Bulgaria: Concluding Statement of the 2015 Article IV Mission

March 13, 2015

A Concluding Statement describes the preliminary findings of IMF staff at the end of an official staff visit (or ‘mission’), in most cases to a member country. Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, or as part of other staff monitoring of economic developments.

The authorities have consented to the publication of this statement. The views expressed in this statement are those of the IMF staff and do not necessarily represent the views of the IMF’s Executive Board. Based on the preliminary findings of this mission, staff will prepare a report that, subject to management approval, will be presented to the IMF Executive Board for discussion and decision.

March 13, 2015

Over the last year, the failure of a large bank and a deterioration in the fiscal balance have tested Bulgaria’s hard-won macroeconomic and financial stability. Growth last year was broadly in line with projections, but looking forward, risks to the outlook have increased. Prompt action, backed by broad political support, is needed to address institutional weaknesses exposed by the bank failure, including in banking supervision. In addition, a prudent budget path must be restored, and scope to accelerate consolidation (including through measures to strengthen the effectiveness of public spending) should be explored. Progress is also needed on structural reforms to drive more rapid income convergence to EU levels; measures currently under discussion to address energy sector inefficiencies are welcome.


Despite a challenging environment, modest growth was achieved in 2014 and is expected to continue this year. An expansionary fiscal stance and rising absorption of EU funds supported domestic demand in 2014. Unemployment, while still high, declined. Lower commodity prices, falling EU-wide inflation, and administered price reductions contributed to deflation. Growth is expected to moderate this year to about 1¼ percent, supported by private consumption and continued EU funds absorption. Net exports are expected to have a neutral effect on growth, with trading partner demand likely remaining subdued. Deflationary pressures are expected to lessen gradually and unemployment to decline further in 2015. Medium-term projections suggest very slow income convergence with other EU countries.

Risks to the outlook have increased. On the domestic side, the coalition government may face challenges in pushing through the difficult measures required to reduce macro-financial risks and raise growth. Sustained disinflationary pressures could adversely affect the fiscal accounts. High corporate debt and non-performing loans (NPLs) and associated encumbered collateral could act as an additional drag on future investment and growth if they are not addressed. On the external side, a protracted slowdown in the region would hinder export performance. While external debt vulnerabilities remain manageable, risks of renewed financial stress in the euro area, notably related to developments in Greece, could rise. Intensification of geo-political tensions related to Russia and Ukraine could also generate negative spillovers from trade and investment channels.

Supporting a Strong Financial System

The banking system has shown substantial resilience to the damage to confidence from last year’s banking failure. Strong system liquidity prior to the failure of Corporate Commercial Bank (KTB), along with the liquidity measures introduced by the BNB and government, helped calm depositors, averting system-wide spillovers. The injection of state resources into the deposit insurance fund also allowed for the payment of insured KTB deposits in December. Significant system liquidity has been maintained subsequent to the KTB failure, with positive year-on-year corporate and retail deposit growth at year-end 2014.

However, decisive actions are needed to address the weaknesses exposed by the KTB failure, restore supervisory credibility, and strengthen crisis management tools. With the term of the BNB governor expiring and the selection of a new head of banking supervision pending, timely confirmation of individuals with a clear mandate to support a strong, independent, and accountable BNB is critical. At the same time, while several specific actions have been announced, further details and decisive follow-up is essential to restore confidence in financial system oversight:

  • Reinforcing confidence in supervision: The joint IMF/World Bank Basel Core Principles Assessment, planned for late March, should help identify areas for improvement in the supervisory framework for banks. This should be complemented by a candid, in-depth and independent review by outside banking experts of past supervisory activity, aimed at strengthening supervisory processes and drawing on lessons from the KTB case. An independent expert review of the Financial Supervision Commission’s supervisory framework would also be useful to reinforce confidence across the financial system.

  • Strengthening system-wide accountability: Concrete plans should be developed by the Commission of Public Oversight of Statutory Auditors (which also would benefit from independent expert input) to enhance the oversight and accountability of external parties conducting statutory audits. Based on inputs from the reviews noted above, the authorities should consider strengthening supervisory powers to investigate related-party lending. Formal guidelines for supervisory enforcement should also be considered, linking supervisory findings to specific remedial actions and establishing procedures for appropriate exceptions.

  • Strengthening the resolution framework: Last year’s events demonstrated that Bulgaria's legal framework did not give the authorities adequate resolution tools. As such, timely transposition of the EU Bank Recovery and Resolution Directive (BRRD) into national law this summer is critical to address the gaps in the resolution and crisis management toolkit, and to provide for coordinated and timely remedial actions.

  • Ensuring an adequate financial safety net: The authorities are considering the best means to recapitalize the Deposit Insurance Fund (BDIF) following the payout of insured KTB deposits. In addition, a revised BDIF law is under discussion to address gaps revealed by the KTB situation, including by facilitating timelier payout of insured deposits. This law will need to be harmonized with that implementing the BRRD.  The forthcoming assessment of the International Association of Deposit Insurers (IADI) core principles by the World Bank can assist the authorities, including in terms of possible improvements to the draft law.

  • Assessing banks: The planned asset quality review (AQR) is a welcome step to strengthen confidence in banks. Success will depend in part on establishing a clear timetable and affirming specific modalities for an arms-length and transparent process. Consistent with international practices, the authorities should develop a well-defined communication strategy and contingency plans in case recapitalization needs materialize. The review will also provide useful inputs for a comprehensive risk and vulnerability assessment that will be undertaken by the IMF-World Bank Financial Sector Assessment Program.   

  • Enhancing access to information: While the BNB publishes a significant amount of financial data, mechanisms to promote availability and ready access to an increased amount of bank-level data could facilitate analysis by interested parties and reduce uncertainty.

Addressing the stock of NPLs and, more broadly, reducing the high private sector debt overhang remain critical. The gradual write-off of NPLs by banks and disposal of encumbered collateral are needed to mitigate asset price uncertainty. Proactive supervisory actions by the BNB to promote NPL reduction should be complemented by other government supported initiatives to facilitate an orderly corporate deleveraging process. In this context, guidelines for voluntary out-of-court debt workouts should be considered, along with measures to address judicial bottlenecks to timely and predictable insolvency proceedings. 

Protecting Fiscal Sustainability

The government’s fiscal strategy recognizes the need to reduce deficits following last year’s slippage, but faster consolidation should be considered. The cash-based fiscal deficit doubled last year to 3.7 percent of GDP, reflecting a failure to adequately contain expenditure once it became clear that optimistic revenue projections would not materialize. This year’s 3 percent deficit target is achievable, but, with downside risks related to deflation and ambitious wage and health spending targets, expenditure restraint will again be critical. Moreover, with limited growth effects from additional spending, any revenue over-performance should be saved. Looking ahead, targeting a structural balance by 2019 would support continued strong debt dynamics, create space to cope with contingent risks, and allow automatic stabilizers to work in the event of a modest negative shock.

Concrete plans are needed to address medium-term fiscal risks. The aging population and continued emigration will create significant long-term public spending challenges. Measures to improve the composition and quality of expenditure and mitigate contingent liabilities arising from state-owned enterprises will also be needed.

  • Design and sustainability of the pension system: The introduction of “optionality” in second-pillar pension participation represents a fundamental change in the design of Bulgaria’s pension system. Sufficient time should be provided for thorough impact analysis and stakeholder consultation in order to mitigate potential risks to both the public and private systems, particularly given the unorthodox nature of some options under discussion (e.g., flexibility for multiple shifts between public and private systems over time). Ensuring public pension sustainability through parametric reforms remains critical, with concerns exacerbated by reversal of earlier reforms.

  • Improving health system efficiency. With recent elimination of the National Health Insurance Fund’s arrears, follow-through on plans to improve its financial strength and the efficiency of the broader health system will be critical. Measures are needed to strengthen cost control mechanisms, increase incentives for proper use of outpatient versus inpatient services, and upgrade IT systems to improve risk management capacity.

  • Monitoring of fiscal risks. To further reinforce public information regarding fiscal policy, disclosure regarding budgetary risks should be enhanced. Specifically, budgetary implications of contingent liabilities, including in relation to public corporations, as well as sustainability analysis of pension and health systems, could be expanded. Redressing delays in the establishment of a fiscal council with operational independence would also support policy credibility.

Setting the Conditions for Growth

Rising costs and productivity drains highlight the urgency of a comprehensive strategy for energy sector reform as part of a broader structural reform agenda. Recent amendments to the energy act providing a foundation to address rigidities in production costs and strengthening regulatory independence can help to reduce pressure on the public electricity company and, in turn, other participants in the market. Establishment of a transparent and well-functioning electricity market in line with EU regulations is also important. At the same time, a well-designed and phased rationalization of electricity prices should proceed in parallel with initiatives to strengthen protections for the poor.

Last year’s events highlight the risks to Bulgaria’s economy from governance challenges. Comprehensive solutions will take time, but clear momentum needs to be established now to demonstrate commitment to reducing corruption and cronyism, strengthen the rule of law, and set the foundation for renewed confidence in critical institutions. Such progress would also likely catalyze the investment and productivity gains essential to unlock Bulgaria’s economic potential, strengthen job creation, and accelerate income convergence.


The mission would like to thank counterparts for the collegial and informative discussions.


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