Press Release No. 98/44

The International Monetary Fund (IMF) approved a three-year credit for Bulgaria equivalent to SDR 627.62 million (about US$864 million at the current exchange rate) under the Extended Fund Facility (EFF)¹ to support the government’s medium-term economic reform program for July 1998-June 2001. Of the total, the equivalent of SDR 52.30 million (about US$72 million) is available immediately.

Background

Bulgaria achieved a remarkable turnaround from the financial crisis of early 1997 by adopting sound economic policies that represented a clear break from the past and attracted significant external support. The severe banking and foreign exchange crisis was rooted in high public indebtedness, years of stalled reforms, and financial indiscipline in the enterprise and banking sectors. The crisis culminated in February 1997, in a bout of hyperinflation and a change of government. With broad public support, the newly elected government opted for a stabilization strategy centered on a currency board arrangement (CBA), underpinned by sound financial policies and an ambitious structural reform program. This bold program, supported by an IMF stand-by credit (see Press Release No. 97/15) attracted sufficient backing from official creditors to restore confidence in the government’s ability to meet its domestic and external obligations.

The program achieved impressive stabilization results much sooner than expected and set the stage for relatively favorable developments in 1998 despite a deterioration in Bulgaria’s external environment. Reflecting the carryover of the recovery from the crises in early 1997, real GDP is expected to grow significantly in 1998. Inflation declined rapidly to about one percent per month in early 1998 and the twelve month rate through August 1998 was 6.1 percent. A sharp remonetization, reflecting the return of confidence, contributed to a rapid decline in interest rates and left the banking system highly liquid. Official reserves rebounded from a low of US$0.4 billion in January 1997, to about US$2.5 billion at the end of August 1998 (equivalent to 4.9 months of imports). While the crisis induced import compression contributed to an improvement in the current account surplus to 4.3 percent of GDP in 1997; the subsequent return of imports to a more normal level and a weakening of key export markets has left the current account in broad balance during the first half of 1998.

The Medium-Term Program

Bulgaria’s medium-term economic adjustment and reform program aims to achieve strong economic growth, higher living standards, and external viability on a sustainable basis while substantially advancing the transition to a competitive market economy and addressing critical social and infrastructure needs. It has been developed in the context of the authorities’ European Union accession strategy with the aim of making substantial progress toward fulfillment of the Copenhagen criteria.

The currency board arrangement will continue to provide a stable nominal anchor and the discipline necessary to spur structural reform. The CBA will be underpinned by prudent fiscal policies to maintain macroeconomic stability and lower the public debt burden. The authorities intend to maintain an underlying fiscal stance of a broadly balanced budget over the medium term, with allowance for an actual deficit of up to 2 percent of GDP during 1999-2001 to cover the transitional costs of structural reform and higher public investment in infrastructure. Financial discipline in state-owned enterprises and banks will be ensured by strengthening banking supervision; completing the privatization of enterprises and banks and the enterprise isolation program; and by implementing appropriate incomes and restructuring policies. Investment in infrastructure and other structural reforms, including the further liberalization of exchange and trade regimes, are expected to raise efficiency and create a favorable investment climate. This would set the stage for an investment driven recovery, initially financed from abroad, and later from internally generated resources as export capacity improves.

The medium-term program targets strong growth, at 4 to 5 percent per annum; a decline in inflation to about 5 percent per year by 2001; and a substantial decline in the public and external debt burden. The external current account deficit will be kept in the range of 3 percent of GDP—a level considered sustainable based on conservative assumptions about inflows of foreign direct investment. With these assumptions and based on modest fiscal deficits and conservatively projected privatization revenues, public debt dynamics are highly favorable.

Structural Reforms

One of the key elements of the medium-term program is the rapid privatization of state owned banks and enterprises, the ultimate tool to exercise financial discipline. Impediments to privatization are being removed and renewed impetus has been given to the transparent and irreversible privatization of remaining state-owned banks. Until privatization is largely complete, state-owned enterprises will remain subject to a strengthened incomes policy which will assist them in achieving and maintaining profitability. This policy will be supplemented by additional measures to harden budget constraints including the continuation of the isolation of problem enterprises from the banking system, increased application of the recently strengthened bankruptcy law, and the increase of budget funded severance payments to facilitate labor retrenchment. An appropriate regulatory framework for financial markets is being established, while the banking system is further developed and banking supervision strengthened.

Other structural reforms aim to improve resource allocation by addressing major inefficiencies in the energy and agriculture sectors, liberalizing trade, and deregulating economic activity. In the energy sector the authorities intend to raise efficiency and restore financial viability while phasing out budgetary subsidies. In agriculture, reforms consistent with Bulgaria’s EU accession strategy include the rapid completion of land restitution, measures to develop an active land market, and phasing out of direct market intervention by the government. Trade reform measures include significant liberalization of non-tariff barriers, elimination of remaining export taxes, abolition of the import surcharge, and reduction of average import tariffs.

Addressing Social Needs

The main objectives of Bulgaria’s social protection reform strategy are to improve targeting and provision of services; reduce disincentives to employment in the formal sector by reducing payroll taxes while ensuring the fiscal sustainability of the social insurance system; and improve administrative efficiency by consolidating overlapping social protection programs. Social assistance will be provided more efficiently by strengthening means-tested benefits to channel assistance to the truly needy, consolidating overlapping benefits, and improving management through more direct participation by communities and the private sector. Pension reform will aim at enhancing sustainability and fairness, and resources will be reallocated to improve the quality and delivery of health care services.

The Challenge Ahead

Bulgaria faces the double challenge of persevering with reform and facing a possible worsening of the external environment. The authorities are well aware of these risks and are strongly motivated to overcome them by their desire to make rapid progress toward EU accession and a competitive market economy, and by the limited window of opportunity provided by present political and public support for reform.

Bulgaria joined the IMF on September 25, 1990; its quota² is SDR 464.9 million (about US$640 million); its outstanding use of IMF credit currently totals SDR 714 million (about US$983 million).

Bulgaria: Selected Economic Indicators 1994 1995 1996 1997 1998 proj. Real Economy (change in percent) Real GDP 1.8 2.1 -10.9 -6.9 5.0 CPI (end of period) 121.9 32.9 310.8 578.5 9.0 Savings and Investment (in percent of GDP) Gross National Saving 7.8 15.4 9.2 16.0 13.0 Total Investment 9.4 15.7 8.4 11.8 13.8 Public Finance (in percent of GDP) General government balance -5.8 -6.3 -12.7 -2.5 0.0 General government primary balance 3.9 6.5 6.4 5.7 4.3 General government debt 140.2 100.9 105.8 104.1 85.1 Money and Credit (end of year, percent change) M3 78.6 39.6 124.5 359.3 9.5 Credit to the non-government sector 33.8 32.4 208.9 215.1 7.9 Balance of Payments (percent of GDP) Trade balance 0.3 1.0 1.9 3.7 -1.1 Current account -1.6 -0.2 0.8 4.3 -0.7 Official reserves (millions of US dollars) 1,311 1,546 781 2,468 3,148 Reserve cover1 3.0 2.9 1.6 5.2 6.3 Source: Bulgarian authorities and IMF staff projections 1In months of imports of goods and nonfactor services 1 The EFF is an IMF financing facility that supports medium-term programs that seek to overcome balance of payments difficulties stemming from macroeconomic imbalances and structural problems. The repayment terms are 10 years with a 4 ½-year grace period, and the interest rate, adjusted weekly, currently is about 4 percent. 2 A member’s quota in the IMF determines, in particular, the amount of its subscription, its voting weight, its access to IMF financing, and its share in the allocation of SDRs.