Press Release No. 06/177

Press Release: IMF Executive Board Completes Third Review Under Stand-By Arrangement for Bulgaria

August 3, 2006

The Executive Board of the International Monetary Fund (IMF) has completed the third review of Bulgaria's economic performance under the 25-month Stand-By Arrangement with Bulgaria. The authorities continue to treat the arrangement as precautionary.

In completing the review, the Board approved the authorities' request for a waiver for the non-observance of the end-April 2006 structural performance criteria on the approval by Parliament of the new law on the value added tax, the end-June 2006 structural performance criterion on the start-up operations of the new business register, and the end-June structural performance criterion on the selection of the winning bidders for the Rousse and Varna electricity generation companies. The Board approved the authorities' request to rephrase and extend the Arrangement until March 31, 2007.

The 25-month Stand-By Arrangement was approved on August 6, 2004 (see Press Release No.04/175) for an amount equivalent to SDR 100 million (about US$148.4 million).

Following the Executive Board discussion, on August 2, 2006, Ms. Anne O. Krueger, First Deputy Managing Director and Acting Chair, said:

"The Bulgarian economy has continued to benefit from confidence inspired by sustained sound macroeconomic policies and optimism surrounding impending EU accession. Spurred by consumption and strong investment, steady growth continues to be accompanied by falling unemployment. However, strong private domestic demand, buoyed by rapid credit growth, has contributed to rising inflation and a substantial deterioration of the current account deficit. Despite the halving of public external debt in recent years to a comparatively low level, Bulgaria's overall external debt is high and climbing, raising the country's vulnerability to external shocks. The authorities' economic and structural reform program under the stand-by arrangement is therefore appropriately aimed at containing the underlying risks.

"Fiscal policy remains the key macroeconomic policy lever under the currency board arrangement. In this regard, the budget surplus in 2006, now expected to exceed 3 percent of GDP, is helping to compensate partly for excess private domestic demand. With the current account deficit expected to remain high over the near term, however, there is little room for a relaxation of fiscal policy. Taking into account the negative budgetary impact of financial flows upon EU accession and the ensuing additional demand pressures, the budget in 2007 should aim to achieve a surplus of 2 percent of GDP. In reaching this minimum target, however, the authorities will need to compensate accession-related spending increases by offsetting cuts in existing programs and projects. Postponing further tax cuts until they are more affordable is also important.

"Credit growth has slowed, although the effectiveness of the credit limits introduced by the central bank has been declining. The program anticipates their gradual phase-out during the remainder of 2006. Although the banking system remains profitable and well capitalized, risks need to be monitored with vigilance following several years of rapid credit growth. Supervisors need to follow monetary and credit developments and ensure the adequacy of banks' risk management frameworks.

"A revitalization of the structural reform effort is needed, and in this vein, the program focuses rightly on speeding up and deepening structural reforms to safeguard competitiveness and boost Bulgaria's growth potential. Particular emphasis is being placed on increasing labor market flexibility to raise labor force participation and employment, improving the business climate to sustain investment, including through reforms of the judiciary and reductions of red tape, and a forceful anti-corruption effort. Privatization of additional state assets will be accelerated.

"Bulgaria's transition from crisis a decade ago to steady growth has helped the country reach the doorstep of EU accession. To reap the full economic benefits of membership, further structural reforms will be particularly crucial, because they hold the promise of making the economy more flexible and dynamic, yielding stronger growth and better export performance. They are also needed for Bulgaria to realize its ambitions for faster convergence of living standards toward EU levels, and to have the agility to function successfully upon eventual membership of the monetary union," Ms. Krueger said.