Press Release No. 04/175

The Executive Board of the International Monetary Fund (IMF) today approved a 25-month Stand-By Arrangement for Bulgaria in an amount equivalent to SDR 100 million (about US$146 million) to support the government's economic program for 2004-06. The authorities intend to treat the arrangement as precautionary.

Following the IMF Executive Board discussion on Bulgaria, Mr. Takatoshi Kato, Deputy Managing Director and Acting Chair, said:

"Bulgaria's economic performance continues to be broadly satisfactory, with robust economic growth, favorable debt dynamics, and strong financial market confidence. To address the vulnerability arising from the deterioration of the external current account and sustain high rates of economic growth, the authorities have devised an appropriate combination of measures to restrain demand and enhance supply.

"With the currency board arrangement remaining a central pillar of the policy framework, the authorities' efforts to restrain demand primarily rely on fiscal tightening and prudent public sector wage policies, supported by measures to drain excess liquidity from the banking system. To enhance supply, the authorities are reinvigorating structural reforms, including privatization.

"The minimum fiscal objective for 2004 is to achieve overall balance in the fiscal accounts. Nonetheless, if the authorities adhere to their commitment not to exceed the expenditure levels under their program, and revenue overperformance continues, there is a possibility that a fiscal surplus may be achieved. The authorities should not ease their fiscal stance in 2005 unless credit expansion is slowing and the external current account deficit ceases to be of concern.

"A critical component of the strategy is wage restraint. Prudent limits on the increases in wages of public enterprises with monopoly position or in financial difficulty, and in the economy-wide minimum wage will be needed to help maintain competitiveness, contain demand pressures, and protect the employment of low-skilled workers.

"The authorities have appropriately taken a number of measures to strengthen prudential supervision and drain bank liquidity in the face of substantial credit growth. Given the constraints on monetary policy of the currency board arrangement and an open capital account, they stand ready to take additional measures as needed, in line with the program.

"Improving the overall business climate will stimulate investment and enhance the economy's competitiveness in preparation for EU membership. To this end, the authorities need to persevere in undertaking structural reforms to product and labor markets and completing rapidly their privatization program, which by generating additional foreign direct investment flows will strengthen the external position and bolster competitiveness," Mr. Kato said.

ANNEX

Recent Economic Developments

Macroeconomic developments have been generally favorable. Real GDP grew by 4¼ percent in 2003, as strong domestic demand was partly offset by a deterioration in net exports. Driven by investments and exports, real GDP grew by 5.3 percent year on year in the first quarter of 2004, with high-frequency indicators suggesting robust growth in the second quarter as well. While consumer price inflation averaged 2¼ percent in 2003, a drought-related jump in food prices raised 12-month CPI inflation to 5½ percent at end-2003. Reflecting higher oil prices and a smaller-than-expected decline in food prices, twelve-month inflation rose to 7.3 percent in June 2004. Unemployment has declined considerably, to 12.2 percent in June, while growth in real wages has been subdued.

Growth in banking system claims on the nongovernment sector has been higher than expected. Claims on the nongovernment sector rose by nearly 50 percent in 2003, with year on year growth in 2004 remaining around that level so far. However, prudential indicators remain strong.

The external current account has been broadly in line with projections. The current account deficit widened to 8½ percent of GDP in 2003, with a deterioration of the trade balance accounting for 90 percent of this widening. The deficit narrowed slightly in the twelve months to June 2004, with a weaker trade deficit offset by better income and transfers balances. Strong foreign direct investment and other capital inflows have led to a surplus in the balance of payments, increasing international reserves to US$6.9 billion in mid-2004. Competitiveness remains broadly adequate but warrants close monitoring.

Fiscal performance has remained strong. The government saved half of the revenue overperformance and balanced the budget in 2003. In 2004, the general government's cash surplus has continued to increase, reaching 2.1 percent of annual GDP by June. The overperformance largely reflects increased tax revenue, while expenditure has been in line with the budget.

Progress has also been made on structural reforms. The privatization of the Bulgarian Telecommunications Company was completed and the binding bids for the privatization of seven electricity distribution companies were received in July 2004. To allow cost recovery, household electricity and district heating prices were increased by 10 percent on average on July 1.

Program Summary

To strengthen the macroeconomic framework centered on the currency board arrangement (CBA), the authorities' program seeks to reduce external vulnerability in the context of high growth. The authorities continue to regard the CBA as the cornerstone of macroeconomic stability, providing a stable nominal anchor and the discipline to maintain tight fiscal and incomes policies. The authorities are complementing these policies with an acceleration of structural reforms, including completion of the privatization process and measures to improve the business climate as well as labor market flexibility.

The authorities and staff agree that the widening of the external current account deficit since mid-2002 reflects the excessive pace of domestic demand, fueled by the credit boom, as financial deepening proceeds, and not a serious erosion of competitiveness. Given the constraints imposed by the CBA, the authorities' plan addresses these developments by targeting a tighter and more transparent fiscal stance for 2004. The program targets at least a fiscal balance for the year, with any revenue overperformance to be saved. Nominal expenditure ceilings will help ensure that this outcome is reached. The authorities plan to proceed cautiously in implementing the budget, providing flexibility in its implementation. The 2005 budget will reflect a neutral fiscal stance and be based on realistic revenue and expenditure projections. Under the program, the authorities also plan to strengthen the pension and health care systems, and to improve tax administration, budget preparation, and expenditure management.

The program intends to slow down bank credit growth to help reduce external vulnerability. Given the policy tools available under a CBA and an open capital account, the authorities have intensified their already strong supervisory activities. In view of the continued rise in bank credit this year, however, the authorities have also implemented various measures to drain liquidity, including transferring government deposits at commercial banks to the central bank, broadening the coverage of reserve requirements, and from October 1, lowering the proportion of cash in vault that can be used to fulfill reserve requirements. In addition to intending to undertake bond sales in excess of those already planned to slow credit growth, the authorities stand ready to take further measures if the expected slowdown does not materialize.

The authorities' structural reform agenda seeks to improve the business climate, which is crucial to boosting investment and productivity. The authorities plan to complete the remaining privatizations, reducing the size of the public sector and improving economic efficiency. A strong incomes policy is envisaged for selected state-owned enterprises to improve their financial situation. Further reforms are envisaged in the Labor Code to improve the functioning of the labor market. The authorities plan to simplify company registration and licensing procedures, expand one-stop shops, and intensify their efforts to combat corruption. They are also pursuing a more active debt management strategy, with the aims of reducing the public debt-to-GDP ratio and reducing the external component of the debt.

Bulgaria joined the IMF on September 25, 1990. Its quota is SDR 640.2 million (about US$934 million), and its outstanding use of IMF resources currently totals SDR 811.32 million (about US$1.2 billion).

Bulgaria: Selected Economic Indicators
	2000	2001	2002	2003	2004Q1
Output, prices, and employment	(Annual percent change, unless otherwise stated)
Real GDP	5.4	4.1	4.9	4.3	5.3
Real industrial sales	...	2.8	1.3	17.4	18.1
Consumer price index (average)	10.4	7.5	5.8	2.3	6.4
(End of period)	11.4	4.8	3.8	5.6	6.2
Unemployment rate (in percent)
Registered unemployment	18.1	17.5	17.4	14.3	14.1
Labor force survey	16.9	19.8	17.8	13.7	...
Real public sector wages	2.4	6.3	2.5	3.9	...
Real private sector wages	7.8	4.1	-4.1	5.7	...
General government	(In percent of GDP)
Revenue	38.7	37.6	36.5	37.9	9.0
Noninterest expenditure	35.7	34.7	34.9	36.2	7.5
Primary balance	3.0	2.8	1.6	1.7	1.5
Interest payments	4.0	3.7	2.2	2.1	0.9
Overall balance	-1.0	-0.9	-0.6	-0.4	0.6
Privatization receipts	1.3	2.9	0.9	1.1	0.3
External financing	1.5	-0.3	1.5	0.0	-0.3
Domestic financing	1.2	-1.7	-1.7	-0.7	-0.5
Public debt (end of period)1	77.0	69.9	56.2	48.3	45.1
Domestic public debt (end of period)1	6.6	6.2	6.5	6.5	6.4
Money and credit2	(Annual percent change, unless otherwise stated)
Broad money (end of period, millions of leva)	9,857	12,401	13,857	16,566	16,806
Broad money (M3)	30.8	25.8	11.7	19.6	23.0
Claims on nongovernment	17.0	32.1	44.0	48.3	52.3
Foreign exchange deposits (euro million)3	2,068	2,516	2,678	3,150	4,020
Foreign exchange deposits (percent of M3)3	41.0	39.7	37.8	37.2	38.6
Broad money to foreign exchange reserves ratio	1.3	1.6	1.5	1.6	1.6
Interest rates (annualized)	(In percent)
BNB basic rate 4	4.6	4.7	3.4	2.7	2.4
Time deposits (leva)	3.3	3.4	3.2	3.2	3.1
Balance of payments	(In millions of euro, unless otherwise stated)
Current account balance	-761	-1,102	-924	-1,498	-518
(In percent of GDP)	-5.6	-7.3	-5.6	-8.5	-12.6
Trade balance	-1,280	-1,779	-1,692	-2,196	-509
Exports, f.o.b.	5,253	5,714	6,063	6,663	1,718
Imports, f.o.b.	-6,533	-7,493	-7,755	-8,859	-2,227
Gross official reserves (end of period)	3,719	4,063	4,575	5,309	5,366
(in months of prospective imports of GNFS)	4.7	5.0	4.9	4.8	4.7
External debt (end of period)5	12,038	12,049	10,769	10,330	10,950
(In percent of GDP)	88.2	79.4	65.1	58.7	56.3
Exchange rates
Leva per euro	Currency Board, peg to euro at lev 1.95583 per euro
Leva per U.S. dollar (end of period)	2,102	2,219	1,885	1,611	1,615
(year-on-year percent change, + means depreciation)	8.0	5.6	-15.1	-14.5	-10.0
REER (end of period; CPI based)
(year-on-year percent change, + means appreciation)	2.6	3.7	5.6	8.6	5.7
Sources: Bulgarian authorities; and IMF Staff estimates. 1Domestic debt as reported by Ministry of Finance and external debt as reported by BNB. 2Starting in 2002, a new format was adopted for monetary data resulting in revisions to historical series. 3Includes foreign currency deposits in broad money and other longer-term liabilities (not included in broad money) 4Average annual yield achieved at the primary market for three-month government securities. 5Includes trade credits.