaner energy sector with stronger governance and reduced fiscal vulnerabilities.
- Challenges:
  - Significant fossil fuel reliance, the highest energy intensity in the EU, and untargeted subsidies that distort market signals and exacerbate environmental and fiscal risks.
  - Recent legislative changes preserve regulated household tariffs and enable continued reliance on coal-fired electricity generation.
- Planned actions: expand renewable energy production, enhance grid connection and storage capacity, add nuclear capacity, boost energy efficiency (particularly through building renovations), and implement targeted support for energy-poor households.
- Governance reforms: reduce financial interdependence within Bulgarian Energy Holding and strengthen its governance to improve transparency and resource allocation.

### Authorities’ views on reforms and implementation
- Authorities agree with staff that productivity-enhancing reforms, increased labor force, and quality public investment are key to raising medium-term growth.
- Ongoing efforts:
  - Identify and engage with people not in employment or education; incentivize return of Bulgarians working abroad.
  - Facilitate employment of non-EU nationals by introducing a one-stop-shop for permits and expanding bilateral arrangements.
  - In September 2025, government launched a project to improve efficiency and quality of public investment as part of a reform to establish a sustainable framework for planning and managing public investments.
- Legislative progress: adoption of acts on whistleblower protection, AML/CFT, and personal insolvency; work underway to complete reform of the Anti-Corruption Commission.
- Energy: ongoing efforts to increase renewable energy share and improve transmission and storage capacity; efforts to define and assess energy poverty for targeted support and retail market liberalization.

### Staff appraisal: outlook, fiscal policy, pensions, and macroprudential stance
- Economic conditions:
  - Economic momentum is strong, the labor market is tight, and inflation is elevated.
  - High wage growth has driven income convergence; credit is expanding rapidly; productivity growth is lagging.
  - External demand is subdued; the external position in 2024 is assessed to be broadly in line with fundamentals; current account projected to remain negative in the near term.
- Euro adoption: a major milestone expected to strengthen institutions, enhance policy credibility, and raise medium-term growth; some benefits already visible in narrowing sovereign spreads and recent upgrades to Bulgaria’s credit rating.
- Fiscal policy recommendations:
  - Fiscal tightening in 2026 would help cool the economy.
  - A neutral stance is recommended in 2025–26, achievable by a combination of expenditure and revenue measures.
  - Moderating public wage growth and benefit indexation would generate significant fiscal savings and ease inflationary pressures.
  - Substantial recapitalization of SOEs contributes to fiscal easing and underscores need for greater transparency.
  - In the medium term, more revenue could be raised by increasing tax rates for both personal and corporate income and moving to progressive income taxation.
- Pension reform:
  - Deficit of the pay-as-you-go pension scheme is widening; population aging will further increase the shortfall.
  - Financial sustainability needs strengthening by increasing contribution revenues, notably removing the cap on insurable income.
  - Improving adequacy of pensions to reduce old-age poverty remains a priority; continue to strengthen second and third pillars.
- Macroprudential stance:
  - Macroprudential policy will need to remain nimble.
  - Rapid growth of consumer credit, particularly mortgage loans, has increased systemic risks in the real estate market.
  - With the drop in reserve requirements following euro adoption, some liquidity may flow into lending and further propel household credit; borrower-based measures will have to proactively manage credit market risks.
- Structural reform imperative: durably raising living standards requires continued structural reforms, enhanced governance, and strategic investments in human and physical capital; RRP implementation and governance improvements are central to unlocking growth dividends.

*Source: IMF staff report content from the supplied PDF chapter/section.*

### 44.      It is recommended that the next Article IV consultation be held on the standard 12-

### 1bgrea2025001-source-pdf - 44.      It is recommended that the next Article IV consultation be held on the standard 12-

### Real sector and price developments
- Growth has been generally stronger than in peers in the last three years.
- Activity driver: services sector, including public administration, is the main engine of growth.
- Retail sales growth remains robust, while industrial production has been declining since the end of 2024.
- Sentiment divergence: consumer sentiment more buoyant than business sentiment (Consumer Confidence Indicator (Avg 2010-19 = 0) vs Business Climate Indicator (Avg 2010-19 = 0)).
- Inflation dynamics:
  - Inflation accelerated in January due to inflationary policy changes compounding pressures from strong domestic demand.
  - Inflation retrenched in April as health services prices, especially hospital fees, were lowered.
- Selected chart indicators (as labeled):
  - Contributions to Gross Value Added Growth (Percent of GVA, by sector) (series through 2025Q2).
  - Industrial Production and Retail Sales Volume (Percent, YoY) (series through Jun-25).
  - Consumer Confidence and Business Climate (series through Aug-25).
  - Inflation Dynamics: Headline and Core (Percent, YoY) (series through Aug-25).
  - HICP Inflation: Goods and Services (Percent, YoY) (series through Aug-25).

### External sector developments
- Current account: deficit that opened during the pandemic is persisting.
- External demand weakness contributing to exports decline; imports holding up on robust domestic demand and military equipment purchases.
- Import and export prices declined since 2023, but are recovering.
- Financial account: decline in FDI and Eurobond issuance drove the financial account balance.
- NIIP continued to improve.
- Gross international reserves marginally declined to 40.1 percent of GDP.
- External debt remained stable at 47.6 percent of GDP.
- Chart/series highlights:
  - Current Account (Percent of GDP) (series 2015–2024).
  - External Trade (Goods and Services) (Percent, YoY) (series through Jul-25).
  - Export/Import Prices and Terms of Trade (Percent, YoY) (series through 2025Q2).
  - Financial Account (Percent of GDP) showing FDI, portfolio equity, portfolio debt, financial derivatives, other investment, reserve assets.
  - Net International Investment Position and Reserves (Percent of GDP).
  - External Debt (Percent of GDP).

### Fiscal developments
- Overall fiscal deficit remained unchanged in 2024.
- Revenue fell slightly in 2024, with a similar decline in expenditure.
- Public debt rising but continues to be among the lowest in the EU.
- At end-2024, the fiscal reserve stayed broadly unchanged from a year ago.
- Chart/series highlights:
  - Overall Balance (Percent of GDP) 2014–2024.
  - Current Primary Revenue by Components (Percent of GDP).
  - Growth of Selected Expenditure Items (Percent of GDP).
  - Government Gross Debt (Percent of GDP) 2014–2024.
  - Government Debt, 2024 (Percent of GDP) comparative across EU.
  - Fiscal Reserve Account (Percent of GDP) 2014–2025.

### Key projections and macro framework (select figures preserved exactly)
- Real GDP (annual percent change): 2024: 3.4; 2025: 3.0; 2026: 3.1; 2027: 2.8; 2028: 2.7; 2029: 2.6; 2030: 2.6.
- Real domestic demand (annual percent change): 2024: 4.7; 2025: 7.1; 2026: 3.8; 2027: 3.1; 2028: 2.1; 2029: 2.3; 2030: 2.5.
- Unemployment rate (percent of labor force): 2024: 4.2; 2025: 4.3; 2026: 3.5; 2027: 3.4; 2028: 3.3; 2029: 3.2; 2030: 3.2.
- HICP (average): 2024: 2.6; 2025: 3.6; 2026: 3.4; 2027: 2.8; 2028: 2.6; 2029: 2.5; 2030: 2.4.
- HICP (end of period): 2024: 5.0; 2025: 2.1; 2026: 4.0; 2027: 3.0; 2028: 2.7; 2029: 2.6; 2030: 2.3.
- General government net lending/borrowing (cash basis, percent of GDP): 2024: -3.0; 2025: -3.4; 2026: -3.5; 2027: -3.6; 2028: -3.3; 2029: -3.1; 2030: -3.1.
- General government gross debt (percent of GDP): 2024: 23.8; 2025: 28.4; 2026: 29.9; 2027: 31.7; 2028: 33.3; 2029: 34.7; 2030: 36.0.
- Current account balance (percent of GDP): 2024: -1.6; 2025: -3.8; 2026: -3.2; 2027: -2.6; 2028: -1.3; 2029: -0.3; 2030: -0.1.
- Gross international reserves (billions of euros): 2024: 42.1; 2025: 45.6; 2026: 47.2; 2027: 46.1; 2028: 44.8; 2029: 45.8; 2030: 46.5.
- Net international investment position (percent of GDP): 2024: -4.4; 2025: -4.9; 2026: -4.1; 2027: -4.0; 2028: -3.4; 2029: -2.0; 2030: -0.4.

### Balance of payments (select projected flows, billions of euros)
- Current account balance: 2024: -1.7; 2025: -4.3; 2026: -3.9; 2027: -3.3; 2028: -1.8; 2029: -0.4; 2030: -0.2.
- Trade balance: 2024: -5.0; 2025: -8.8; 2026: -9.2; 2027: -9.9; 2028: -9.6; 2029: -9.8; 2030: -10.2.
- Exports (f.o.b.): 2024: 43.7; 2025: 41.9; 2026: 42.7; 2027: 45.9; 2028: 49.2; 2029: 52.8; 2030: 56.5.
- Imports (f.o.b.): 2024: 48.8; 2025: 50.7; 2026: 51.9; 2027: 55.9; 2028: 58.8; 2029: 62.6; 2030: 66.7.
- Financial account balance: 2024: 0.1; 2025: -5.4; 2026: -1.3; 2027: 0.0; 2028: 1.6; 2029: 0.9; 2030: 1.5.
- Foreign direct investment balance (billions of euros): 2024: -2.0; 2025: -3.2; 2026: -4.2; 2027: -4.8; 2028: -5.1; 2029: -5.4; 2030: -5.7.

### General government operations (select nominal and percent-of-GDP figures)
- Revenue (billions of leva): 2024: 68.2; 2025: 78.8; 2026: 86.6; 2027: 86.5; 2028: 91.1; 2029: 95.3; 2030: 99.4.
- Expenditure (billions of leva): 2024: 74.3; 2025: 86.3; 2026: 94.9; 2027: 95.7; 2028: 100.1; 2029: 104.2; 2030: 108.8.
- Net lending/borrowing (billions of leva): 2024: -6.2; 2025: -7.6; 2026: -8.3; 2027: -9.2; 2028: -9.0; 2029: -8.9; 2030: -9.4.
- Net lending/borrowing (percent of GDP): 2024: -3.0; 2025: -3.4; 2026: -3.5; 2027: -3.6; 2028: -3.3; 2029: -3.1; 2030: -3.1.
- Fiscal reserve account (billions of leva): 2024: 11.4; projected constant at 11.4 through 2030 in the table.

### Monetary accounts and liquidity (select figures)
- Broad money (M3, billions of leva): 2024: 168.3; 2025: 177.8; 2026: 194.1; 2027: 210.1; 2028: 225.9; 2029: 241.8; 2030: 258.9.
- Reserve money (billions of leva): 2024: 58.1; 2025: 53.3; 2026: 59.4; 2027: 65.8; 2028: 72.2; 2029: 78.8; 2030: 86.1.
- Net foreign reserves (BNB, billions of euro): 2024: 40.1; 2025: 43.6; 2026: 45.2; 2027: 44.1; 2028: 42.8; 2029: 43.8; 2030: 44.5.
- Broad money growth (annual percent change): 2024: 8.7; 2025: 5.7; 2026: 9.1; 2027: 8.3; 2028: 7.5; 2029: 7.1; 2030: 7.1.
- Domestic private credit growth (annual percent change): 2024: 14.5; 2025: 13.1; 2026: 11.8; 2027: 10.3; 2028: 9.8; 2029: 7.9; 2030: 7.8.

### Financial soundness indicators (select 2024 values)
- Capital to risk-weighted assets: 22.7.
- Tier 1 capital to risk-weighted assets: 21.3.
- Nonperforming loans to total gross loans: 3.2.
- Nonperforming loans net of provisions to capital: 9.2.
- Return on assets: 2.3.
- Return on equity (Tier I denominator): 17.2.
- Liquid assets to total assets: 29.8.
- Customer deposits to total (non-interbank) loans: 130.7.

*Source: Bulgarian authorities; BNB; Haver Analytics; Eurostat; Bloomberg Finance L.P.; Ministry of Finance; and IMF staff estimates as presented in the provided content unit.*

### Annex I. Risk Assessment Matrix

### Annex I. Risk Assessment Matrix

### Bulgaria-specific risks
- Fiscal policy miscalibration.
  - Relative Likelihood: High
  - Expected Impact: High
  - Description: Too loose fiscal policy and fiscal slippages. Excessively expansionary fiscal policy amidst robust private demand may rekindle inflation in the short term and undermine fiscal sustainability in the medium term.
  - Policy Response: Tighten fiscal policy to support disinflation, growth, and income convergence by focusing on expanding the supply capacity of the economy.
- Political instability. Re-emerging policy uncertainty.
  - Relative Likelihood: High
  - Expected Impact: High
  - Description: Reform momentum could fade, jeopardizing progress needed to unlock RRP funds and the quality of fiscal adjustment; policy uncertainty would hamper policy making.
  - Policy Response: Shore up political and social consensus on policy continuity.
- Property market overheating and credit excess.
  - Relative Likelihood: Medium
  - Expected Impact: Medium
  - Description: Rapid credit expansion and banks’ growing exposure to mortgage credit could create vulnerabilities in the financial sector.
  - Policy Response: Continuously monitor real estate and credit risks, tighten macroprudential policies as needed.

### Global risks
- Escalating trade measures and prolonged uncertainty.
  - Relative Likelihood: High
  - Expected Impact: High
  - Description: Rising trade barriers and prolonged policy uncertainty could reduce trade, investment, and growth. Inflationary pressures may re-emerge—especially in countries imposing tariffs. These effects can be amplified by strategic complementarities or bottlenecks in global value chains or inventory overhang.
  - Assessment for Bulgaria: As a globally integrated small open economy, a disruption in trade and FDI flows will impact Bulgaria. However, deep EU integration, strengthened with euro adoption, will provide a buffer against extra-EU shocks, which will affect Bulgaria mostly indirectly through economic slowdown in trading partners.
  - Policy Response: In case of severe disruptions, targeted, time-bound fiscal measures to support vulnerable households and firms.
- Commodity price volatility.
  - Relative Likelihood: High
  - Expected Impact: High
  - Description: Shifts in supply and demand—driven by geopolitical tensions and conflicts, OPEC+ actions, or the green transition—may fuel commodity price swings, intensifying external and fiscal pressures, social unrest, and macroeconomic instability.
  - Assessment for Bulgaria: Commodities have a large weight in the inflation basket and a sharp rise in their price would hurt business and households. Adverse terms of trade shock would weaken the external position.
  - Policy Response: In the event of steep price increases, consider targeted and temporary support for the most vulnerable groups.
- Geopolitical tensions.
  - Relative Likelihood: High
  - Expected Impact: High
  - Description: Intensification of conflicts, coupled with the weakening of multilateralism, may trigger commodity price volatility, increase migration pressures, reignite inflation, and weigh on growth by undermining confidence, investment, tourism, trade, and supply chains.
  - Assessment for Bulgaria: An escalation of conflicts would affect the economy through lower external demand and disruptions of commodity trade that rekindle inflation. Direct energy and trade links with Russia and Ukraine have decreased and financial links are extremely low.
  - Policy Response: In case of severe disruptions, fiscal stimulus and well-targeted, temporary support for most vulnerable groups should be deployed.

### Definitions and caveats on likelihood and interaction of risks
- The risk assessment matrix (RAM) shows events that could materially alter the baseline path. The relative likelihood is the staff’s subjective assessment of the risks surrounding the baseline:
  - “low” is meant to indicate a probability below 10 percent,
  - “medium” a probability between 10 and 30 percent,
  - “high” a probability between 30 and 50 percent.
- The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities.
- Non-mutually exclusive risks may interact and materialize jointly.

*Source: Annex I. Risk Assessment Matrix (as provided).*

### Annex III. Figure 5. Bulgaria: Medium-Term Risk Assessment

### Annex III. Figure 5. Bulgaria: Medium-Term Risk Assessment

### Debt and Debt Fanchart Metrics
- Final Fanchart (Pct of GDP): 43.5
- Contrib 1/: 0.6
- (percent of GDP) — label retained from source

- Probability of debt non-stabilizaiton (percent): 99.9
- Contrib: 0.8

- Terminal debt-to-GDP x: 17.9
- Contrib: 0.4

- institutions index: (label present in source)
- Debt fanchart index (DFI): 1.9
- Risk signal: 3/ Moderate

### Gross Financing Needs (Pct of GDP) — GFN Module
- Average baseline GFN (percent of GDP): 4.6
- Contrib: 1.6

- Banks' claims on the gen. govt (pct bank assets): 9.6
- Contrib: 3.1

- Chg. In banks' claims in stress (pct banks' assets): 2.9
- Contrib: 1.0

- GFN financeability index (GFI): 5.7
- Risk signal: 4/ Low

### Medium-Term Index (Index Number) — Medium-Term Risk Analysis
- Debt fanchart index (normalized): 1.86 (Value)
- GFN finaceability index (normalized): 5.67 (Value)
- Medium-term index: (combined index reported in figure)
- Risk signal: 5/ Final assessment: (presented as) Moderate

- Prob. of missed crisis, 2025-2030, if stress not predicted: 18.2 pct.
- Prob. of false alarms, 2025-2030, if stress predicted: 39.8 pct.

### Thresholds and Signal Definitions (as reported in figure notes)
- 3/ The signal is low risk if the DFI is below 1.13; high risk if the DFI is above 2.08; and otherwise, it is moderate risk.
- 4/ The signal is low risk if the GFI is below 7.6; high risk if the DFI is above 17.9; and otherwise, it is moderate risk.
- 5/ The signal is low risk if the GFI is below 0.26; high risk if the DFI is above 0.40; and otherwise, it is moderate risk.

### Percentile in peer group
- Comparison group: emerging markets, non-commodity exporter, surveillance (percentile in peer group 2/)
- Percentile scale shown in figure: 0, 25, 50, 75, 100
- Visual indicators in figure: Low, Moderate, High risk bands (values shown in source graphics)

*Source: IMF staff estimates and projections.*

### Annex VI. Figure 4. Bulgaria: Cumulative Inflation Dynamics

### Annex VI. Figure 4. Bulgaria: Cumulative Inflation Dynamics

### Price conversion, dual pricing, and retail monitoring
- Dual display of prices in lev and euro became effective in early August and will remain in place for all of 2026.
- The Law on the Introduction of the Euro underpins the dual pricing requirement.
- Authorities are preparing a dedicated website to publish weekly pricing information from large retail chains.
- Government monitoring of price setting began in June 2025, with the National Revenue Authority conducting inspections in retail outlets and identifying price hikes in some of the 14 groups of goods monitored (monitoring to be continued through end-2026).
- In July, three government institutions joined forces to ensure transparency and effective competition during the changeover and to create a mechanism for joint action, including possible sanctions from October 2025. The three institutions are:
  - The Commission for the Protection of Competition (CPC)
  - The Consumer Protection Commission (CPC)
  - The Communications Regulation Commission (CRC)
- The Consumer Protection Commission tracks on its website prices of key products at large supermarkets.

### Inflation developments and recent headline figures
- HICP headline inflation rose to 4.1 percent in September (year-on-year).
- Core inflation reached 3.4 percent y/y in September.
- Prices for services strengthened to 5.2 percent y/y in September.
- In the first three quarters of 2025, average HICP inflation reached 3.5 percent compared to the same period last year.
- Staff notes that the proposed increase in the public wage bill in the draft 2026 budget presents an upside risk to inflation.

### Managing excess bank liquidity and reserve requirement change
- In January 2026, reserve requirements for domestic banks will drop by 11 percentage points to the uniform ECB rate of 1 percent of eligible liabilities, freeing up a sizable liquidity buffer for alternative investment.
- A recent survey suggests Bulgarian banks will choose to maintain a sizable part of that liquidity in the remunerated ECB Deposit Facility.
- Alternative uses of the freed-up liquidity include purchases of government securities or additional lending, subject to internal limits and risk-return considerations.
- The freed-up liquidity may, at least in part, be gradually used to augment consumer credit, particularly for house purchases — a sector that already shows signs of overheating.

### Macroprudential policy role and recommended settings
- With the loss of autonomous monetary policy tools upon euro adoption, macroprudential policy together with fiscal policy will be the principal instrument to manage domestic demand and safeguard financial stability.
- Important actions and areas to reassess frequently:
  - Borrower-based measures introduced in October 2024 should be frequently re-assessed.
  - Limits to the debt-service-to-income ratio (DSTI) and loan-to-value ratios, currently set at 50 and 15 percent, respectively, need to be reassessed and possibly finetuned periodically.
  - Revisiting the setting of macroprudential capital buffers, notably the Systemic Risk Buffer and the Countercyclical Capital Buffer, may be warranted.
  - Bank-specific risks, such as very high concentration in mortgage loans, may be addressed by Pillar 2 requirements as part of the Supervisory Review and Evaluation Process (SREP).

### Fiscal draft 2026 highlights and risks (supplementary information)
- The 2026 draft budget (to be discussed in Parliament) targets a deficit of 3 percent of GDP.
- Key policy proposals in the draft:
  - A 2-percentage point increase in the social security contribution rate and a higher ceiling for insurable income.
  - Raising the dividend income tax rate from 5 to 10 percent.
  - Increases in tobacco excise taxes.
- Estimated revenue and expenditure impacts in the draft:
  - Policy measures would raise about 1.2 percent of GDP.
  - Additional revenue gains from tax administration measures of about 1.4 percent of GDP (staff considers this optimistic).
  - Public wage expenditure is set to increase by about 11 percent.
  - The draft envisages additional discretionary spending on subsidies, transfers, and other compensation of about 0.4 percent of GDP.
  - The draft budget projects that public debt will increase to about 31 percent of GDP in 2026, including due to 2.6 percent of GDP borrowing under the EU’s SAFE instrument for defense spending.
- Staff assessment: Significant expenditure consolidation measures are absent; fiscal policy challenges and risks for 2026 remain broadly as outlined in the staff report.

### Other risks to the outlook
- Strengthened U.S. sanctions against Lukoil are set to take effect on November 21, presenting possible disruptions to fuel supply and negative budgetary implications.
- To safeguard energy security, authorities are preparing to appoint a special manager at the Burgas refinery; Lukoil announced plans to divest its international holdings.

*Annex VI. Figure 4. Bulgaria: Cumulative Inflation Dynamics — IMF staff report content.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2025/english/1bgrea2025001-source-pdf.pdf_