Bulgaria: Staff Concluding Statement of the 2016 Article IV Mission
IMF News, September 16, 2016
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- Published: September 16, 2016
Context: Short term resilience but long term challenges
- The economy withstood the failure of the fourth largest bank in 2014 and spillovers from the Greek crisis in 2015.
- Current macroeconomic developments are encouraging: output is growing at a steady pace, unemployment is at its lowest level in seven years, and the external current account has remained in surplus.
- The fiscal balance improved significantly in 2015 and the outturn so far points to a considerable overperformance in 2016.
- Government debt, despite a noticeable increase in 2014, is among the lowest in Europe.
- Materially improving economic welfare requires raising potential growth. Bulgaria’s per capita income on a purchasing power parity basis remains less than half of the EU countries’ average.
- Potential output growth has fallen since the global financial crisis, reflecting subdued investment, slower gains in productivity and adverse demographic developments (aging and emigration).
- Key structural reform priorities: mitigate effects of aging and emigration, reduce red tape and corruption, improve performance of state-owned enterprises (SOEs), and protect long-term fiscal sustainability against rising health- and pension-related spending pressures.
Outlook: Slow convergence
- GDP growth forecast: economy is expected to grow 3 percent in 2016.
- Mission’s growth forecast revised up reflecting improved sentiment and rising private consumption.
- Public investment: expected to contract in 2016 as transition to the new EU funds programming period takes hold, but to gather speed in subsequent years.
- Medium-term potential growth: below the average of similar European countries due to unfavorable demographic trends, slow implementation of structural reforms, and modest private investment outlook.
- Risks to the outlook:
- External downside risks: protracted slowdown in the euro area; instability in Turkey; indirect effects of Brexit through impact on the EU and sustained uncertainty.
- Domestic downside risks: delay in absorption of EU funds; contingent liabilities threatening the fiscal position.
- Upside scenarios: ambitious structural reforms or a faster recovery in Europe could improve growth prospects.
Financial system: Restoring credibility
- Recent measures and oversight steps:
- New leadership at the Bulgarian National Bank (BNB) and a Plan on Reforms and Development of Banking Supervision adopted in October 2015 and being implemented.
- An assessment of the Basel Core Principles for Effective Banking Supervision undertaken in 2015.
- An asset quality review (AQR) and stress test of the banking system completed in August 2016.
- A Financial Sector Assessment Program (FSAP) is being undertaken jointly by the IMF and the World Bank; scheduled to be finalized in the first half of 2017.
- Financial Supervision Commission conducting reviews of pension funds’ assets and insurance companies’ balance sheets.
- AQR and stress test findings and implications:
- Exercise covered all 22 banks in the system; methodology broadly followed the European Central Bank (AQR) and the European Banking Authority (stress test); assumptions and scenarios were generally conservative.
- Most of the system remains well-capitalized even after AQR adjustments.
- AQR results: three banks—the largest domestically-owned bank and two small ones—had to restore the coverage of their capital buffers by an aggregate amount of 0.3 percent of GDP.
- One of the two small banks has already raised needed capital.
- The other two banks have until mid-2017 to reach additional capital buffers required by the BNB.
- Bringing in new bona fide investors would help improve credibility and governance; if banks fail to meet requirements within the announced time frame, authorities should intervene.
- The AQR and stress test should also help banks prepare for the introduction of new international financial reporting standards (IFRS9).
- Recommended further actions:
- Continue reforms to strengthen institutional framework for financial system oversight (new governance structure for bank supervision at the BNB; supportive legislation to strengthen BNB powers to dismiss senior managers, board members and auditors).
- Use AQR and stress test information to pursue a more risk-based supervisory review and evaluation process; secure adequate resources for more inspections.
- Tighten legal framework on ultimate beneficial owners and related party lending; BNB to announce a comprehensive set of indicators for early intervention in banks.
- Reduce NPLs, especially in banks with lower capital ratios; reinforce and monitor the insolvency framework.
- Strengthen the financial safety net: operationalize the resolution framework and ensure adequate funding for the Bulgarian Deposit Insurance and Banking Resolution funds; minimize use of public funds if needed.
- Inform initiatives by the FSAP findings.
Structural reforms: Rekindling Bulgaria’s potential
- Key reform areas and recommendations:
- Stimulating private investment:
- Swiftly implement the authorities’ investment action plan which seeks to remove major regulatory bottlenecks to improve the investment climate.
- Absorbing EU funds:
- Ensure a smooth transition to the new EU funds cycle to boost public investment in growth-enhancing areas.
- Reducing emigration by boosting job prospects at home:
- Strengthen active labor market policies, promote investment in areas attractive to emigrants, and foster conditions for emigrants to return.
- Enhancing performance of SOEs:
- Establish clear performance targets and evaluation tools for SOEs; professionalize SOE boards; have a dedicated unit in government monitor, analyze, and disseminate information on SOEs’ financial performance and fiscal risks.
- Deregulate, open up to foreign investors, and enhance competition in SOE-dominated industries, in particular the energy sector, to strengthen productivity across the economy.
- Anti-corruption and judicial reforms:
- Adopt a comprehensive anti-corruption law free of amendments that compromise its effectiveness.
- Establish a single agency with adequate powers and independence; consolidate anticorruption work currently performed by several separate agencies.
- Advance reforms in the judicial system.
Fiscal policy: Ensuring long-term sustainability
- Recent fiscal performance:
- Cash fiscal deficit declined by ¾ percent of GDP in 2015 to 2.9 percent of GDP, driven largely by administrative revenue measures and stronger economic activity.
- Fiscal overperformance has continued in 2016 due to increases in excise rates, sustained administrative efforts, faster-than-expected growth, and under-execution of EU-funded capital spending.
- Mission projects revenues for 2016 to overperform the budget target by ¾ percent of GDP on current trends.
- Policy stance and projections:
- Mission supports authorities’ plan to save the revenue overperformance to strengthen fiscal buffers against contingent liabilities in the energy, financial, and other sectors.
- Assuming revenue overperformance is saved and EU funds spending is accelerated, the mission projects the cash deficit to be 0.8 percent of GDP for 2016.
- Authorities’ medium-term plan: reach fiscal balance by 2020 on an accrual basis through a combination of revenue measures and expenditure restraint.
- If expenditure savings do not materialize, scope exists to use additional tax measures, such as raising property taxes.
- Adhering to the medium-term consolidation plan and maintaining a structurally balanced budget thereafter will help reduce government debt gradually to below 25 percent of GDP by 2020.
- Keeping public debt low is especially important given Bulgaria’s currency board arrangement.
- Managing contingent liabilities and long-term pressures:
- Main fiscal threats: poor performance of SOEs, weak finances of subnational governments, concerns regarding the viability of private pension funds (potential shifts to the public pension system).
- Recommendation: estimate potential negative impact from these risks and incorporate them in fiscal scenarios.
- Mission welcomes establishment of the Fiscal Council; ensuring its operational independence and enhancing its capacity would help support policy credibility.
- Long-term demographic pressures:
- Projected aging and decline in Bulgaria’s population will significantly affect the public pension system and health spending and depress long-term economic growth if unaddressed.
- 2015 pension reform was important to improve near- and medium-term sustainability of the public pension system.
- Additional options: introduce parametric pension reforms, contain health spending, improve education to boost labor productivity, and raise high-quality public investment.
- Review of private pension funds’ assets would help identify needed changes in the private pension system.
Closing
- The mission is grateful to the authorities and other counterparts for their warm hospitality and excellent cooperation.
Source: Bulgaria: Staff Concluding Statement of the 2016 Article IV Mission (September 16, 2016), IMF Communications Department.