Bulgaria—2010 Article IV Consultation, Concluding Statement
IMF News, March 3, 2010
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- Published: March 3, 2010
Background and recent developments
- Large capital inflows prior to the global crisis generated a domestic demand boom, delivering strong GDP and employment growth but widening the current account deficit to very high levels and producing overheating with high wage growth and double-digit inflation.
- The boom ended in Q4 2008 following the default of Lehman Brothers. Capital inflows contracted sharply and exports fell due to recessions in trading partners.
- GDP contracted by 5.1 percent in 2009—the first decline since the crisis of 1996/97.
Economic outlook (mission projections)
- Real GDP is projected to increase by 0.2 percent in 2010.
- Domestic demand is expected to decline further driven by:
- Unwinding investment boom and tightened credit → investment likely to drop further.
- Declining employment → private consumption expected to suffer.
- Current account deficit projected to narrow from 8½ percent in 2009 to 5½ percent of GDP in 2010.
- Inflation projected at about 2.2 percent in 2010, with almost half reflecting higher excise duties.
- Unemployment expected to increase from an estimated 7.8 percent in 2009 to 9.2 percent in 2010.
Adjusting to lower capital inflows — private sector and policy implications
- Capital inflows expected to recover somewhat over time but remain well below pre-2009 highs; both the private sector and public policies must adjust.
- Private sector adjustments:
- Shift resources from non-tradable to tradable sector (non-tradable expansion during boom driven by construction, real estate and banking).
- Wage growth needs to slow considerably in 2010 and remain moderate over the medium term.
- Wage growth decline observed: peak of 25 percent y/y in Q2 2008 to 10.6 percent y/y in Q4 2009; temporary statistical effects may still inflate current wage growth which is likely to decline further.
- Public policy adjustments:
- In 2007 and 2008, expenditure grew by 18 percent annually as revenues surged and were used to increase expenditure rather than fiscal surpluses.
- Continuation of past spending trends would have converted the fiscal surplus into a large deficit, eroding public sector buffers that support the currency board.
- Private sector vulnerabilities:
- Private sector external debt is 102 percent of GDP.
- Foreign currency debt of the non-financial private sector amounts to 80 percent of GDP.
- External environment is more benign than a year earlier but risks remain, including from euro area developments.
- Euro area membership preparation:
- The currency board is a pillar of stability; eventual euro adoption is described as the only viable exit strategy.
- Maintaining fiscal discipline and deepening structural policies is necessary to meet the Maastricht criteria and avoid re-emergence of imbalances.
Fiscal policy — recent correction, 2010 challenges, and medium-term guidance
- 2009 fiscal correction:
- Sharp spending cuts in H2 2009 and reforms of tax administration and customs contained the cash deficit to 0.8 percent of GDP; arrears built up widened the deficit to around 1.9 percent in ESA-95 (accrual) terms.
- Expenditure initially grew by 24.5 percent y/y in the first seven months of 2009 before the cuts.
- 2010 fiscal challenges:
- Government cash deficit target: 0.7 percent of GDP.
- Short-term revenue projections seem optimistic given H2 2009 shortfalls.
- Recent increases in excise duties and reforms to improve tax compliance help but may not offset receipt deterioration and a 2 percentage point cut in the social security contribution rate.
- Budgeted measures: public wage and general pension freezes, streamlining public administration, stricter controls on health care spending.
- Repayment of 2009 arrears will add pressure on the cash deficit though they do not affect ESA-95 deficit; mission projects a cash deficit of 1.8 percent of GDP for 2010.
- Emphasis that budgeted spending limits must be closely adhered to; large deficits could endanger macroeconomic stability and the currency board arrangement.
- Medium-term fiscal framework recommendations:
- Focus on overall spending envelope rather than headline balances within a medium-term budgetary framework.
- Target real spending growth in line with cautious estimates of potential GDP growth to make public spending more predictable and contain intra-year adjustments.
- Use revenue windfalls to build fiscal buffers for revenue shortfalls.
- Tax rate reductions should be offset by further expenditure reductions.
- Cautions:
- Lowering social security contribution rates could widen the social security financing gap and require larger government transfers, risking medium-term balanced budget targets and pension sustainability.
- Mission advises against a cut in VAT rates at the current juncture because the budget relies heavily on VAT and exports are exempt from VAT, so competitiveness gains would be weak.
- Fiscal policy to support export-led adjustment:
- Rationalize and increase efficiency of public administration and improve absorption of EU funds to free space for infrastructure and productivity-raising spending (education and training).
- Contain public wage growth (public wage freeze in 2010; future increases aligned with productivity) to support budget constraint and competitiveness.
- Ensure sustainability of social pension systems via urgent reforms:
- Slow pension increases after the 2010 freeze.
- Adjust pension system parameters (including increasing retirement age or minimum years of contribution).
- Address underreporting of insurable income and revise parameters creating inefficiencies.
- Comprehensive health care reform to improve efficiency and quality; address proliferation of hospitals and rising financing pressures; swift completion of broad-based reform is crucial.
- Renewed privatization push to expand private sector role and replenish fiscal reserve account.
Other structural reforms
- Strengthen business climate by cutting red tape and reducing regulatory costs.
- Decisively tackle the high share of the informal economy and corruption.
- Improve legal and institutional frameworks to support corporate workouts, restructuring and bankruptcy procedures.
- Mission welcomes authorities’ plan to assess and amend the corporate insolvency framework to support faster resolutions and creditor-debtor trust.
Financial system — stability, buffers, and main challenges
- Global liquidity pressures have abated; stabilization of Western European banking reduces external funding risks.
- Domestic interest rates have started to come down; credit growth shows signs of stabilization after a sharp slowdown in H1 2009.
- Main banking challenge: absorb increase in non-performing loans.
- System buffers and indicators at end-2009:
- Reported aggregate capital adequacy ratio at end-2009 was 17 percent (regulatory minimum 12 percent; EU minimum 8 percent).
- Coverage ratio of non-performing loans by provisions exceeded 80 percent.
- Banks continued to report profits in 2009.
- Policy recommendations for financial sector:
- Supervisors’ enforcement of a cautious dividend policy remains appropriate.
- Contingency planning is essential; mission welcomes creation of a financial stability unit at the BNB.
Concluding statement issued in Sofia, March 1, 2010; Mission concluding statement published March 3, 2010.