## _cr04176

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### Executive summary — background and recent developments
- Macroeconomic performance generally favorable, but surge in credit growth and sharp widening of the external current account deficit point to possible overheating.
- Bank claims on the nongovernment sector rose by nearly 8 percentage points of GDP in 2003.
- External current account deficit widened to 8½ percent of GDP in 2003.
- Fiscal policy tightened in 2003: government saved half of revenue overperformance and reduced the deficit to 0.4 percent of GDP.
- Two-year SBA expired on March 15, 2004; authorities expressed interest in a successor arrangement to be treated as precautionary.
- Staff mission visited Sofia during March 25–April 13, 2004 for the 2004 Article IV consultation and Ex Post Assessment (EPA).

### Key indicators and trends (selected)
- Real GDP growth: 4¼ percent in 2003; nearly 5 percent in 2002.
- Registered unemployment rate: 13½ percent (seasonally adjusted, Q1/2004); unemployment dropped by 3½ percentage points between end-2002 and Q1/2004.
- Inflation: averaged 2¼ percent in 2003; 12-month CPI inflation rose to 5½ percent at end-2003; 6¼ percent in March 2004 (mainly reflecting higher excise taxes).
- Bank credit growth: claims on the nongovernment sector rose by nearly 50 percent in 2003; 12-month rate remained above 50 percent in March 2004.
- Broad money growth: accelerated to nearly 20 percent in 2003.
- Residential real estate prices: increased by 12¼ percent in 2003.
- Current account financing and external position:
  - FDI covered 82½ percent of the current account deficit in 2003.
  - International reserves rose to over 2½ times short-term debt.
  - External debt declined by 6½ percentage points to 58¾ percent of GDP (with 5½ percentage points of the reduction reflecting valuation effects).
  - Sovereign spreads fell to some 190 basis points; sovereign rating upgraded to one notch below investment grade.

### Fiscal developments and measurement (2003–2004)
- 2003: government balanced the budget (Actual overall fiscal balance 0.0 percent of GDP) against a programmed deficit of 0.7 percent of GDP.
- Revenue was 1½ percent of GDP higher than expected; grants were ½ percent of GDP below budget.
- Expenditure was 0.7 percent of GDP higher than budgeted due to municipal spending, clearing hospital arrears, year-end wage and pension bonuses, and other nonbudgeted items.
- Staff reclassification and fiscal accounting (In percent of GDP):
  - 2003: Actual overall fiscal balance 0.0; Budget -0.8; Rev. Budget 0.0.
  - Reclassified below-the-line (B-T-L) operations: 0.4 (for all three columns).
  - Overall fiscal balance including B-T-L operations: -0.4 (Actual), -1.2 (Budget), -0.4 (Rev. Budget).
- 2004 budget and authorities’ adjustments:
  - 2004 budget envisaged a deficit (after reclassification) of 1¼ percent of GDP.
  - Authorities intended to cut spending by ¾ percent of GDP in 2004, bringing the deficit to ½ percent of GDP.
  - Authorities intended to save up to ½ percent of GDP of any revenue overperformance, potentially bringing the budget into balance in 2004.
- Recommended fiscal implementation measures:
  - Expenditure-side correction: cap discretionary spending at 93 percent of revised levels through Q3; cut wage bill mainly via sequestering unfilled vacancies; reduce projections for capital spending and interest payments.
  - Move to accrual accounting; implement National Revenue Agency (NRA) in 2005; deploy FMIS in all ministries; incorporate lev-denominated accounts of autonomous budgetary entities in Treasury Single Account.

### External position, credit surge, competitiveness, and outlook
- Staff and authorities agree widening current account deficit increased macroeconomic risks.
- Stabilizing external debt ratio with a current account deficit of 8–9 percent of GDP over the medium term would require FDI inflows in excess of those projected.
- Two-thirds of 2003 investment was in the nontradable sector; consumer goods imports rose rapidly.
- Competitiveness indicators:
  - CPI-based REER suggested some loss of competitiveness vis-à-vis some non-EU members.
  - Unit labor costs (ULCs) in manufacturing continued to decline; economy-wide ULCs remained flat.
  - Total PPI recently increased more strongly than manufacturing PPI, indicating a relative shift toward nontradables.
- 2004 baseline projections (assuming appropriate policies):
  - Real GDP growth: 5 percent.
  - Average consumer price inflation: 5¾ percent; 12-month inflation falling to 3½ percent by year-end.
  - Growth in credit to nongovernment sector should fall to 26 percent year on year by end-2004.
  - 12-month current account deficit likely broadly unchanged for the year as a whole: 8.2 percent of GDP.
  - FDI coverage of the deficit: 82 percent coverage expected (owing partly to privatization receipts).
  - Gross external debt ratio would decline by half a percentage point of GDP.
- Medium-term outlook (authorities; staff broadly concur):
  - Medium-term growth of 5–5½ percent achievable conditional on higher investment ratio, productivity-boosting reforms, and higher labor force participation and employment.
  - Inflation should fall to 3½ percent.
  - Current account deficit projected to decline gradually to 6 percent of GDP by 2009.
  - External debt ratio projected to decline to 43 percent.
  - Sustainability scenario: only with lower exports, higher imports and smaller FDI inflows would external debt ratio rise to 64 percent in 2009.

### Risks to the baseline
- Near-term:
  - Credit and import growth might not slow if capital inflows replace reduced domestic liquidity.
  - External demand might be softer than projected (e.g., weaker EU recovery).
  - FDI might not develop as expected (implementation risk ahead of election).
- Medium-term:
  - Continued rapid credit expansion could increase financial vulnerabilities, deteriorate bank asset quality, and generate asset price bubbles.
- If risks materialize, external position would weaken, possibly requiring further policy adjustment.

### Policy stance and recommended mix
- Short run: contain domestic demand; medium run: boost export and output capacity.
- Fiscal policy is key to restrain demand under the CBA (currency board arrangement).
- Authorities’ combined strategy: tighten fiscal policy relative to initial plans; moderate credit growth by draining banking system liquidity.
- Agreed liquidity-draining measures (implemented Q2–Q3 2004):
  - Transfer government deposits from commercial banks to the central bank.
  - Tighten reserve requirements by broadening coverage to liabilities with maturities of two years or above and excluding part of banks’ cash in vault from reserve requirement calculation.
  - These measures amount to 13¾ percent of reserve money.
- Staff caveats: efficacy depends on responsiveness of capital flows to domestic monetary conditions; monitor credit growth closely and consider further measures (including minimum liquid asset ratios) if credit does not decelerate.
- Structural reform priority: revitalize reforms to raise output and export capacity and spur FDI; create a new privatization pipeline for 2005-06.

### Financial sector, FSAP follow-up, and vulnerabilities
- Banking environment: sound supervision, high capital, profitability and liquidity levels; rapid credit growth is the key concern.
- BNB supervisory actions commended: tighten loan classification and provisioning, increase on-site inspections, extend credit register, restrict conditions for including current profits in regulatory capital.
- FSAP follow-up implemented or underway:
  - Financial Sector Commission for nonbank institutions and supervisory coordination committee created; capacity and enforcement need strengthening.
  - More effective bank insolvency regime introduced but largely untested or slow to implement.
  - Payment system updated; new real-time interbank gross-settlement system launched.
- Vulnerabilities and sectoral external positions (selected exact figures):
  - Banking sector euroization: 48 percent of the sector’s liabilities are in foreign currency, mostly euros.
  - NFPS short-term external liabilities exceed liquid external foreign-currency assets by about 6 percent of GDP.
  - FPS short-term foreign-currency liabilities exceed liquid foreign-currency assets by 12½ percent of GDP.
  - Liquid foreign currency-denominated assets exceed short-term foreign-currency liabilities by more than 11 percent of GDP for the public sector.
  - Amortizations in 2004: €241 million (1.4 percent of GDP).

### Privatization, structural reforms, and sectoral measures
- Progress:
  - Bank privatization virtually completed in 2003.
  - New energy law passed; retail electricity and district heating prices raised toward cost-recovery levels.
  - Railway payrolls reduced by 10 percent; subsidies better targeted.
- Delays in crucial reforms:
  - Sale of tobacco holding (Bulgartabac) delayed.
  - Sale of telecoms company (BTC) signed for 65 percent stake in February but completion delayed by GSM license dispute (later resolved in June).
  - Operationalization of NRA delayed.
  - Health, education, and railway reforms incomplete.
- Staff urged completion of pending privatizations and creation of a new privatization pipeline for 2005-06, including plans for electricity generation sector (in cooperation with World Bank).
- Energy sector: regulator to announce 10 percent increase in average household electricity and district heating prices effective July 1, 2004.
- Railways: further payroll reductions and tariff increases planned with World Bank collaboration.

### Social sector, pensions, health, and labor market
- NSSI (National Social Security System):
  - Authorities project NSSI deficit would disappear by 2013, with rising surpluses thereafter.
  - Outlook assumes pension indexation practice of ¼ wages, ¾ prices maintained.
- Staff recommendations:
  - Enshrine indexation formula (¼ wages, ¾ prices) in law.
  - Strengthen certification process for disability pensions.
- Health care reforms: expand activity-based financing of hospitals; impose stricter controls over claims and reimbursements.
- Labor market:
  - Plan to amend labor law with World Bank to ease entry and exit from work.
  - Active labor market policies to reintegrate long-term unemployed.
  - Public sector wage policies restrained: nominal increase in aggregate wage bill of the 60 largest public enterprises limited to 4 percent in 2004.

### Trade policy and EU accession implications
- Trade policies aligned with European Commission guidance pre-accession.
- Temporary ban on exports of wheat and flour in response to poor 2003 harvest scheduled to expire on July 31, 2004.
- Authorities expected EU accession in early 2007; EU-related expenditures likely to produce a deficit in 2007 (authorities estimate 2–3 percent of GDP).
- Staff recommendation: adjust priorities to make room for EU-related spending and allow a small temporary deficit in 2007 reflecting pre-payment of agricultural subsidies.

### Program engagement with the Fund — SBA considerations
- Continued Fund engagement under a successor SBA would be appropriate provided sufficiently strong policies agreed.
- Given long-term program engagement and absence of imminent financing need, a new SBA should have lower access and be precautionary; could cover two to three years bridging to EU accession.
- Rationale: Fund support would facilitate internal consensus, provide confidence to foreign investors and lenders, and help mobilize multilateral support.
- Board views: most Directors preferred a successor SBA with lower access and precautionary character; some saw surveillance-only as an alternative.

### Data, standards, safeguards, and statistical issues
- Data quality and timeliness generally adequate for surveillance and program monitoring; some deficiencies remain (national accounts, price statistics, balance of payments revisions).
- Bulgaria subscribed to the Special Data Dissemination Standard on December 1, 2003.
- BNB implemented all but one recommendation of 2002 safeguards assessment—the establishment of an audit committee—BNB monetary board considered to perform that role.
- Core statistical indicators and data reporting characteristics updated as of May 11, 2004.

### Ex Post Assessment (EPA) findings and lessons
- EPA high-level findings (1994–2003 focus):
  - Transition difficult: GDP 40 percent below 1990 level by 1997; inflation averaged 233 percent per year during 1990–97; fiscal deficit averaged 8½ percent during 1990–97.
  - Post-1997 stabilization anchored by CBA produced high and stable growth (4–5½ percent during 2000–2003), low inflation, but remaining unemployment and poverty and emerging risks (widening current account deficit, credit boom).
- Why 1997 program succeeded:
  - Credibly severing SOEs/banks link and detailed structural conditionality; CBA provided institutional barrier to monetary financing and a coordination focal point.
- EPA conclusion: balance of arguments favors a precautionary SBA as most effective way to support the government’s economic program en route to EU accession, provided policies are sufficiently strong.

### Selected numeric tables and high-frequency updates (selected series preserved)
- Table excerpts (selected exact figures):
  - Real GDP (2000–2004): 5.4; 4.1; 4.9; 4.3; 5.0.
  - Current account (percent of GDP, 2000–2004): -5.6; -7.3; -5.6; -8.5; -8.2.
  - Claims on nongovernment (12-month percent change): 21.4; 17.0; 32.1; 44.0; 48.3; 25.9 (1999–2004).
  - Broad Money (12-month percent change): 13.4; 30.8; 25.8; 11.7; 19.6; 18.2 (1999–2004).
  - Gross international reserves (end-period, millions of euros): 3,719; 4,063; 4,575; 5,309; 5,775 (2000–2004).
  - External debt (end-period, percent of GDP): 88.2; 79.4; 65.1; 58.7; 58.2 (1999–2004).
  - FSAP/sectoral vulnerabilities: NPLs in percent of total loans: 17.3; 13.1; 8.6; 7.3 (2000–Q4-03).
- Statement by IMF Staff Representative (June 14, 2004) high-frequency updates:
  - Industrial output surged by 17¼ percent year on year in the first quarter.
  - Twelve-month external current account deficit widened to 8.8 percent of GDP in March.
  - Growth of credit to the nongovernment sector slowed from 52¼ percent y-o-y in March to 50¾ percent in April.
  - Credit to households rose by 80 percent y-o-y (April); credit to nonfinancial corporations rose by 40 percent y-o-y (April).
  - Government accumulated a cash fiscal surplus of 1.4 percent of GDP in the first four months of the year.

### Staff appraisal — summary recommendations (selected)
- Tighten macroeconomic policy to moderate demand and contain external vulnerabilities:
  - Adopt a more prudent fiscal stance and be ready to tighten further if external situation does not improve.
  - Drain banking system liquidity (transfer government deposits to BNB; tighten reserve requirements; consider minimum liquid asset ratios if needed).
- Revitalize structural reforms to enhance supply and export capacity:
  - Complete privatizations (BTC, Bulgartabac, electricity distributors) and create a new privatization pipeline for 2005-06.
  - Improve business climate, governance, and measures to spur FDI.
- Strengthen fiscal institutions and reporting:
  - Reclassify below-the-line capital transfers as expenditure where appropriate; move to accrual accounting; implement NRA and FMIS without delay.
- Financial sector:
  - Continue FSAP follow-up: strengthen supervision, loan classification, provisioning, on-site inspections, and bank insolvency framework.
  - Monitor credit growth and nonbank financial sector activity; assess currency and maturity composition of credit.
- Program engagement:
  - Support a precautionary successor SBA with lower access to facilitate policy implementation and provide confidence to markets, conditioned on sufficiently strong policy commitments.

*Source: IMF staff report — Executive Summary, Article IV consultation and Ex Post Assessment (March 25–April 13, 2004; related appendices and staff updates as provided in the source document).*

### Executive Summary ......................................................................................................

### Executive Summary

### Background and recent macroeconomic developments
- Macroeconomic performance has generally been favorable, although a surge in credit growth and a related sharp widening of the external current account deficit point to possible economic overheating.
- Bank claims on the nongovernment sector rose by nearly 8 percentage points of GDP in 2003.
- The external current account deficit widened to 8½ percent of GDP in 2003.
- Fiscal policy was tightened in 2003: the government saved half of the revenue overperformance and reduced the deficit to 0.4 percent of GDP.
- The pace of structural reform has slowed; two large privatizations and fiscal structural measures were delayed.
- The government’s popularity stabilized at low levels but it retains some latitude in policy implementation due to general wariness to hold early elections.
- A two-year SBA expired on March 15, 2004; the authorities expressed interest in a successor arrangement to be treated as precautionary.
- A staff team visited Sofia during March 25-April 13, 2004 to conduct the 2004 Article IV consultation and discuss the Ex Post Assessment (EPA).

### Key indicators and trends (selected)
- Real GDP growth: 4¼ percent in 2003; nearly 5 percent in 2002.
- Registered unemployment rate: 13½ percent (seasonally adjusted, Q1/2004); unemployment dropped by 3½ percentage points between end-2002 and Q1/2004.
- Inflation: averaged 2¼ percent in 2003; 12-month CPI inflation rose to 5½ percent at end-2003; 6¼ percent in March 2004 (mainly reflecting higher excise taxes).
- Bank credit growth: claims on the nongovernment sector rose by nearly 50 percent in 2003; the 12-month rate remained above 50 percent in March 2004.
- Broad money growth: accelerated to nearly 20 percent in 2003.
- Residential real estate prices: increased by 12¼ percent in 2003.
- Current account financing and external position:
  - FDI covered 82½ percent of the current account deficit in 2003.
  - International reserves rose to over 2½ times short-term debt.
  - External debt declined by 6½ percentage points to 58¾ percent of GDP (with 5½ percentage points of the reduction reflecting valuation effects).
  - Sovereign spreads fell to some 190 basis points; sovereign rating upgraded to one notch below investment grade.

### Fiscal developments (2003)
- The government balanced the budget in 2003 against a programmed deficit of 0.7 percent of GDP.
- Revenue was 1½ percent of GDP higher than expected, mainly driven by the import boom (accounting for 80 percent of the overperformance) and improved tax collection.
- Grants were ½ percent of GDP below budgeted levels.
- Expenditure was 0.7 percent of GDP higher than budgeted due to fully funded municipal spending, clearing hospital arrears, year-end wage and pension bonuses, and other nonbudgeted spending.

### Discussions with authorities: policy priorities and measures
- Staff and authorities concurred that the widening external imbalance increased macroeconomic risks and agreed on a policy mix of short-run demand containment and medium-run supply enhancement.
- Authorities indicated they would target a deficit of ½ percent of GDP in 2004, rather than 1¼ percent of GDP as originally planned.
- Authorities agreed to use any revenue overperformance to achieve budgetary balance.
- Authorities intend to achieve budgetary balance in 2005-06; EU-related expenditures were likely to produce a deficit in 2007.
- Measures to reduce bank liquidity under consideration include tightening reserve requirements and shifting government deposits from commercial banks to the central bank.
- There was agreement on revitalizing structural reforms to raise output and export capacity and to spur FDI, which is critical for medium-term growth and short-term external financing.
- The authorities broadly agreed with Bulgaria’s ex post assessment that a program-based engagement with the Fund would be the most effective way to support the government’s economic program in the run-up to EU accession in 2007.

### Staff appraisal and policy recommendations
- The authorities’ macroeconomic program for 2004 represents an adequate response to the heightened risks.
- The implied fiscal adjustment is small; the authorities should stand ready to tighten fiscal policy further if the external situation does not improve as expected.
- Fiscal flexibility is particularly important because planned measures to reduce bank liquidity may be limited in their effect on credit growth given the open capital account.
- To provide room to respond to possible shocks, the authorities are right to aim at fiscal balance in 2005–06 but should take steps to contain fiscal deficits upon EU accession in 2007.
- The intention to complement demand management with structural reforms aimed at enhancing supply is appropriate; creating a new privatization pipeline for 2005-06 is particularly important.

*Source: IMF staff report — Executive Summary (Article IV consultation and EPA, March 25–April 13, 2004).*

### 8.      Notwithstanding progress in certain areas, the pace of structural reform has

### _cr04176 - 8.      Notwithstanding progress in certain areas, the pace of structural reform has

### Structural reform: progress and delays
- Bank privatization was virtually completed in 2003.
- A new energy law was passed and retail electricity and district heating prices were raised further toward cost-recovery levels.
- Restructuring of district heating companies advanced, cutting subsidies to that sector.
- Railway payrolls were reduced by 10 percent, while subsidies were better targeted.
- Fiscal measures: large taxpayer office expanded; program budgeting and better budget preparation practices were initiated.
- Crucial reforms experienced delays, including:
  - selling the tobacco holding (Bulgartabac),
  - finalizing the sale of the telecoms company (BTC) (a 65 percent stake sale was signed in February, but completion delayed by a dispute about granting BTC a GSM license),
  - operationalizing the National Revenue Agency (NRA),
  - reforming the health, education, and railway sectors.

### Key strategic issues identified in Article IV discussions
- Main macroeconomic concerns:
  - The surge in credit growth and the related weakening of the external current account.
  - Maintaining a tight fiscal stance in the run-up to the election amid reduced political support.
  - Raising growth performance further to reduce the income gap vis-à-vis the most advanced European transition countries and reduce poverty.
- Questions for policy focus:
  - To what extent do credit and external developments involve macroeconomic risks and how could policies minimize them?
  - Will the authorities resist pressures to increase spending ahead of elections?
  - What priorities and reforms will most effectively raise growth and reduce poverty?

### External position, credit surge, and competitiveness
- Staff and authorities concurred that the widening external current account deficit had increased macroeconomic risks.
- Stabilizing the external debt ratio with a current account deficit of 8-9 percent of GDP over the medium term would require inflows of FDI in excess of those projected.
- Over the medium term, with privatization inflows shrinking, a deficit higher than some 7 percent of GDP would likely involve an increase in the external debt ratio from still sizable levels.
- Authorities noted partial mitigation from rising export capacity associated with higher investment goods imports; staff noted:
  - consumer goods imports rose rapidly,
  - two thirds of investment in 2003 was in the nontradable sector and would thus not raise export capacity.
- Competitiveness indicators:
  - CPI-based REER suggested some loss of competitiveness vis-à-vis some non-EU members.
  - Unit labor costs (ULCs) in manufacturing had continued to decline.
  - Bulgaria’s share in EU and world imports had risen.
  - Economy-wide unit labor costs remained flat while manufacturing ULCs fell, and the total PPI recently increased more strongly than manufacturing PPI, pointing to a relative shift toward nontradables.

### Policy stance: short-run containment and medium-term reform
- Broad agreement: short run—contain domestic demand; medium term—boost export and output capacity.
- Fiscal policy emphasized as the key tool to restrain demand given the constraints on monetary policy under the CBA (currency board arrangement).
- Authorities’ combined strategy:
  - tighten fiscal policy relative to initial plans,
  - moderate credit growth by draining banking system liquidity.
- Agreement that authorities should be ready to tighten fiscal policy and/or implement credit measures beyond current plans if needed.
- Staff emphasized revitalizing structural reform to relieve external constraints and accelerate growth; policies to spur FDI were particularly important.

### Macroeconomic outlook and specific projections (2004 baseline and medium term)
- 2004 outlook (assuming appropriate policies):
  - Real GDP growth would increase to 5 percent.
  - Average consumer price inflation at 5¾ percent, with the 12-month inflation rate falling to 3½ percent by year-end.
  - Growth in credit to the nongovernment sector should fall to 26 percent year on year by end-2004.
  - The 12-month current account deficit should narrow as credit decelerated, but the deficit likely broadly unchanged for the year as a whole: 8.2 percent of GDP.
  - A further increase in FDI—owing partly to privatization receipts—should ensure 82 percent coverage of the deficit and, combined with other capital inflows, a further rise in international reserves.
  - The gross external debt ratio would decline by half a percentage point of GDP.
- Medium-term outlook (authorities; staff broadly concurred):
  - Medium-term growth of 5-5½ percent is achievable, conditional on higher investment ratio, reforms to boost productivity, and increases in labor force participation and employment despite a declining working age population.
  - Inflation should fall to 3½ percent.
  - Higher investment needs met by a rise in the private saving rate and higher public saving via a shift from current to capital expenditure.
  - Current account deficit projected to decline gradually to 6 percent of GDP by 2009.
  - Initially, high deficits mostly covered by FDI boosted by privatization receipts; later declining deficits financed largely by greenfield FDI.
  - External debt ratio projected to decline to 43 percent.
  - A sustainability scenario showed that only in the scenario with lower exports, higher imports and smaller FDI inflows would the external debt ratio rise to 64 percent in 2009.

### Risks to the baseline
- Near-term risks:
  - Credit and import growth might not slow as expected if capital inflows replace reduced domestic liquidity.
  - External demand might be softer than projected (e.g., weaker EU recovery).
  - FDI might not develop as expected, reflecting implementation risk ahead of the election.
- Medium-term risks:
  - Continued rapid credit expansion might lead to increased financial vulnerabilities, including deteriorating bank asset quality and an asset price bubble.
- If risks materialize, the external position would weaken, possibly requiring further policy adjustment.

### Fiscal policy: measurement, 2004 plans, and implementation measures
- Staff proposed reclassifying some below-the-line capital transfers as expenditure to reflect true fiscal stance; these transfers were similar to subsidies and had an expansionary demand effect.
- Staff urged moving to accrual accounting in line with international standards.
- Fiscal outcomes and reclassification (In percent of GDP):
  - 2003: Actual overall fiscal balance 0.0; Budget -0.8; Rev. Budget 0.0.
  - Reclassified below-the-line (B-T-L) operations: 0.4 (for all three columns).
  - Overall fiscal balance including B-T-L operations: -0.4 (Actual), -1.2 (Budget), -0.4 (Rev. Budget).
- 2004 budget and adjustments:
  - The 2004 budget envisaged a deficit (after reclassification) of 1¼ percent of GDP, a fiscal expansion with respect to the 2003 outcome.
  - Authorities intended to implement the budget more restrictively by cutting spending by ¾ percent of GDP in 2004, bringing the deficit down to ½ percent of GDP.
  - Authorities intended to save up to ½ percent of GDP of any revenue overperformance, potentially bringing the budget into balance in 2004.
  - Staff preferred a more ambitious fiscal adjustment and suggested saving any revenue overperformance.
- Measures to achieve fiscal tightening:
  - Focus on expenditure-side correction, limiting late-year unbudgeted spending by cutting the wage bill (mainly by sequestering unfilled vacancies) and reducing projections for capital spending and interest payments.
  - Cap discretionary spending at 93 percent of the downward revised levels through the third quarter.
  - The transfer to the road enterprise proposed in the budget would not take place in 2004.
- Tax administration and expenditure management reforms:
  - Maintain a tax system with low rates and few exemptions while continuing to shift from direct to indirect taxation.
  - Implement the NRA in 2005 to improve tax administration; efforts to combat tax evasion and fraud stepped up with establishment of a “tax police.”
  - 2005 budget preparation brought forward; program budgeting introduced in additional ministries.
  - Incorporation of lev-denominated accounts of all autonomous budgetary entities in the Treasury Single Account and deployment of the Financial Management Information System (FMIS) in all ministries planned to enhance expenditure management.
  - Strengthen local government finances through closer monitoring.
  - Staff urged expeditious implementation, noting that the NRA and FMIS reforms were well behind schedule.

*Source: _cr04176 - 8.      Notwithstanding progress in certain areas, the pace of structural reform has*

### 22.      The authorities were targeting budget balance in 2005-06, but deficits would

### _cr04176 - 22.      The authorities were targeting budget balance in 2005-06, but deficits would

### Fiscal policy and budget outlook
- Authorities targeted budget balance in 2005-06, but deficits would reemerge from 2007.
- For 2005, if the external position were to improve faster than expected, a small deficit may be envisaged.
- Planned revenue measures:
  - Further lower the corporate and personal income tax rates.
  - Introduce tax breaks for families.
  - Raise excise taxes toward minimum EU levels.
  - Improve tax collection.
- Staff caution:
  - Envisaged tax changes may threaten achieving fiscal balance in 2005.
- Planned expenditure priorities:
  - Better targeted social spending.
  - Outlays related to EU accession and infrastructure.
  - Wage bill increase in 2005 limited to projected inflation.
  - Further reduction of subsidies.
- Authorities’ view: EU-related expenditure would lead to a deficit of 2-3 percent of GDP from 2007.
- Staff recommendation:
  - Adjust priorities to make room for EU-related spending.
  - Allow a small temporary deficit in 2007 reflecting the pre-payment of agricultural subsidies related to the EU’s Common Agricultural Policy.
- Note: Chapter III of Selected Issues and Statistical Appendix (to be issued) explores the fiscal requirements of EU accession.

### Pension and health insurance systems
- Authorities concurred on the need to maintain sustainability of the pension and health insurance systems.
- National Social Security System (NSSI):
  - Long-term outlook for NSSI balance, while weakened since the 1999 reform, remained favorable.
  - Authorities projected the deficit would disappear by 2013, with rising surpluses thereafter.
  - Surpluses likely to be used to strengthen the fully-funded second pillar and reduce high contribution rates.
  - Outlook assumes current pension indexation practice (¼ wages, ¾ prices) would be maintained.
- Staff recommendations:
  - Enshrine the indexation formula (¼ wages, ¾ prices) in law to reduce discretion.
  - Strengthen the certification process for disability pensions.
- Health care reforms needed to address long-term sustainability risks:
  - Expand activity-based financing of hospitals to induce restructuring.
  - Impose stricter controls over claims and reimbursements.
- Authorities: generally committed but noted political resistance to reforms.

### Incomes policy and labor market flexibility
- Authorities favored a strict incomes policy and increasing labor market flexibility to strengthen competitiveness.
- Public sector wage policy:
  - Restrained public sector wage policy to guide private sector wage bargaining.
  - Nominal increase in the aggregate wage bill of the 60 largest public enterprises (monopolies, subsidized, or loss-making in Q3 2003) limited to 4 percent in 2004.
- Labor market reforms:
  - Plan, in collaboration with the World Bank, to amend labor law to make entry to and exit from work more flexible.
  - Continue active labor market policies to reintegrate the long-term unemployed.
- Staff caution: ensure policies do not result in prolonged hidden public sector employment.

### Financial sector, credit growth, and reserve/liquidity measures
- Financial intermediation increase viewed positively structurally; financial stability and prudential risks not a major concern.
- BNB supervisory actions commended: tighten loan classification and provisioning, increase on-site inspections, extend credit register, restrict conditions for including current profits in regulatory capital.
- High credit growth seen as macroeconomically problematic.
- Agreed measures to decelerate credit:
  - Transfer certain government deposits held in commercial banks to the BNB.
  - Tighten reserve requirements by broadening coverage to liabilities with maturities of two years or above and excluding part of banks’ cash in vault from reserve requirement calculation.
  - These measures—which would be implemented in the second and third quarters of 2004—amount to 13¾ percent of reserve money.
- Staff caveats:
  - Efficacy depends on responsiveness of capital flows to domestic monetary conditions; monitor effect on credit growth closely.
  - Consider further measures—including minimum liquid asset ratios—if expected decline in credit growth does not materialize.

### FSAP follow-up: strengths, vulnerabilities, and actions
- Banking sector environment: sound supervision, high capital, profitability and liquidity levels; vulnerabilities contained but rapid credit growth is key concern.
- Risks highlighted:
  - Credit risk requires close monitoring as asset quality indicators may not give early warnings; need to monitor overall private sector indebtedness and nonbank financial sector activity.
  - Foreign borrowing may generate foreign exchange risk, especially with exclusion of euros from prudential open foreign currency position limit; mitigated by large BNB foreign reserves.
  - New credit products may introduce liquidity and interest rate risks due to longer-term lending and limited shift to fixed interest rates.
- Implemented FSAP recommendations include:
  - Creation of a financial sector supervisory coordination committee and a single supervisory agency for nonbank financial institutions (Financial Sector Commission) — capacity and enforcement need strengthening, especially in insurance.
  - Introduction of a more effective bank insolvency regime — implementation largely untested or slow.
  - Progress in identifying and assessing banks’ ownership structures; capital restructuring and replacement of off-shore shareholders where necessary.
  - Creation of a Council for Financial Stability — need to strengthen monitoring of cross-sectoral linkages.
  - Updated payment system, including launch of a new real-time interbank gross-settlement system.

### Government debt and liquidity management
- Government strategy: shift from external to domestic borrowing to absorb bank liquidity and develop the domestic capital market.
- Domestic borrowing could be stepped up for liquidity withdrawal purposes.
- Debt management considerations: authorities considering prepaying some obligations to the Fund and may buy back or prepay other external obligations, subject to maintaining an adequate level of international reserves, in excess of base money as required by the CBA.

### Trade policy
- Trade policies aligned with European Commission guidance prior to EU accession.
- Temporary ban on exports of wheat and flour in response to poor 2003 harvest and higher food prices; scheduled to expire on July 31, 2004.

### Other structural reforms, privatization, and sectoral adjustments
- Business climate reforms underway: company registration, dispute resolution, judgment enforcement, collateral law, corporate governance; laws simplifying investment procedures and assistance to investors submitted to parliament.
- Staff note: avoid special tax incentives in these laws.
- Authorities report declining corruption and continued commitment to implement the 2001 anti-corruption strategy.
- Privatization status and recommendations:
  - BTC sale nearly completed; final bids for power distribution companies to be accepted by end-June.
  - Bulgartabac companies being prepared for sale.
  - Staff urged completion of pending privatizations and creation of a new pipeline for 2005-06, including plans for electricity generation sector, in cooperation with the World Bank.
- Sectoral reforms:
  - Energy sector: energy regulator to announce a 10 percent increase in average household electricity and district heating prices to take effect on July 1, 2004, allowing short-term cost recovery and reducing subsidy needs.
  - Staff recommended articulating an electricity sector strategy with the World Bank.
  - Railways: authorities committed, with World Bank collaboration, to make the railway sector sustainable by further reducing payroll and increasing tariffs.

### Relations with the Fund and program engagement
- No major disagreements with EPA analysis; officials emphasized greater obstacles to reform compared to immediate post-crisis period and the critical role of the CBA in policy credibility.
- EPA conclusion: a program-based engagement would be most effective to support the government’s economic program and mobilize support on the way to EU accession.
- Rationale: Bulgaria’s receptivity to Fund advice and post-1997 stabilization mitigate typical drawbacks of longer-term program engagement.

### Data, standards, and AML/CFT progress
- Data quality and timeliness generally adequate for surveillance and program monitoring, with some deficiencies remaining (Appendix IV).
- Bulgaria subscribed to the Special Data Dissemination Standard in December 2003.
- Implemented all but one recommendation of the 2002 safeguards assessment—the establishment within the BNB of an audit committee—which authorities consider performed by the BNB’s monetary board.
- Continued efforts to combat money laundering and financing of terrorism, including aligning anti-money laundering law with EU standards and enacting a new law to counter terrorism financing since the 2001/02 FSAP.

### Staff appraisal, risks, and recommended policy mix
- Assessment of performance:
  - Bulgaria’s economic performance solid due to prudent macroeconomic policies and structural reforms; CBA central to achievements.
  - Robust growth, modest inflation, falling external and public debt ratios; falling unit labor costs in manufacturing have supported competitiveness.
- Main risks:
  - Increased external vulnerability driven by credit expansion causing import surge and sharp widening of current account deficit.
  - If unchecked, credit growth could reverse favorable external debt dynamics.
  - Structural reform progress has slowed: remaining large state monopolies (BTC, Bulgartabac) not privatized; limited reform in health, education, railway; need to improve business climate.
- Policy recommendations to address challenges:
  - Tighten macroeconomic policies and advance structural reform more forcefully.
  - Mix of policies to moderate demand and enhance supply/export capacity within CBA constraints:
    - (i) A more prudent fiscal stance.
    - (ii) Drain liquidity from the banking system while pursuing FSAP follow-up recommendations.
    - (iii) Accelerate structural reforms.
  - Maintain CBA until euro introduction and adopt timely policies to support it.
- Assessment of 2004/05 program:
  - Represents an adequate response, though a more ambitious fiscal adjustment would have been preferable, particularly in 2004.
  - Authorities reversed expansionary stance underlying the 2004 budget and envisaged tightening in 2005.
  - With tax revenues likely to exceed conservative budget projections, critical that lowered spending ceilings are not exceeded until budget balance is reached; consider saving a portion of any continued revenue overperformance thereafter.
  - Without additional savings, the fiscal target for 2004 involves a broadly neutral stance vis-à-vis 2003 with little dampening effect on domestic demand.
  - Fiscal flexibility must be maintained to respond promptly should credit growth continue to fuel excessive domestic demand and imports.
- Medium-term fiscal pressures:
  - Strategy of shifting from direct to indirect taxation appropriate but risk of worsening fiscal balance if poorly implemented.
  - Implement tax administration and expenditure management reforms without delay.
  - Ensure medium-term sustainability of pension and health care systems.
  - As entering ERM2 with a solid fiscal position is important, take timely steps to contain fiscal deficits upon EU accession; fiscal expansion envisaged for 2007 involves significant risks.
- Structural policy priorities:
  - Complement demand management with reforms to enhance supply and attract FDI.
  - Complete sales of BTC and Bulgartabac and adhere to schedule for sale of electricity distributors.
  - Create a new privatization pipeline for 2005-06.
  - Further labor market reforms to facilitate entry to and exit from work.

*Source: _cr04176 - 22.      The authorities were targeting budget balance in 2005-06, but deficits would*

### 41.      As important macroeconomic risks remain, continued Fund engagement under

### _cr04176 - 41.      As important macroeconomic risks remain, continued Fund engagement under

### Macroeconomic risks and Fund engagement
- Continued Fund engagement under a successor stand-by arrangement (SBA) would be appropriate provided that sufficiently strong policies can be agreed.
- Fund support would:
  - facilitate internal consensus on policy implementation, including in the run-up to next year’s election,
  - provide confidence to foreign investors and lenders.
- Given the long-term program engagement and the absence of an imminent financing need, a new SBA should have lower access and be precautionary.
- EU accession, expected in early 2007, would serve as a natural exit from a program-based relationship with the Fund.

### Reserve position and repayments
- Given the strong international reserve position, the authorities’ intention to make repayments to the Fund on the expectations schedule is appropriate.
- Maintenance of an adequate reserve cover should guide the authorities’ plans to prepay external obligations.

### Data quality and safeguards
- Data quality and transparency have improved substantially.
- Data are adequate for surveillance and program monitoring.
- The BNB’s safeguards practices are broadly adequate.

### Consultation cycle recommendation
- It is proposed that Bulgaria return to the standard 12-month consultation cycle.

### Millennium Development Goals — selected indicators for Bulgaria
- Target 1: Halve, between 1990 and 2015, the proportion of people whose income is less than one dollar a day.
  - 1. Population below $1 a day (%)...4.74.7...
  - 2. Poverty gap at $1 a day (%)...1.41.4...
  - 3. Percentage share of income or consumption held by poorest 20%......6.7...
- Target 2: Halve, between 1990 and 2015, the proportion of people who suffer from hunger.
  - 4. Prevalence of child malnutrition (% of children under 5)............
  - 5. Population below minimum level of dietary energy consumption (%)............
- Target 3: Ensure that, by 2015, children everywhere, boys and girls alike, will be able to complete a full course of primary schooling.
  - 6. Net primary enrollment ratio (% of relevant age group)86.189.994.3...
  - 7. Percentage of cohort reaching grade 5 (%)90.693.0......
  - 8. Youth literacy rate (% ages 15-24)99.499.699.799.7
- Target 4: Eliminate gender disparity in primary and secondary education preferably by 2005 and to all levels of education no later than 2015.
  - 9. Ratio of girls to boys in primary and secondary education (%)94.593.697.5...
  - 10. Ratio of young literate females (% ages 15-24)99.899.799.899.8
  - 11. Share of women employed in the nonagricultural sector (%)............
  - 12. Proportion of seats held by women in the national parliament (%)21.013.011.026.0
- Target 5: Reduce by two-thirds, between 1990 and 2015, the under-five mortality rate.
  - 13. Under-five mortality rate (per 1,000)18.719.016.017.1
  - 14. Infant mortality rate (per 1,000 live births)14.814.814.014.0
  - 15. Immunization , measles (% of children under 12 months)98.094.096.0...
- Target 6: Reduce by three-quarters, between 1990 and 2015, the maternal mortality ratio.
  - 16. Maternal mortality ratio (modeled estimate, per 100,000 live births)...23.0......
  - 17. Births attended by skilled health staff (% of total)............
- Target 7: Have halted by 2015, and begun to reverse, the spread of HIV/AIDS. Have halted by 2015, and begun to reverse, the incidence of malaria and other major diseases.
  - 18. Prevalence of HIV, female (% ages 15-24)............
  - 19. Contraceptive prevalence rate (% of women ages 15-49)............
  - 20. Number of children orphaned by HIV/AIDS............
  - 21. Incidence of tuberculosis (per 100,000 people)......41.0...
  - 22. Tuberculosis cases detected under DOTS (%)......22.0...
- Target 8: Integrate the principles of sustainable development into country policies and programs and reverse the loss of environmental resources. Halve, by 2015, the proportion of people without sustainable access to safe drinking water. By 2020, to have achieved a significant improvement in the lives of at least 100 million slum dwellers.
  - 23. Forest area (% of total land area)31.5...33.4...
  - 24. Nationally protected areas (% of total land area)...4.44.54.5
  - 25. GDP per unit of energy use (PPP $ per kg oil equivalent)1.82.12.7...
  - 26. CO2 emissions (metric tons per capita)8.66.75.1...
  - 27. Access to an improved water source (% of population)......100.0...
  - 28. Access to improved sanitation (% of population)......100.0...
  - 29. Access to secure tenure (% of population)............
- Target 9: Develop further an open, rule-based, predictable, non-discriminatory trading and financial system. Address the Special Needs of the Least Developed Countries. Address the Special Needs of landlocked countries and small island developing states. Deal comprehensively with the debt problems of developing countries through national and international measures in order to make debt sustainable in the long term. In cooperation with developing countries, develop and implement strategies for decent and productive work for youth. In cooperation with pharmaceutical companies, provide access to affordable, essential drugs in developing countries. In cooperation with the private sector, make available the benefits of new technologies, especially information and communications.
  - 30. Youth unemployment rate (% of total labor force ages 15-24)4.726.334.2...
  - 31. Fixed line and mobile telephones (per 1,000 people)...307.2550.6...

*Source: _cr04176 - 41.      As important macroeconomic risks remain, continued Fund engagement under*

### 32. Personal computers (per 1,000 people)10.516.644.3...

### _cr04176 - 32. Personal computers (per 1,000 people)10.516.644.3...

### General indicators and Millennium Development Goals (selected)
- Personal computers (per 1,000 people): 10.5, 16.6, 44.3...
- Population: 8.7 million, 8.4 million, 7.9 million, 7.9 million
- Gross national income ($): 19.7 billion, 11.5 billion, 13.2 billion, 14.1 billion
- GNI per capita: $2,260, $1,370, $1,670, $1,790
- Adult literacy rate (% of people ages 15 and over): 97.2, 97.9, 98.5, 98.6
- Total fertility rate (births per woman): 1.8, 1.2, 1.3, 1.3
- Life expectancy at birth (years): 71.4, 70.9, 71.7, 71.8
- Aid (% of GNI): 0.1, 0.9, 2.6...
- External debt (% of GNI): 57.1, 81.2, 72.6...
- Investment (% of GDP): 25.6, 15.7, 20.4, 20.5
- Trade (% of GDP): 69.8, 90.9, 118.9, 110.8
- Source: World Development Indicators database, April 2002.

### Table 2 — Selected Economic Indicators, 2000-2004 (major series)
- Real GDP: 5.4, 4.1, 4.9, 4.3, 5.0
- Consumer price index (average): 10.4, 7.5, 5.8, 2.3, 5.8
- CPI (end-of-period): 11.4, 4.8, 3.8, 5.6, 3.2
- Registered unemployment (percent): 18.1, 17.5, 17.4, 14.3...
- Labor force survey unemployment (percent): 16.9, 19.8, 17.8, 16.8...
- General government revenue: 38.7, 37.6, 36.5, 37.9, 35.4
- Noninterest expenditure: 35.7, 34.7, 34.9, 36.2, 33.9
- Primary balance: 3.0, 2.8, 1.6, 1.7, 1.6
- Interest payments: 4.0, 3.7, 2.2, 2.1, 1.9
- Overall balance: -1.0, -0.9, -0.6, -0.4, -0.4
- Privatization receipts: 1.3, 2.9, 0.9, 1.1, 4.1
- External financing: -1.5, -0.3, 1.5, 0.0, 0.9
- Domestic financing: 1.2, -1.7, -1.9, -1.8, -4.6
- Public debt (end of period) 1/: 77.0, 69.9, 61.4, 53.4, 47.3
- Broad money (end of period; millions of leva): 9,857, 12,401, 13,857, 16,566, 19,585
- FX deposits (euro millions): 2,068, 2,516, 2,678, 2,684, 3,944
- Broad money to FX reserves ratio: 1.3, 1.6, 1.5, 2.0, 1.7
- Current account balance (millions of euros): -761, -1,102, -924, -1,498, -1,601
- Current account (percent of GDP): -5.6, -7.3, -5.6, -8.5, -8.2
- Trade balance (millions of euros): -1,280, -1,779, -1,692, -2,196, -2,478
- Exports, fob (millions of euros): 5,253, 5,714, 6,063, 6,663, 7,436
- Imports, fob (millions of euros): -6,533, -7,493, -7,755, -8,859, -9,914
- Gross official reserves (end of period): 3,719, 4,063, 4,575, 5,309, 5,775
- External debt (end of period): 12,038, 12,049, 10,769, 10,330, 11,214
- Exchange rate: Leva per U.S. dollar (end of period): 2.1022, 2.219, 1.8851, 1.6111, 1.614
- Currency board, peg to euro at lev 1.95583 per euro.

### Table 3 — Real GDP by Expenditure Category, 1999-2003 (selected growth and contributions)
- Real GDP (percentage change): 2.3, 5.4, 4.1, 4.9, 4.3 (1999–2003)
- Private consumption (percentage change): 9.6, 4.3, 5.2, 3.6, 6.4
- Gross fixed capital formation (percentage change): 20.8, 15.4, 23.3, 8.5, 13.8
- Exports of goods and services (percentage change): -5.0, 16.6, 10.0, 7.0, 8.0
- Imports of goods and services (percentage change): 9.3, 18.6, 14.8, 4.9, 14.8
- Nominal GDP (in millions of leva): 23,790, 26,753, 29,709, 32,335, 34,410

### Table 4 — Monetary Survey, 1999-2004 (end-period levels and growth)
- Broad Money 1/: 7,536; 9,857; 12,401; 13,857; 16,566; 19,585 (1999–2004)
- Currency outside banks: 1,962; 2,374; 3,081; 3,335; 3,874; 4,305
- Deposits: 5,574; 7,483; 9,319; 10,519; 12,591; 15,098
- Lev deposits: 2,772; 3,438; 4,400; 5,302; 6,514; 7,681
- Foreign currency deposits: 2,802; 4,044; 4,919; 5,218; 6,077; 7,417
- Net Foreign Assets: 6,566; 8,196; 9,454; 9,892; 10,049; 11,106
- Net Domestic Assets: 3,273; 4,345; 5,835; 7,368; 10,499; 12,954
- Domestic credit: 3,640; 4,770; 6,009; 7,656; 10,251; 12,736
- Fixed assets: 674; 759; 879; 951; 1,183; 1,221
- 12-month percent change: Broad Money: 13.4, 30.8, 25.8, 11.7, 19.6, 18.2
- Claims on nongovernment (12-month percent change): 21.4, 17.0, 32.1, 44.0, 48.3, 25.9
- Broad Money (percent of GDP): 31.7, 36.8, 41.7, 42.9, 48.1, 51.6
- Memorandum: Reserve money: 2,725; 3,021; 4,033; 4,482; 5,266; 5,970
- Money multiplier (M3/reserve money): 2.8, 3.3, 3.1, 3.1, 3.1, 3.2

### Table 5 — Selected Vulnerability Indicators, 2000-2003
- Real GDP growth (in percent): 5.4, 4.1, 4.9, 4.3 Q4-03
- CPI inflation (period average, in percent) 1/: 10.4, 7.5, 5.8, 2.3 Q4-03
- Short-term interest rate (in percent): 4.6, 4.7, 3.4, 2.7 Dec-03
- EMBI + secondary market spread (bps; end of period): 772, 433, 291, 177 Dec-03
- Exchange rate NC/US$ (end of period): 2.12, 2.21, 1.91, 1.5 Dec-03
- Current account balance (percent of GDP) 2/: -5.6, -7.3, -5.6, -8.5 Q4-03
- Net FDI inflows (percent of GDP) 3/: 8.1, 5.9, 5.8, 7.0 Q4-03
- Export growth (Euro value, GNFS) 4/: 40.6, 6.3, 5.5, 10.7 Q4-03
- Real effective exchange rate (1995 = 100; end of period): 127.5, 132.1, 139.4, 151.0 Dec-03
- Gross international reserves (GIR) in Euro billion: 3.7, 4.1, 4.6, 5.3 Dec-03
- GIR in percent of ST debt at remaining maturity: 238.6, 293.8, 258.1, 269.2 Dec-03
- Total gross external debt in percent of GDP: 88.2, 79.4, 65.1, 58.7 Dec-03
- Short-term debt (original maturity in percent of GDP): 11.4, 9.1, 10.7, 11.2 Dec-03
- Private sector debt (in percent of GDP): 14.9, 14.9, 17.0, 18.0 Dec-03
- Public sector overall balance (percent of GDP): -1.0, -0.9, -0.6, -0.4 Dec-03
- Public sector gross debt (in percent of GDP): 80.5, 69.9, 60.2, 52.2 Dec-03
- Capital adequacy ratio (in percent): 35.6, 31.3, 25.2, 22.0 Q4-03
- NPLs in percent of total loans: 17.3, 13.1, 8.6, 7.3 Q4-03
- Return on average assets (in percent): 3.1, 2.9, 2.1, 2.4 Q4-03
- FX deposits (in percent of total deposits): 54.0, 52.7, 49.3, 48.2 Dec-03

### Table 6 — Balance of Payments, 2000-2009 (selected series, millions of euros and projections)
- Current account: -761, -1,102, -924, -1,498, -1,601, -1,561, -1,651, -1,709, -1,172, -1,755 (2000–2009)
- Trade balance: -1,280, -1,779, -1,692, -2,196, -2,478, -2,534, -2,653, -2,784, -2,972, -3,218
- Exports (f.o.b.): 5,253; 5,714; 6,063; 6,663; 7,436; 8,244; 8,973; 9,920; 11,014; 12,212 (2000–2009)
- Exports y-o-y change (percent): 40.7, 8.8, 6.1, 9.9, 11.6, 10.9, 8.8, 10.6, 11.0, 10.9
- Imports (f.o.b.): -6,533; -7,493; -7,755; -8,859; -9,914; -10,778; -11,625; -12,705; -13,986; -15,430
- Imports y-o-y change (percent): 37.8, 14.7, 3.5, 14.2, 11.9, 8.7, 7.9, 9.3, 10.1, 10.3
- Services, net: 547, 454, 486, 524, 615, 702, 871, 977, 1,013, 1,123
- Income, net: -345, -340, -285, -439, -410, -540, -741, -911, -1,049, -1,212
- Current transfers, net: 316, 562, 567, 613, 671, 811, 872, 1,010, 1,837, 1,552
- Capital and financial account: 950, 1,527, 1,656, 2,280, 2,052, 1,696, 1,730, 1,628, 2,068, 2,094
- Foreign direct investment, net 1/: 1,100, 893, 951, 1,235, 1,314, 1,366, 1,186, 1,280, 1,435, 1,522
- Overall balance: 188, 426, 732, 781, 451, 135, 80, -81, 89, 633, 39 (selected years)
- Gross international reserves (stock, e.o.p.): 3,719; 4,063; 4,575; 5,309; 5,715; 5,636; 5,444; 5,139; 5,912; 6,189
- Gross external debt (stock, e.o.p.): 12,038; 12,049; 10,769; 10,330; 11,305; 11,550; 11,751; 11,822; 12,273; 12,722
- GDP (millions of euros): 13,646; 15,184; 16,533; 17,594; 19,416; 21,079; 22,906; 24,892; 27,101; 29,507

### Table 7 & 8 — General Government, 2000-2007 (levels and percent of GDP)
- Total revenue and grants (millions of leva): 10,361; 11,164; 11,799; 13,052; 13,450; 14,441; 15,692; 17,639 (2000–2007)
- Tax revenue (millions of leva): 8,005; 8,517; 8,873; 10,214; 10,622; 11,487; 12,489; 13,531
- Social insurance contributions (millions of leva): 2,241; 2,311; 2,352; 2,806; 2,945; 3,179; 3,417; 3,673
- Total expenditure and net lending (millions of leva): 10,631; 11,423; 12,009; 13,197; 13,602; 14,424; 15,694; 18,046
- Noninterest expenditure, net lending (percent of GDP): 35.7, 34.7, 34.9, 36.2, 33.9, 33.0, 32.8, 34.9 (2000–2007)
- Primary balance (percent of GDP): 3.0, 2.8, 1.6, 1.7, 1.6, 2.0, 2.3, 1.4 (2000–2007)
- Interest (percent of GDP): 4.0, 3.7, 2.2, 2.1, 1.9, 2.0, 2.3, 2.2 (2000–2007)
- Overall balance (percent of GDP): -1.0, -0.9, -0.6, -0.4, -0.4, 0.0, 0.0, -0.8 (2000–2007)
- Privatization receipts (percent of GDP): 1.3, 2.9, 0.9, 1.1, 4.1, 1.6, 0.2, 0.2

### Table 9 — Macroeconomic Framework, 2000-2009 (selected projections)
- Real GDP (annual percent change): 5.4, 4.1, 4.9, 4.3, 5.0, 5.2, 5.3, 5.3, 5.5, 5.5 (2000–2009)
- GDP deflator (annual percent change): 6.7, 6.7, 3.8, 2.1, 5.1, 3.2, 3.2, 3.2, 3.2, 3.2
- CPI (end of period): 11.4, 4.8, 3.8, 5.6, 3.2, 3.6, 3.5, 3.5, 3.5, 3.5
- Broad money (nominal, end of period) annual percent change: 30.8, 25.8, 11.7, 19.6, 18.2, 16.3, 12.2, 13.4, 13.7, 12.5
- Credit to non-government (nominal, end of period) annual percent change: 17.0, 32.1, 44.0, 48.3, 25.9, 20.1, 14.4, 12.0, 13.1, 12.5
- Foreign saving (in percent of GDP): 5.4, 8.7, 7.3, 9.5, 9.6, 8.7, 7.8, 7.3, 7.2, 7.1
- Gross national saving: 12.7, 13.4, 14.2, 13.2, 14.1, 15.4, 15.9, 16.6, 19.9, 18.6
- Gross domestic investment (percent of GDP): 18.3, 20.7, 19.8, 21.7, 22.4, 22.8, 23.1, 23.5, 24.2, 24.5
- Total public debt (percent of GDP): 77.1, 69.9, 61.4, 53.4, 47.3, 44.6, 41.5, 37.1, 33.8, 31.1
- Balance of payments: Current account (percent of GDP): -5.6, -7.3, -5.6, -8.5, -8.2, -7.4, -7.2, -6.9, -4.3, -5.9
- External debt/GDP (percent): 88.2, 79.4, 65.1, 58.7, 58.2, 54.8, 51.3, 47.5, 45.3, 43.1
- Nominal GDP (millions of leva): 26,753; 29,709; 32,335; 34,410; 37,973; 41,226; 44,801; 48,685; 53,006; 57,711
- Nominal GDP (millions of euros): 13,646; 15,184; 16,533; 17,594; 19,416; 21,079; 22,906; 24,892; 27,101; 29,507

### Table 10–11 — External Debt Sustainability and Gross External Financing Need (1998-2009)
- External debt (percent of GDP): 83.1, 89.5, 88.2, 79.4, 65.1, 58.7, 58.2, 54.8, 51.3, 47.5, 45.3, 43.1 (1998–2009)
- Change in external debt: -17.3, 6.3, -1.2, -8.9, -14.2, -6.4, -0.5, -3.4, -3.5, -3.8, -2.2, -2.2
- Identified external debt-creating flows (percent of GDP): -13.3, -7.8, -12.6, -7.0, -5.0, -1.2, -4.0, -3.7, -2.3, -2.4, -4.8, -2.9
- Current account deficit, excluding interest payments (percent of GDP): -4.0, 1.1, 1.5, 3.4, 3.4, 6.4, 6.3, 5.5, 5.0, 4.5, 2.0, 3.6
- Net non-debt creating capital inflows (negative, percent of GDP): -5.8, -6.3, -8.3, -5.3, -4.2, -5.7, -6.7, -6.5, -5.2, -5.1, -5.3, -5.2
- Automatic debt dynamics (percent): -3.5, -2.5, -5.8, -5.1, -4.2, -1.8, -3.6, -2.7, -2.1, -1.7, -1.5, -1.3
- Contribution from nominal interest rate (percent): 4.2, 3.7, 4.1, 3.9, 2.2, 2.1, 1.9, 1.9, 2.2, 2.4, 2.3, 2.4
- Contribution from real GDP growth (percent): -3.7, -1.8, -4.3, -3.2, -3.6, -2.6, -2.7, -2.8, -2.7, -2.5, -2.4, -2.3
- Gross external financing need (in billions of euros): 1.8, 2.5, 2.7, 3.8, 3.3, 4.1, 4.4, 4.7, 5.0, 5.6, 5.1, 6.0
- Gross external financing need (percent of GDP): 16.2, 20.3, 20.0, 24.8, 20.1, 23.1, 22.7, 22.2, 21.9, 22.3, 18.7, 20.4
- Stress test scenarios (selected outcomes, external debt percent of GDP):  
  - A1 (historical averages): 58.7, 54.5, 47.2, 38.9, 30.7, 26.9, 21.4 (-5.8)
  - A2 (higher trade deficit and lower FDI): 58.7, 60.4, 61.1, 60.4, 60.8, 62.9, 64.1 (-5.6)
  - B6 (one-time 30 percent nominal depreciation in 2004): 58.7, 80.5, 73.3, 66.4, 59.3, 55.6, 51.2 (-8.9)

### Table 12–13 — Public Debt Sustainability and Gross Public Sector Financing Need (1998-2009)
- Public sector debt (percent of GDP): 83.2, 86.7, 77.1, 69.9, 61.3, 53.4, 47.3, 44.6, 41.5, 37.1, 33.8, 31.1
- Change in public sector debt (percent of GDP): -30.3, 3.5, -9.6, -7.1, -8.6, -7.9, -6.1, -2.7, -3.2, -4.3, -3.3, -2.8
- Identified debt-creating flows (percent of GDP): -11.8, 2.1, -5.6, -5.5, -2.6, -2.4, -6.7, -3.5, -2.0, -1.1, -1.6, 0.2
- Primary deficit (percent of GDP): -5.2, -2.8, -3.0, -2.8, -1.6, -1.7, -1.6, -2.0, -2.3, -1.4, -2.0, -1.7
- Revenue and grants (percent of GDP): 35.4, 38.5, 38.7, 37.6, 36.5, 37.9, 35.4, 35.0, 35.0, 36.2, 37.8, 37.2
- Primary (noninterest) expenditure (percent of GDP): 30.2, 35.7, 35.7, 34.7, 34.9, 36.2, 33.9, 33.0, 32.8, 34.9, 35.8, 35.5
- Automatic debt dynamics (percent of GDP): -12.3, -0.9, -5.6, -3.9, -3.5, -1.6, -3.1, -1.7, -1.3, -1.1, -1.0, -1.1
- Privatization receipts (negative, percent of GDP): -1.5, -2.1, -1.3, -2.9, -0.9, -1.1, -4.1, -1.6, -0.2, -0.2, 0.0, 0.0
- Debt-stabilizing primary balance (percent of GDP) (A1 historical averages 2004-09): 53.4, 44.7, 39.2, 33.4, 25.8, 20.4, 15.7, 1.9 (selected years/scenario)
- Gross financing need (in billions of euros): 8.9, 7.6, 7.0, 6.1, 4.8, 4.1, 2.4, 2.5, 2.9, 4.7, 2.8, 2.5
- Gross financing need (percent of GDP): 1.0, 0.9, 1.0, 0.9, 0.8, 0.7, 0.5, 0.5, 0.7, 1.2, 0.7, 0.7
- Stress tests for gross financing need (selected scenarios):  
  - B1 (real interest rate shock): elevated gross financing need outcomes shown across 2004–09.  
  - B5 (one-time 30 percent real depreciation in 2004): increases gross financing need notable in 2004–09.

### Appendix I — Bulgaria: Fund Relations (as of March 31, 2004)
- Membership Status: Joined 09/25/1990; Article VIII 09/24/1998
- Quota: 640.20 SDR million (100.0 percent)
- Fund holdings of currency: 1,445.522 SDR million (225.79 percent)
- Reserve position in Fund: 32.78 SDR million (5.12 percent)
- SDR Department holdings: 80.20 SDR million (N/A percent)
- Outstanding Purchases and Loans:  
  - Stand-by: 240.00 SDR million (37.49 percent)  
  - EFF: 588.40 SDR million (91.91 percent)  
  - STF: 9.69 SDR million (1.51 percent)
- Financial Arrangements (selected):  
  - Stand-by approval 02/27/2002; expiration 03/15/2004; amount approved 240.00 SDR million; amount drawn 240.00 SDR million  
  - EFF approval 09/25/1998; expiration 09/24/2001; amount approved 627.62 SDR million; amount drawn 627.62 SDR million
- Projected Payments to Fund (SDR million; on expectation basis):  
  - Principal forthcoming: 2004: 76.13; 2005: 178.07; 2006: 225.76; 2007: 186.01; 2008: 102.39  
  - Charges/Interest forthcoming: 2005: 13.35; 2006: 15.64; 2007: 11.22; 2008: 6.54; 2009: 3.04  
  - Total forthcoming: 2004: 89.48; 2005: 193.71; 2006: 236.97; 2007: 192.55; 2008: 105.42

*Source: _cr04176 - 32. Personal computers (per 1,000 people)10.516.644.3... (IMF staff report content as supplied).*

### APPENDIX                                                                                   I

### APPENDIX I

### VII. Safeguards Assessment
- Under the Fund’s safeguards assessment policy, the Bulgarian National Bank (BNB) was subject to an assessment with respect to the SBA arrangement approved on February 27, 2002.
- The assessment was completed on June 12, 2002, identified certain weaknesses and made appropriate recommendations, as reported in IMF Country Report No. 02/174.
- The BNB has implemented most of the safeguards recommendations and committed to implementing the remaining ones.
- The BNB is subject to a subsequent assessment with respect to the expected new arrangement; necessary documentation has been provided by the authorities and the assessment is underway.

### VIII. Exchange Arrangement
- An amendment to the Law on the Bulgarian National Bank (BNB) effectively established a currency board arrangement from July 1, 1997.
- The deutsche mark was chosen as the peg currency and has since been replaced with the euro at the rate of lev 1.95583 per € 1 at par.
- The BNB is required to sell and purchase on demand and without restriction currencies of EU member countries for leva on the basis of spot exchange rates that may not differ from the official exchange rate by more than 0.5 percent.
- Bulgaria has accepted the obligations of Article VIII, Sections 2, 3, and 4 of the Articles of Agreement, and maintains an exchange rate system that is free of restrictions on the making of payments and transfers for current international transactions.

### IX. Article IV Consultation
- The last Article IV consultation was concluded on July 22, 2002 (see IMF Country Report No. 02/174).
- Bulgaria is on a 24-month cycle.
- The Acting Chairman’s summing-up of the discussion was circulated as SUR/02/80.

### X. FSAP Participation and ROSCs
- Bulgaria participated in an FSAP held from October 29 to November 14, 2001.
- Table 14 provides information on the production of ROSCs.

- Table 14. Bulgaria: ROSCs (selected entries preserved exactly as in source)
  - ROSC update – Data dissemination and fiscal transparency. — 08/07/2002 — IMF Country Report No. 02/172
  - ROSC – Monetary and financial policy transparency, banking supervision, securities regulation, insurance regulation, and payment systems — 07/15/2002 — IMF Country Report No. 02/188
  - ROSC update – Data dissemination, fiscal transparency, transparency of monetary and financial policies, banking supervision, deposit insurance, insurance supervision, securities market supervision — 03/08/2001 — www.imf.org
  - ROSC – Data dissemination, fiscal transparency, transparency of monetary policy, banking supervision, system of deposit insurance, insurance supervision, securities market supervision — 03/17/2000 — www.imf.org
  - Experimental ROSC – Data transparency, fiscal transparency, transparency of monetary policy, banking supervision, system of deposit insurance, insurance supervision, securities market supervision, insurance supervision, accounting and auditing practices — 08/27/1999 — www.imf.org

### XI. Technical Assistance
- Table 15 provides information on IMF technical assistance activities in Bulgaria for 1998–2003.

- Table 15. Bulgaria: Technical Assistance, 1998–2003 (selected items preserved exactly as in source)
  - MAE — Banking supervision/debt management — Mission — Apr. 98 — BNB
  - MAE — Organization and management — Expert — Jun., Sep., Dec. 98 — BNB
  - MAE — Information technology — Expert — Nov. 98 — BNB
  - MAE — Cash processing — Expert — Dec. 98 — BNB
  - MAE — Foreign exchange — Expert — 98-99 various visits — BNB
  - MAE — Payment system — Expert — Jan. 99 — BNB
  - MAE — Banking supervision, organization and management — Mission — Mar.-Apr. 99 — BNB
  - MAE — Accounting — Expert — Jun. & Aug./Sep.99 — BNB
  - MAE — Transparency Report/Based Core Principles — Mission — Jul. 99 — BNB
  - MAE — Deposit insurance — Mission — Oct. 99 — BNB
  - MAE — Payment system/liquidity management/bank bankruptcy legislation — Mission — May 00 — BNB
  - MAE — Bank bankruptcy legislation — Expert — Jun. 00 — BNB
  - MAE — Foreign exchange — Mission — Nov. 00 — BNB
  - MAE — Accounting — Mission — Dec. 00 — BNB
  - MAE — Short-term advisor payment system — Expert — Jun. 01 — BNB
  - MAE — Review of TA needs resulting from FSAP — Mission — May 02 — BNB
  - FAD — Tax administration — Expert — Feb.-Aug. 98 — MOF
  - FAD — Public expenditure management — Mission — Mar. 98 — MOF
  - FAD — Tax administration — Mission — Aug. 98 — MOF
  - FAD — Resident treasury advisor — Expert — Since Oct. 98 — MOF
  - FAD — Collection of tax and social security contributions — Mission — May 99 — MOF
  - FAD — Treasury system — Mission — Sep. 99 — MOF
  - FAD/WB — Implementation strategy — Mission — Jan. 00 — MOF
  - FAD — Unified revenue agency (URA) — Mission — Jan.-Feb. 00 — MOF
  - FAD — National revenue agency — Expert — Apr-Jun. 00 — MOF
  - FAD — Tax administration — Mission — May 00 — MOF
  - FAD — Short-term resident advisor on the URA — Expert — May-Jun. 00 — MOF
  - FAD — National revenue agency — Mission — Jun. 00 — MOF
  - FAD — Social security administration — Expert — Jun. 00 — MOF
  - FAD — Long-term resident advisor — Expert — Sep. 00-Sep. 01 — MOF
  - FAD — National revenue agency — Mission — Jan. 01 — MOF
  - FAD — Budget reform — Mission — Jan.-Feb. 01 — MOF
  - FAD — Budget and treasury reform — Mission — Jun. 01 — MOF
  - FAD — Tax administration - follow-up — Mission — Sep. 01 — MOF
  - FAD — National revenue agency — Expert — Oct.-Sep. 01 — MOF
  - FAD — Customs administration — Mission — Oct.-Nov. 01 — MOF
  - FAD — Tax administration — Mission — Sep. 01 — MOF
  - FAD — Revenue administration — Mission — Apr. 02 — MOF
  - FAD — Long-term resident advisor — Expert — Apr. 02- Mar. 03 — MOF
  - FAD — Tax policy — Mission — Apr. 02 — MOF
  - FAD — Advisor Visit — Sep.-Oct. 02 — MOF
  - FAD — Advisor Visit — Mar.-Apr. 03 — MOF
  - STA — Producer prices — Mission — Apr. -May 98 — NSI
  - STA — BOP statistics — Mission — Jun.-Jul. 99 — BNB
  - STA — GDDS — Mission — Jul. 99 — BNB
  - STA — National accounts — Mission — Nov. 99 — NSI
  - STA — Price statistics — Mission — Jun. 00 — NSI
  - STA — BOP statistics — Mission — Dec. 00 — BNB
  - STA — Producer prices — Mission — Nov. 01 — NSI
  - STA — Producer prices — Mission — Apr. 02 — NSI
  - STA — Price statistics — Mission — May 02 — NSI
  - STA — Producer prices — Mission — Jan 03 — NSI
  - STA — SDSS — Mission — Sep. 03 — BNB

### XII. Resident Representatives
- Mr. James Roaf took up the resident representative position on August 24, 2003.

*Source: APPENDIX I and APPENDIX II of the provided IMF document*

### 13. Railways. The Bank has been the government’s main external partner in the

### _cr04176 - 13. Railways. The Bank has been the government’s main external partner in the

### Railways: progress, remaining reforms, and Bank support
- Transformation progress:
  - Railway Rehabilitation Project completed in June 2002.
  - Transformation is "at present only half way achieved."
- Measures implemented under the PAL program:
  - Divestiture of all railway ancillary activities.
  - Major reduction in staffing.
  - Institutional separation of the national company into two new enterprises: infrastructure and rail services.
  - Opening of rail services to private operators.
- Key remaining steps (refined in PEIR and supported by the Bank through the PALs):
  - Tariff reform.
  - Reduction of loss-making services to only those that can be socially justified and supported by state contracts (public service obligations).
  - Further reduction of staff.
  - Improved corporate governance.
- Follow-up actions:
  - Detailed assistance with reform design to be provided through transport sector work in the near future.

### Education: objectives, Bank support, and planned actions
- Reform objectives:
  - Improve expenditure management in view of declining population, especially school age.
  - Enhance quality and access to education.
  - Reallocate expenditures from surplus capacity in teaching staff and underused facilities toward modernization and upgrading of curricula, textbooks, teaching materials, schools, and other quality-enhancing education inputs.
- Bank support and instruments:
  - Education Modernization Project loan (closed on March 31, 2004).
  - PALs and analytical work for the Poverty Assessment, the PEIR, and the Inter-governmental Finance study.
- Forward plan:
  - Under PAL-2 the government developed a concept for an education reform strategy and action plan; implementation would be supported through PAL-3.

### Health care: priorities and Bank projects
- Key reform priorities:
  - Address surplus capacity in health facilities.
  - Reverse deterioration in quality of facilities and health services.
  - Modernize equipment.
  - Ensure financial integrity of the NHIF (central point of reforms).
- Bank involvement:
  - Health Sector Restructuring Project (closed at end-2001).
  - Health Sector Reform project (approved late 2000) under implementation, focusing on:
    - Administrative and information systems of the NHIF.
    - Support to ambulatory care sector and hospital sector.

### Social protection programs: coverage, reform priorities, and Bank assistance
- Coverage and challenges:
  - Programs—pensions, labor market programs, social assistance, and short-term and family benefits—have wide coverage.
  - Some programs have become more pro-poor since the mid-1990s and play a major role in alleviating poverty.
  - System challenges: plethora of programs, complex designs, need for consolidation and systematic monitoring of costs and effectiveness.
- Pension reform priorities:
  - Improve compliance with, and coverage of, the public pillar.
  - Define a clear rule for indexing pensions.
  - Preparation of a policy-oriented note during FY04 to support pension policy dialogue.
- Labor market programs:
  - Need close monitoring to improve effectiveness and long-term impact in stimulating labor demand.
  - "Subject to progress in key reforms, consideration should be given to reduce the tax burden related to labor market policies in order to curtail labor costs."
- Bank support and projects:
  - Grants amounting to US$2.2 million focusing on:
    - Poverty monitoring and evaluation.
    - Integration of ethnic minorities.
    - Child development.
    - Building social capital in disadvantaged communities.
  - Child Welfare Reform project (Bank-financed).
  - Social Investment and Employment Promotion (SIEP) approved in 2002 (supports community and employment creation and strengthening of ALMPs).
- IMF role:
  - IMF has been monitoring sustainability of the pension system and advancement of labor market reforms in terms of relevance for the Fund’s program objectives (not subject to structural performance criteria or benchmarks).

### Areas where the World Bank leads (no direct IMF involvement)
- Private Sector Development:
  - Completed divestiture of about 95 percent (based on value of assets) of non-infrastructure SOEs since 1995.
  - Needed improvements: reduce barriers to entry, reduce compliance cost of regulatory regime, develop competitive environment, eliminate constraints to bank lending, establish efficient exit mechanisms for non-viable enterprises.
  - Under PALs, major legislative changes initiated: Commercial Code, Civil Procedure Code, Labor Code, and passage of legislation on state regulation of economic activity.
- Bank role in enterprise sector restructuring:
  - Support through two Finance and Enterprise Adjustment Loans (FESALs) and the PAL program.
  - Privatization of SOEs a major component of FESALs.
  - Under PAL-1 and PAL-2, Bank led dialogue on regulatory regimes, insolvency process, labor markets, and competition.
- Public sector governance:
  - Government program to improve public administration capacity, service delivery, reduce corruption, and reform judiciary; main focus of PAL-2.
  - Reforms and measures:
    - Policy, legal and institutional framework to strengthen merit and depolitization.
    - Performance standards for service delivery developed.
    - One-stop shop principles introduced in five central administrations and six regional administrations.
    - Enhanced system of performance appraisal and professional development within state administration.
    - Strengthened conflict of interest and asset declaration regime.
    - Monitoring system designed to track anti-corruption objectives.
    - Key ministries and agencies prepared detailed anticorruption action plans.

### World Bank Group Strategy and Lending Operations: CAS and lending portfolio
- Country Assistance Strategy (CAS) discussed May 9, 2002, focuses on three themes:
  - Promotion of competitive private sector led growth.
  - Strengthening public administration reforms and anti-corruption initiatives.
  - Mitigating the social impact of restructuring and delivering social services more effectively.
- Programmatic Adjustment Lending:
  - Up to three Programmatic Adjustment Loans (PALs); first approved by the Board in February 2003.
  - PAL objectives include:
    - Completion of privatization and restructuring in energy and infrastructure.
    - Improving environment for private sector led growth.
    - Deepening the financial sector.
    - Reducing poverty and improving human capital, and better delivery of social services.
    - Support public administration reform and anti-corruption programs.
- Bank assistance to date:
  - 33 operations for a total original commitment of US$1,820.9 million equivalent, comprising:
    - Eleven adjustment loans (US$1050.8 million).
    - 19 investment projects (US$750.7 million).
    - Two Bank-managed Global Environmental Fund (GEF) grants and one Bank-managed Prototype Carbon Fund (PCF) operation—Wood Residue to Energy.
  - Of these 33 operations:
    - 24 have been completed (two restructured and partially cancelled during implementation).
    - Nine operations currently under implementation.
- IFC activities in Bulgaria:
  - 17 projects totaling US$213 million supporting financial sector development, infrastructure, and restructuring of post-privatized companies.
  - Of those, 15 projects were approved from 1999-on.
  - IFC supported two specialized SME banks, established Bulgaria’s first micro lending bank, invested in a leasing company and a venture capital fund targeting the SME sector.
- Economic and Sector Work:
  - Completed: Bulgaria: Country Financial Accountability Assessment (2004) and Bulgaria: Inter-governmental Finances (2004).
  - Ongoing/completed: studies on environmental sequencing, infrastructure and energy, national energy efficiency, and expenditure needs for roads.
  - Planned additional work: pension funds, gender and ethnicity issues, rural development assessment, private sector assessment, and a CEM focused on policy reforms for growth.
- Representative operations list (selected entries with amounts and board dates as presented):
  - Trade and Transport Facilitation in Southeast Europe — 7.4 — 2000
  - Health Sector Reform — 63.3 — 2000
  - Child Welfare Reform — 8.0 — 2001
  - Registration and Cadastre — 30.0 — 2001
  - Wetlands Restoration and Pollution Reduction (GEF Grant) — 7.5 — 2002
  - Social Investment and Employment Promotion — 50.0 — 2002
  - Programmatic Adjustment Loan (PAL 1) — 150.0 — 2003
  - Revenue Administration Reform Project — 34.2 — 2003
  - District Heating Project — 34.2 — 2003
  - Wood Residue to Energy — 2.0 — 2003

### Aggregate balance sheet analysis (end-2003): currency and maturity mismatches
- Overall assessment:
  - Currency and maturity mismatches contained at aggregate level but considerable in individual sectors.
  - Short-term external liabilities in foreign currency of private sector exceed liquid external foreign-currency assets, but public sector liquid foreign assets more than outweigh private sector shortfalls.
  - Public sector’s large international reserves and public debt structure limit official demands on central bank foreign currency reserves.
- Nonfinancial Private Sector (NFPS):
  - Sizable overall short foreign currency position (medium- and long-term as well as short-term).
  - Short-term external liabilities in foreign currency exceed liquid external foreign-currency assets by about 6 percent of GDP (Appendix Figure 1).
  - Substantial degree of euroization: 48 percent of the banking sector’s liabilities are in foreign currency, mostly euros.
  - Potential pressures (e.g., reduced rollover of credit lines) would be transmitted to domestic banking sector.
- Financial Private Sector (FPS):
  - Long overall foreign currency position.
  - Short-term foreign-currency liabilities exceed liquid foreign-currency assets by 12½ percent of GDP, reflecting financial intermediation role and euroization.
  - Short-term external liabilities in foreign currency exceed liquid external foreign-currency assets only by a limited amount.
- Public sector:
  - Short overall foreign currency position derives from large (though falling) external debt.
  - Debt is medium and long-term (by original maturities); little short-term refinancing risk.
  - Liquid foreign-currency assets exceed short-term foreign-currency liabilities by a margin of more than 11 percent of GDP (including coverage of the monetary base by foreign exchange required by the currency board).
  - Amortizations of external debt falling due in 2004 are about €241 million (1.4 percent of GDP).
- Net implication:
  - Public external short-term foreign currency position is strong enough to offset private sector weaknesses (Appendix Figure 4).
  - Cushion of official reserves sufficient to counterbalance weaknesses, but comes at a cost including moral hazard, and may require continued reserve build-up through inflows on non-debt creating financing.
  - Credit developments likely to weaken private sector balance sheets further, increasing demands on public reserves and aggravating moral hazard and political/budgetary costs.
- FX-related definitions used:
  - FX: Foreign currency.
  - STFX: Short-term position in foreign currency.
  - STFXE: Short-term external position in foreign currency.
- Selected sectoral magnitudes and observations preserved exactly as reported:
  - Banking sector euroization: 48 percent of the sector’s liabilities are in foreign currency, mostly euros.
  - NFPS short-term external liabilities exceed liquid external foreign-currency assets by about 6 percent of GDP.
  - FPS short-term foreign-currency liabilities exceed liquid foreign-currency assets by 12½ percent of GDP.
  - Liquid foreign currency-denominated assets exceed short-term foreign-currency liabilities by more than 11 percent of GDP for the public sector.
  - Amortizations in 2004: €241 million (1.4 percent of GDP).

### Statistical issues and data dissemination
- Overall data assessment:
  - Bulgaria compiles and submits data to the Fund of sufficient quality and in a regular timely manner to permit program monitoring and surveillance.
  - Problems remain in national accounts and price statistics, particularly coverage of the emerging private sector, and in balance of payments statistics where frequent and substantial revisions have hampered analysis.
  - Work remains to reconcile high frequency economic activity data with quarterly and annual national accounts data.
  - Annual international investment position statistics are compiled and reported to STA for publication.
- SDDS subscription:
  - On December 1, 2003, Bulgaria subscribed to the IMF's Special Data Dissemination Standard (SDDS).
- Real sector specifics:
  - NSI, with OECD technical assistance, compiles national accounts according to ESA 1995; GDP by activity and expenditure reconciled within an annual supply and use framework.
  - Government output and final consumption estimated on a cash rather than accrual basis.
  - National accounts include current and capital accounts for five domestic sectors; financial account and balance sheets are missing.
  - Monthly industrial production index compiled; IMF STA mission found problems with inventories data quality and deflation method for industrial production index and made recommendations.
  - NSI compiled quarterly GDP by expenditure categories from Q1 1994 through Q3 2002 based on improved quarterly surveys.
  - Problems remain in deflation methods for household consumption, capital formation, and external trade, and in coverage of private sector activities.
  - Significant progress made in development of export and import deflators.
  - Producer Price Index (PPI) under revision; 83 percent of domestic industry sales now covered in expanded transaction-price collection.

*Source: _cr04176 - 13. Railways. The Bank has been the government’s main external partner in the (PDF chapter content provided).*

### APPENDIX                                                                        IV

### APPENDIX IV

### Price and trade statistics (PPI, CPI, customs, trade indices)
- PPI revision process scheduled for completion by June 2004.
- Rebasing of the PPI began in March 2003:
  - weights and reference period updated to 2000;
  - series linked at December 2002 to form a continuous monthly series for January 2000 to January 2003.
- CPI developments:
  - NSI linked annual Laspeyres price indices to produce a time series beginning in 1995;
  - Series follows new classifications and index methods recommended by Eurostat and STA and is published as the official CPI;
  - Coverage extended but still excludes owner-occupied housing;
  - New method for imputing missing observations of new products applied;
  - Quality adjustment procedures applied only in a few particular cases (example: the heating component).
- Customs and trade data:
  - Flow of customs data improved significantly since the April-May 1998 STA mission;
  - New system for processing customs records near completion;
  - Development of export and import unit value indices progressing smoothly, with additional support expected from Eurostat;
  - Current indices usable as deflators for import and export components of the national accounts;
  - Import and Export Division meets monthly with the Bulgarian National Bank to review data and ensure consistency with balance of payments data.

### Labor statistics and household surveys
- Main shortcomings of labor data collected by NSI:
  - Under-reporting of private sector wages;
  - Reporting limited to average gross earnings (not wages for time worked and not wages by occupation);
  - Lack of coverage of the self-employed and of employment in small firms.
- Data collection details:
  - Annual data: census of all establishments.
  - Monthly establishment survey: covers all public employers and a sample of private employers (excludes establishments with less than 5 employees; includes about 10,000 private employers out of approximately 69,000 qualifying establishments).
- Planned and alternative improvements:
  - Use NSSI data to estimate wages by occupation and age and to estimate number of self-employed and employment in small firms;
  - Household budget survey could provide alternative source for private sector wages;
  - NSI household labor force survey is an alternative source for employment but needs improvements to be consistent with establishment survey, especially for agricultural employment;
  - Labor force survey needs consistent schedule (semi-annually or quarterly); survey has been conducted twice a year since 1993 (three times a year since 1999) but at irregular intervals; from 2001 onward NSI intended to conduct it quarterly;
  - Eurostat provided support since mid-2000 in a pilot project (ending mid-2001) to improve compliance with Eurostat recommendations.
- Population Census:
  - Conducted in early 2001 and used to redesign household surveys (household budget survey and labor force survey).

### Government finance and fiscal reporting
- September 1999 combined STA/FAD mission:
  - Reviewed progress under budget execution reform program;
  - Assisted MoF with development of a new chart of accounts for the government sector;
  - Advised on implementation of accrual accounting for government, budgetary, and statistical systems.
- Key recommendations from mission and Experimental Report on Implementation of Standards and Codes (August 1999):
  - Improve fiscal data to meet EU accession reporting requirements, notably implement new chart of accounts and Financial Information Management System;
  - Disseminate information on arrears of central and local governments, local government debt, and details of financing;
  - Compile and disseminate discrete monthly and quarterly data;
  - Update the MoF website monthly.
- Reporting status:
  - Consolidated central government operations routinely reported for publication in the GFS Yearbook and in IFS;
  - For the GFS Yearbook 2003, 2002 data for general government sector and subsectors were reported on an accrual basis in accordance with GFSM 2001;
  - Ministry of Finance prepares data on execution of the consolidated government on a monthly basis; these data do not conform to GFS standards and, while not published in bulletin format, are posted on the Ministry of Finance’s website.

### Money and banking statistics
- Statistical methods conform with key classification and valuation principles in IMF’s Monetary and Financial Statistics Manual, 2000.
- From January 2003, positions on financial derivatives (small at present) to be included in balance sheets.
- Consistency improvements:
  - BNB’s claim on banks (which included claims on liquidated banks) and banks’ liabilities to the BNB improved in January 2003 after BNB wrote off most claims on liquidated banks.
- Harmonization with ECB framework:
  - BNB progressively harmonizing data collection and compilation methods with the European Central Bank’s framework for monetary statistics;
  - Significant enhancements in sectoral and instrument detail and classification made in data for 1995 onward;
  - Enhancements reflected in revised monetary statistics published in the August 2002 and November 2003 issues of IFS.

### Balance of payments statistics
- Bulgaria reports monthly balance of payments data regularly and timely but data are subject to frequent and substantial revisions.
- December 2000 IMF TA mission recommendations to strengthen systems:
  - Develop a closed-type international transactions reporting system;
  - Develop estimates of “shuttle trade” with bordering countries;
  - Strengthen methodology for travel transactions;
  - Compile data on trade credit liabilities.
- Treatment clarified for mobile telephone license:
  - GSM license purchase recorded under foreign direct investment in equity capital component in Q1 2001;
  - No repayment obligation so transaction does not change external debt position;
  - Related transactions no longer recorded for subsequent periods.
- ROSC mission (2003) identified problems:
  - Residents’ foreign currency accounts with resident banks incorrectly included;
  - Merchandise trade data prone to errors and not timely;
  - Most data collected on a cash basis.

### Core statistical indicators and data reporting characteristics (as of May 11, 2004)
- Table 17 (Bulgaria: Core Statistical Indicators as of May 11, 2004) shows:
  - Observation dates include May 11, Apr 30, Mar 2004, Mar 2004, Mar 2004, Mar 2004, Mar 2004, Feb 2003, Feb 2003, Feb 2003, Q4 2003 (qtrly), Feb 2003.
  - Date Received entries range from May 11 to Mar 31, 2004.
  - Frequencies reported include Daily, Weekly, Monthly, Quarterly, and Annually for different series.
  - Sources of update include BNB, NSI, MoF, and combined MoF and BNB.
  - Modes of reporting include Email, website, Email/fax, and Email from BNB.
  - Confidentiality column records entries of "Yes" and "No" depending on series.
  - Frequency of publication includes Daily, Weekly, Monthly, Quarterly, and Annually across series.

### Ex Post Assessment (EPA) overview and introduction (May 19, 2004)
- Purpose and scope:
  - Bulgaria had a longer-term engagement with the Fund requiring an Ex Post Assessment (EPA) under IMF (2003);
  - EPA focuses primarily on 1994-2003 and on strategy for future engagement.
- EPA team members:
  - Mr. Cottarelli (head, EUR), Mr. Dell’Ariccia (RES), Mr. Duenwald (EUR), Mr. Nystedt (PDR), and Mr. Teo (MFD).
- Methodology and resources:
  - EPA based on analysis of available documents and EPA interviews in Washington and Sofia with current and former Fund staff, World Bank staff, and current and former representatives of the authorities;
  - Preparation estimated to have required about 0.3 person year (includes EPA team and related assistance, excludes time by reviewing departments and staff met during interviews).
- High-level findings summarized in the Introduction:
  - Transition was difficult with GDP 40 percent below 1990 level by 1997;
  - Inflation averaged 233 percent per year during 1990-97 and turned into hyperinflation in late 1996-early 1997;
  - Fiscal deficit averaged 8½ percent of GDP during 1990-97 with large quasi-fiscal deficits;
  - After 1996-97 crisis, reforms anchored by a currency board arrangement produced high and stable growth (in the 4-5½ percent range during 2000–2003) and low inflation, though unemployment and poverty remained high and risks (widening current account deficit, booming bank credit) emerged.
- Engagement history:
  - After a one-year SBA, three consecutive SBAs went off track in the early period; starting in 1997 two SBAs and one EFF were successfully completed;
  - Bulgaria was engaged with Fund-supported programs for 118 out of 168 months during 1990–2003, and for 94 out of 120 months during the last ten years.
- Questions addressed by EPA:
  - Why did pre-1997 programs fail and later programs succeed?
  - Why was Fund support needed for seven years after stabilization?
  - What are the present risks, and does Bulgaria still need Fund support?

*Source: _cr04176 - APPENDIX IV (May 19, 2004).*

### 7.       In this context, early programs, aimed primarily at stabilizing the economy,

### 7.       In this context, early programs, aimed primarily at stabilizing the economy, 

### Early programs, macroeconomic deterioration, and crises
- A first SBA was completed in March 1992; a second SBA went off track in late 1992.
- GDP dropped, unemployment surged, and the external current account deficit approached 13 percent of GDP in 1993.
- After failure of the second SBA, a hiatus with persistently lax monetary and fiscal policies and little progress in structural reform led to a first currency crisis in late 1993-early 1994.
- A third SBA in April 1994 was derailed in the Fall when the government fell.
- A fourth SBA in mid-1996 responded to a rapid surge in inflation and depreciation; the primary surplus rose to 9¼ percent of GDP that year, but Fund endorsement failed to catalyze support and implementation of structural reforms was hesitant.
- By September 1996, one-third of banks had been closed; by year-end Bulgaria experienced hyperinflation, international reserves had collapsed, and support for the government had dissipated.

### The SOEs–banks nexus: nature and scale of the problem (Box 1)
- Until mid-1996, no large- to medium-sized loss-making SOEs had been declared bankrupt; by end-1996, less than 6 percent of the assets of SOEs had been privatized.
- Cumulative losses of SOEs averaged 22 percent of GDP during 1993-95 (OECD, 1997).
- Losses were financed by arrears and bank loans, which were refinanced by the central bank; periodically the state assumed banks’ bad loans via bonds amounting to half of domestic debt in 1993-95 (OECD, 1997).
- In early 1996, 70 percent of outstanding loans were classified as nonperforming, and the negative net worth of the banking system was estimated at 10 percent of GDP.
- Poor accounting, auditing, reporting, and disclosure standards, weak governance, insufficient protection against insiders’ interests, and inadequate supervision encouraged irresponsible lending and speculative positions (including foreign exchange).

### The 1997 stabilization strategy and the currency board arrangement (CBA)
- Crisis led to resignation of the socialist government in December 1996; a reform-minded caretaker government took over; reformists won April 1997 elections and a new 14-month SBA was approved in April 1997.
- Key elements of the 1997 program:
  - Introduce a currency board to prevent central bank financing of banks and the budget.
  - Sever the SOEs–banks link by closing and restructuring loss-making SOEs and strengthening bank supervision.
  - Increase independence and intervention powers of bank supervision; align the prudential framework with international standards.
  - Strengthen incomes policy for SOEs to harden budget constraints and guide wage expectations.
  - Revive and accelerate privatization.
- Conditionality: SOE/bank structural reform and privatization were covered in the 1997 SBA and the following EFF by very detailed conditionality, which served as a blueprint for reform and facilitated policy coordination.

### Market reaction and macro outcomes after 1997
- Bulgaria’s gap against the EMBI fell by 250 basis points the week after the socialist government resigned, and by 100 bps after IMF board approval of the new program; by 1998 the gap was approaching zero and Bulgaria’s rating was upgraded in early 1998.
- Domestic interest rates fell from 400 percent in 1996 to 7 percent in 1997.
- The 1997 SBA was successfully completed and followed by two new arrangements focusing on continued fiscal prudence (falling interest payments permitted a reduction in the primary surplus) and further reforms.
- Output rose by 22½ percent in the last five years (period context in text), despite the Asian, Russian, and Kosovo crises.
- Inflation fell to single digits, and external debt declined.
- External current account deficit averaged about 4¼ percent of GDP during 1998-2002 and was financed by FDI; the external current account deficit rose to 8½ percent of GDP in 2003 as imports accelerated due to a credit boom.
- Trade liberalization: average tariffs dropped from about 17 percent in 1997 to 11½ percent in 2003.
- Privatization accelerated especially in 1999-2000; SOE restructuring and banking sector law strengthening progressed; land restitution process completed.
- Structural conditionality compliance: some waivers were needed after 1997; under the most recent SBA the number of structural conditions met with delay or not met increased in relative terms and the structural reform process slowed.

### Why the 1997 program succeeded — diagnosis from EPA interviews
- Core success factor: credibly severing the SOEs/banks link broadened adjustment and addressed the core of Bulgaria’s inflationary spiral.
- Both components were critical and mutually reinforcing:
  - Structural reform and privatization (detailed conditionality) provided a reform blueprint and facilitated coordination.
  - The CBA provided an institutional barrier against monetary financing of SOEs and banks and served as a communication tool around which society coalesced; consistency with the CBA became the ultimate litmus test for key economic policy decisions.
- Political change: the mid-1997 government was homogeneously reformist and supported by a wide parliamentary majority, reassuring markets.
- The CBA increased credibility and avoided the need for excessive front-loading of reforms; however, the reform agenda was incomplete in 1997 (EBRD transition index improved sharply in 1997 but remained below transition-country average and improved further only after 1998).

### Factors assessed: initial conditions, external environment, over-optimism, and financing (Box 2)
- Initial conditions: Bulgaria’s starting point on the transition route was weak; by 1997 some structural progress and increased implementation capacity existed; the early 1997 hyperinflation cut domestic debt burden, strengthening fiscal accounts; but inflation expectations, lower per capita GDP, high unemployment, and inflated external debt remained problems.
- External environment: market sentiment was weak in 1994 and 1996; the 1997 program benefited from more favorable conditions (average EMBI spread for the six months around program start: 727 basis points for 1996 program and 449 basis points for 1997 program). The 1997 program proved resilient to external shocks (e.g., Russian crisis caused only a brief rise in Bulgaria’s spread).
- Over-optimism: repeated failures of pre-1997 programs resulted in sizable over-prediction of growth and under-prediction of inflation; EPA interviews did not single out over-optimism as a primary cause of failure.
- Financing: lack of financing was not the key factor behind pre-1997 failures. By end-1995, the Fund was Bulgaria’s largest creditor, accounting for 8¼ percent of external debt. Fund support to the failed 1996 program was broadly equal to that to the successful 1997 program and was frontloaded. Some argued larger access in 1996 could have bought time, but donors were reluctant given the authorities’ poor track record.

### Why the change did not occur earlier
- Lack of a pro-reform consensus across government, parliament, and population prior to 1997 impeded reform implementation; pre-1997 governments included reformers but were not homogeneously reformist.
- The 1996–97 crisis exposed failures of earlier policies, producing the political dynamic that allowed addressing the SOEs/banks core problem.
- The Fund had identified the SOEs/banks link as critical by at least 1993; 1994 and 1996 programs regarded SOE/banking reforms as critical, but their conditionality did not cover reforms to the same extent as the 1997 program.
- Quantitative macro-conditionality in earlier programs indirectly highlighted structural slippages; when ownership was strong in 1997, detailed structural conditionality assisted implementation by providing a clear blueprint.

*Source: _cr04176 - 7.       In this context, early programs, aimed primarily at stabilizing the economy,*

### Box 3. Did Lack of Data Prevent Diagnosing the SOEs/Banks Problem?

### _cr04176 - Box 3. Did Lack of Data Prevent Diagnosing the SOEs/Banks Problem?

### Data limitations and diagnosis of SOE/bank problems
- By the mid-1990s all SOEs had to provide financial data quarterly, but poor accounting standards made the reported data relatively unreliable.
- The existence of severe problems in SOEs and banks was well known and was confirmed by:
  - repeated need for the government to cover bank losses through the injection of securities, and
  - repeated need for the central bank to provide liquidity.

### Why the Fund supported programs that proved too weak
- Prolonged program discussions ahead of the 1994 and 1996 programs, authorities’ unwillingness to take adequate measures, and repeated slippages in earlier programs signaled problems; internal Fund documents repeatedly pointed to political risks.
- Structural conditionality:
  - 1994 letter of intent committed authorities to SOE reform and privatization, but these actions were not covered by conditionality except through the program review process; the Fund relied on an indirect approach via credit ceilings.
  - 1996 program included a series of structural prior actions but they were not sufficiently comprehensive; one prior action was agreement “in principle” with the World Bank on a program for enterprise reform. The Fund accepted a “two-step” approach to bank restructuring with a side letter and provided for an early review to assess financial sector developments and progress in SOE reform.

### Reasons given for proceeding despite political-economy risks
- Crisis context: decisions to support Bulgaria in 1994 and 1996 were taken under crisis situations, making it harder to deny support; delaying could have deepened the crisis.
- Authorities’ partial performance: central budget position was strengthened in both 1994 and 1996, reflecting control of the Ministry of Finance by the most reformist component of the government’s coalition.
- Ownership considerations: increased attention to ownership issues is relatively recent; in the mid-1990s it was harder for Fund staff to deny support based on ownership.

### Fund vs. World Bank cooperation and roles
- The World Bank delayed support in 1994-96 due to lack of structural reform progress; the Fund proceeded.
- After 1997 the Fund again led support and, in the absence of a World Bank–supported program, negotiated macroeconomic policies and structural reform, including in banking and SOE sectors.
- The Fund’s mandate including crisis prevention may have made it more willing to take risks relative to the World Bank.

### Benefits of Fund support: financial, catalytic, and political-economic
- Financial benefits (examples preserved exactly):
  - 1997 SBA annual benefit: 0.4 percent of GDP.
  - 1998 EFF annual benefit: 0.3 percent of GDP.
  - 2002 SBA annual benefit: less than 0.1 percent of GDP.
  - Considering outstanding stock of Fund resources committed in earlier programs, the financial benefit for Bulgaria would be about 0.7 percent of GDP per year during 1997–2002.
- Catalytic effects:
  - 1997 SBA contributed to a tightening of spreads, consistent with a catalytic effect; effect on spreads was more limited in later programs.
  - Recent studies suggest catalytic effects emerge only when fundamentals are “not too bad”; given Bulgaria’s high external debt ratio, no program was likely to have a catalytic effect.
- Mobilizing internal support:
  - Fund endorsement facilitated reform implementation significantly, particularly in later years.
  - The Fund’s support added to legitimacy and made measures less likely to be opposed in parliament, increasingly important as parliamentary majorities became more fragmented (notably relevant to the 2002 SBA).

### Key statistics and indicators (preserved as in source)
- Bank credit to the private sector rose by close to 50 percent in 2003.
- External current account deficit almost doubled in 2003, to 8½ percent of GDP.
- FDI coverage of the current account deficit was 82 percent in 2003 (but only 63 percent excluding privatization receipts).
- A model-based post-transition equilibrium bank credit-to-GDP ratio for a country with Bulgaria’s fundamentals is some 50 percent; the actual 2003 level was 27½ percent.
- The current account deficit is now some 1½ percentage points of GDP above what staff regards as adequate to stabilize the external debt ratio without relying on one-off privatization receipts.
- Bulgaria ranks 54th out of 133 countries in the Transparency International Corruption Perceptions Index (Transparency International, 2003).

### Risks ahead identified
- Macroeconomic risks:
  - Rapid bank credit growth and a nearly doubled current account deficit in 2003 may signal unsustainable imbalances.
  - Prudential indicators do not yet show deterioration but are lagging signals.
  - External debt remains high and exposure to market sentiment persists.
- Political and social risks:
  - Growth has been good but not impressive; unemployment and poverty remain relatively high.
  - Political support for the government has weakened; coalition cohesion eroded; potential for reform fatigue.
  - Consensus to maintain the CBA and advance EU accession partially offsets political uncertainty.

### Recommended policy responses and program design considerations
- Macro policy:
  - Tight fiscal policy should be the main instrument to contain excessive domestic demand growth; maintain fiscal flexibility in response to shocks.
  - Improve fiscal policy quality: focus on enhancing tax administration and expenditure management.
  - Strengthen the 1999 pension reform in some respects.
- Competitiveness and incomes:
  - Enforce strict incomes policies in the public sector.
  - Increase labor market flexibility through labor market reform to reduce inflationary pressures and boost competitiveness.
- Financial sector and supervision:
  - Monitor credit growth closely; if excessive, be ready to implement further measures including possibly tightening reserve requirements and prudential regulations (effectiveness depends on capital mobility and degree of bank capitalization).
  - Continue strengthening financial supervision to reduce financial stability risks.
- Structural reforms to boost long-term growth:
  - Improve business environment to attract foreign capital and boost potential output and exports.
  - Complete privatization, strengthen governance, and intensify the fight against crime.

*Source: _cr04176 - Box 3. Did Lack of Data Prevent Diagnosing the SOEs/Banks Problem?_*

### 35.      The balance of the arguments would be for recommending continued program

### _cr04176 - 35.      The balance of the arguments would be for recommending continued program

### Recommendation for continued program involvement
- The balance of the arguments favors recommending continued program involvement, assuming a successful completion of the program discussions.
- Given the longer-term program engagement and the absence of an imminent financing need, a new SBA should be lower access and precautionary.
- A precautionary SBA could cover a period of two to three years, bridging the gap before possible EU accession in early 2007.
- The new arrangement is expected to be the last one, with EU accession serving as a natural exit from a program-based relationship.

### Rationale: economic conditions, risks, and Fund role
- Market sentiment towards Bulgaria is currently favorable, and there does not appear to be an imminent balance of payments need.
- Economic and political risks are nontrivial; there is little room for policy slippages given Bulgaria’s lack of monetary flexibility, and a potential balance of payments need cannot be ruled out.
- The macroeconomic nature of the risks justifies the Fund’s involvement.
- Authorities indicated Fund support could:
  - (i) facilitate internal consensus on appropriate policies, including in the run up to the 2005 elections; and
  - (ii) provide confidence to foreign investors, rating agencies, and perhaps other multilateral institutions.
- The EPA team concurs that the Fund’s presence has and would likely continue to facilitate enactment of appropriate policies, particularly when caution in macroeconomic policies may be jeopardized by a more fragmented political situation.
- Catalytic effects vis-à-vis private capital are unlikely to be strong in the future, but other multilaterals—the EBRD, the European Commission, and the World Bank—may prefer to engage with Bulgaria in the context of Fund arrangements.
- The longer-term program engagement during 1997-2003 reflected authorities’ appreciation for Fund advice; therefore common drawbacks identified for longer engagements (Independent Evaluation Office (2002))—weaker incentives to take decisive action, loss of credibility for the Fund in supporting weak programs, poor ownership, and weakening of the surveillance function—do not apply to Bulgaria.

### Surveillance-only relationship versus program conditionality
- A surveillance-only relationship, while feasible, would be significantly less effective in supporting the authorities’ program.
- EPA interviews highlighted that a surveillance-only relationship would be seen as signaling a more detached role for the Fund in the eyes of Bulgaria’s public opinion and may not be very effective in maintaining policy discipline.
- Program conditionality would facilitate gathering political support for appropriate policies.

### Design and purpose of a precautionary SBA
- A precautionary SBA is in line with Executive Board decisions on signaling devices: precautionary agreements provide a framework for monitoring policies in countries that meet standards for Fund financial support but do not have an immediate financing need.
- Management’s guidance note for Assessments of Countries with a Longer-Term Program Engagement (IMF(2003)) indicates “precautionary arrangements may provide a more effective device for facilitating the transition from sustained reliance on Fund resources... .”
- The proximity of EU accession, and later the need to progress towards adoption of the euro, will provide an alternative discipline to that arising from Fund support. Euro adoption would, in a successful scenario, be the exit strategy from the CBA.

### Program discussion priorities and risk assessment
- Program discussions should focus on understanding better the extent of the risks, including:
  - The level of competitiveness.
  - The determinants of the import boom, particularly the extent to which it is driven by investment that would raise export capacity.
  - Prospects for greenfield FDI.
  - Determinants of the credit boom, especially any sign of emerging asset price bubbles.
- Further analysis required on the credit boom includes:
  - Breakdown of credit by borrowing sector, maturity, and currency composition.
  - Risk management practices.
  - Banks’ funding sources.
- Political economy factors should be assessed to evaluate the risk of noncompliance and implementation risk arising from political economy factors.

### EPA team conclusions (numbered and bulleted findings)
- The nature of Bulgaria’s longer-term engagement with the Fund differs between pre-1997 and later periods: pre-1997 engagement occurred in the context of programs that failed to achieve their objectives; later engagement occurred within successful programs and reflected authorities’ belief that the Fund could play a useful role even after initial stabilization.
- Pre-1997 program failures reflected insufficient ownership and support for reform; programs recognized the need for SOE/bank reforms but commitments were violated.
- A major shortcoming in the Fund’s actions historically was willingness to support programs that lacked sufficient ownership; this underscores the importance of adequate assessment of political economy factors, though the Fund cannot control those factors.
- The 1996–97 crisis was a watershed that triggered changes in politics and policies, boosting program ownership.
- From 1997 onward, the Fund provided a blueprint for reform and helped muster domestic support; this role has become more important given a less homogeneous composition of government forces.
- Fund–World Bank cooperation went through phases:
  - In 1994 and 1996 the Fund supported Bulgaria without a World Bank supported program.
  - In 1997 the Fund again took the lead in supporting a successful program and designing structural conditionality where a World Bank program was absent.
  - In more recent years cooperation aligned more with respective areas of responsibility; detailed structural conditionality helped coordinate domestic policies particularly during 1997–2001.
  - The 1997–1999 level of structural conditionality would have been significantly more difficult under the 2002 guidelines on streamlining conditionality.
- Looking forward, the balance of arguments favors accepting the authorities’ request for a new precautionary SBA, provided policies are right.
- A new program should contain measures to limit risks related to the widening external current account deficit and the ongoing bank lending boom; these fall within the Fund’s mandate, including financial sector stability.
- The reform process should continue with the goal of further privatization and improvement in the business climate to stimulate a supply response, which is critical for political sustainability of macroeconomic stability; cooperation with the World Bank in this area is essential.
- Fund conditionality can play a selective role in structural areas with more direct macroeconomic implication such as privatization (given its relevance for lowering external debt).
- Any pre-program discussion should include a proper evaluation of current macroeconomic risks and implementation risk arising from political economy factors.

*Source: IMF staff report excerpt (EPA team conclusions and recommendations).*

### REFERENCES

### _cr04176 - REFERENCES

### References (bibliography)
- Bristow, J.A., 1996, The Bulgarian Economy in Transition, Edward Elgar: UK.
- Cottarelli, C., G. Dell’Ariccia, and I. Vladkova-Hollar, 2003, “Early Birds, Late Risers, and Sleeping Beauties: Bank Credit Growth to the Private Sector in Central and Eastern Europe and the Balkans,” IMF Working Paper No. 03/213 (Washington: International Monetary Fund).
- Feyzioğlu, T., B. Horváth, P. Stella, M. Cangiano, and A. Doughty, 1999, Bulgaria: Recent Economic Developments and Statistical Appendix,” IMF Staff Country Report No. 99/26, (Washington: International Monetary Fund).
- Giatzidis, E., 2002, “An Introduction to Post-Communist Bulgaria: Political, Economic, and Social Transformation,” Manchester University Press: UK.
- Gourinchas, P.-O., R. Valdes, and O. Landerretche, 2001, “Lending Booms: Latin America and the World,” Economia, pp. 47-99. (Spring)
- International Monetary Fund (Independent Evaluation Office), 2002, “Report of the Independent Evaluation Office on Prolonged Use of IMF Resources,” (Washington: International Monetary Fund).
- International Monetary Fund, 2003, “Operational Guidance for Assessments of Countries with a Longer-Term Program Engagement,” http://www.imf.org/external/np/pdr/ufr/2003/082003.htm
- Mody, A. and D. Saravia, 2003, “Catalyzing Capital Flows: Do IMF-Supported Programs Work as Commitment Devices?” IMF Working Paper No. 03/100 (Washington: International Monetary Fund).
- OECD, 1997, OECD Economic Surveys—1996-97, Bulgaria, Paris.
- Transparency International, 2003, Corruption Perceptions Index 2003, Berlin (http://www.transparency.org).
- World Bank (Operations Evaluation Department), 2002a, “Republic of Bulgaria: Country Assistance Evaluation,” Report No. 23809 (Washington: World Bank).
- World Bank, 2002b, “Bulgaria—Poverty Assessment,” Report No. 24516-BUL (Washington: World Bank).

### Statement by the IMF Staff Representative (June 14, 2004) — Key updates and data
- High-frequency indicators:
  - Industrial output surged by 17¼ percent year on year in the first quarter.
  - Sales volume rose by 15½ percent year on year in the first quarter.
  - Twelve-month inflation eased from 6.2 percent in March to 6.1 percent in April.
  - Registered unemployment rate declined to 13.2 percent in April.
  - Real wages increased by 0.1 percent year on year in January-March 2004.
- External sector:
  - Twelve-month external current account deficit widened to 8.8 percent of GDP in March.
  - Trade deficit was 13.4 percent of GDP in March.
  - Net FDI inflows were €280 million in the first quarter, covering 58 percent of the current account deficit.
  - Net FDI inflows were mostly greenfield.
  - Net FDI inflows and strong capital inflows contributed to a small gain in international reserves.
- Credit and banking measures:
  - Growth of credit to the nongovernment sector slowed from 52¼ percent year on year in March to 50¾ percent in April.
  - Credit to households rose by 80 percent year on year (April).
  - Credit to nonfinancial corporations rose by 40 percent year on year (April).
  - Authorities’ measures to reduce bank liquidity:
    - Shifted government deposits in commercial banks to the central bank.
    - Imposed a reserve requirement of 4 percent (from July 1) on previously excluded instruments with maturities of two years or above.
    - Excluding (from September 1) 50 percent of cash in vault from reserve requirement calculations.
- Fiscal developments:
  - Government accumulated a cash fiscal surplus of 1.4 percent of GDP in the first four months of the year.
  - Large revenue overperformance of 1.8 percent of GDP, partly offset by higher expenditure of 0.4 percent of GDP.
  - Revenue overperformance driven mainly by higher-than-projected corporate profits in 2003 and imports in the first quarter of 2004.
  - Expenditures for maintenance and operations, subsidies and social programs exceeded budget allocations.
- Privatization and EU accession:
  - Communications regulatory commission approved granting of a GSM license to BTC, removing remaining obstacle to its sale.
  - Deadline for binding bids for privatization of seven electricity distribution companies extended to July 9 at bidders’ request.
  - On June 4, Bulgaria closed three additional EU accession chapters; negotiations on the last one (competition policy) expected to be completed by end-June.

### Public Information Notice (PIN) No. 04/65 — Executive summary and assessment (June 18, 2004)
- Background and recent performance:
  - Average real GDP growth of 4½ percent since the last Article IV consultation.
  - In 2003, government reduced the deficit to 0.4 percent of GDP.
  - Bank claims on the nongovernment sector rose by nearly 8 percentage points of GDP in 2003.
  - Current account deficit widened to 8½ percent of GDP in 2003.
  - Foreign direct investment inflows strong and reserves rising.
- Policy stance and risks:
  - Authorities agreed to a deficit of 0.4 percent of GDP for 2004 (revised from 1.2 percent of GDP in the original budget).
  - Authorities intend to achieve balance for 2004 using expected revenue overperformance, and to achieve balance in coming years (small deficit possible in 2007 for EU-related expenditures).
  - Authorities plan to reduce bank liquidity by tightening reserve requirements and shifting government deposits to the central bank.
  - Authorities plan measures to improve governance, business climate, and privatization of remaining state-owned enterprises to facilitate further FDI inflows.
- Executive Board views and recommendations:
  - Directors welcomed solid economic performance but were concerned about the widening external current account deficit driven by sharp credit expansion.
  - Recommended policies to moderate domestic demand and accelerate structural reforms:
    - Tighten fiscal stance.
    - Drain liquidity from banking system.
    - Implement structural reforms, including privatization, more vigorously.
  - Many Directors preferred a more ambitious fiscal adjustment in 2004 to dampen domestic demand.
  - Urged authorities to save revenue overperformance at least until budget balance is assured and to resist pre-election spending pressures.
  - Advised shifting partially from direct to indirect taxation in a revenue neutral way, strengthen tax administration and expenditure management, and ensure sustainability of pension and health care systems.
  - Emphasized need for timely steps to prevent fiscal deficits upon EU accession and to prepare for ERM2 entry with a solid fiscal position.
  - Commended measures to reduce credit growth but noted effectiveness remains to be seen given an open capital account; fiscal flexibility needs to be maintained.
  - Supported complementing demand management with structural reforms to enhance supply and export capacity; stressed privatization as critical to meeting external financing requirements and increasing productivity.
  - Most Directors viewed a successor Stand-By Arrangement (SBA) with lower access and precautionary character as appropriate; a few saw surveillance-only as an alternative.
  - Welcomed improvements in data quality and decision to subscribe to the Fund’s Special Data Dissemination Standard.

### Bulgaria: Selected Economic Indicators (2000–2004)
- Real economy (Percent change):
  - Real GDP: 2000 = 5.4; 2001 = 4.1; 2002 = 4.9; 2003 = 4.3; 2004 = 5.0 (Projection).
  - Consumer price index (end of period): 2000 = 11.4; 2001 = 4.8; 2002 = 3.8; 2003 = 5.6; 2004 = 3.2 (Projection).
  - Registered Unemployment: 2000 = 18.1; 2001 = 17.5; 2002 = 17.4; 2003 = 14.3; 2004 = ...
- Public finance (In percent of GDP):
  - General government balance: 2000 = -1.0; 2001 = -0.9; 2002 = -0.6; 2003 = -0.4; 2004 = -0.4 (Projection).
  - Public debt (end of period): 2000 = 77.0; 2001 = 69.9; 2002 = 61.4; 2003 = 53.4; 2004 = 47.3 (Projection).
- Money and credit (Annual percent change):
  - Broad money (nominal, end of period): 2000 = 30.8; 2001 = 25.8; 2002 = 11.7; 2003 = 19.6; 2004 = 18.2 (Projection).
  - Credit to nongovernment sector (nominal, end of period): 2000 = 17.0; 2001 = 32.1; 2002 = 44.0; 2003 = 48.3; 2004 = 25.9 (Projection).
- Interest rates (annualized):
  - BNB basic rate: 2000 = 4.6; 2001 = 4.7; 2002 = 3.4; 2003 = 2.7.
  - Time deposit (leva): 2000 = 3.3; 2001 = 3.4; 2002 = 3.2; 2003 = 3.2; 2004 = ...
- Balance of payments (In millions of euro):
  - Gross official reserves (end of period): 2000 = 3,719; 2001 = 4,063; 2002 = 4,575; 2003 = 5,309; 2004 = 5,775 (Projection).
  - In months of prospective imports of GNFS: 2000 = 4.7; 2001 = 5.0; 2002 = 4.9; 2003 = 5.1; 2004 = 5.1 (Projection).
  - Current account (percent of GDP): 2000 = -5.6; 2001 = -7.3; 2002 = -5.6; 2003 = -8.5; 2004 = -8.2 (Projection).
  - Trade balance (percent of GDP): 2000 = -9.4; 2001 = -11.7; 2002 = -10.2; 2003 = -12.5; 2004 = -12.8 (Projection).
- Exchange rates:
  - Exchange rate regime: Currency Board since July 1997.
  - Leva per dollar (end of period): 2000 = 2.102; 2001 = 2.219; 2002 = 1.885; 2003 = 1.611; 2004 = 1.614 (Projection).
  - Nominal effective exchange rate (1995=100, Annual average level): 2000 = 6.0; 2001 = 6.3; 2002 = 6.6; 2003 = 7.2; 2004 = ...
  - Real effective exchange rate (1995=100, CPI-based): 2000 = 125.3; 2001 = 131.2; 2002 = 137.0; 2003 = 144.7; 2004 = ...
- Notes:
  - Sources: Bulgarian authorities; and IMF Staff estimates.
  - 1 Projection.
  - 2 The Currency Board arrangement fixed the exchange rate at 1,000 leva = 1 DM through end-1998 and 1,955.83 leva = 1 euro since January 1, 1999. On July 5, 1999, the lev was redenominated by removing three zeroes.
  - 3 Annual average level.
  - 4 CPI-based.

*Content derived from _cr04176 - REFERENCES (IMF PDF)._

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