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Bulgaria: Economic Performance, Prospects and Risks Craig Otter, Economist Intelligence Unit May 11th 2007 Outline Economic performance 1996-2006 Economic prospects 2007-2008 Key challenges Conclusion Growth robust and stable Real GDP growth, % and contributions, pp 15 10 Net trade Investment Public exp Private exp Actual growth 5 0 -5 -10 -15 1996 1998 2000 2002 2004 2006 Falling unemployment Unemployed persons, % of labour force 20 18 16 14 12 10 8 6 4 2 0 1996 1998 2000 2002 2004 2006 Moderating price and wage inflation Consumer price index and wages, average % change 19 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 18 16 14 12 10 8 6 4 2 0 CPI Wages Supportive fiscal policy Government budget balance, % GDP 4 2 0 -2 -4 -6 -8 -10 -12 1996 1998 2000 2002 2004 2006 Credit expanding fast, but level low Growth in domestic credit stock 35 30 25 20 15 10 5 0 -5 -10 120 100 80 60 40 20 0 1996 1998 2000 2002 2004 2006 Growth (Left axis) % GDP (Right axis) External weakness growing External balances, % of GDP 15 10 5 0 CA balance Trade balance -5 -10 -15 -20 -25 1996 1998 2000 2002 2004 2006 Overall debt dynamics favourable External debt, % GDP 120 100 80 Private sector Public sector 60 40 20 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 0 Foreign capital inflows booming Foreign Direct Investment, US$mn 6000 5000 4000 3000 2000 1000 0 1996 1998 2000 2002 2004 2006 FDI shifting focus FDI by sector, average share of total FDI in 1997-98 Other Construction Financial intermediation Wholesale and retail trade etc. Transport, storage and communication Manufacturing FDI shifting focus (continued) FDI by sector, average share of total FDI in 2005-06 Wholesale and retail trade etc. Construction Other Energy Financial intermediation Real estate, renting and business activities Manufacturing Capital investment driving potential output Growth in labour, capital and total factor productivity, % 25 20 15 10 5 0 -5 -10 -15 -20 -25 -30 Capital TFP Labour Potential output 1996 1998 2000 2002 2004 2006 Business environment improves World Bank Ease of Doing Business Rank (1 = highest) 0 10 20 30 40 50 60 70 80 90 100 2007 2006 UK LT EE DE LV FR SK RO CZ BG SQ HU PL IT RU Catch-up proceeding slowly Ratio of Bulgarian to EU-27 and CEE GDP per head at PPP 90 80 70 60 50 EU-27 CEE 40 30 20 10 20 05 20 03 20 01 19 99 19 97 19 95 19 93 19 91 19 89 0 EU15 growth at 2% pa Lithuania Latvia Estonia Serbia Croatia Romania Bulgaria Slovenia Slovakia Poland Hungary Czech Catch up: GDP per head, EU15=100 90 80 70 60 50 40 30 20 10 0 2005 2025 Currency board Reserves have been rebuilt since 1996-97 Peg has been in place since July 1997 Currency pegged to D-Mark and currency restrictions introduced Anchor currency shifted to euro in 1999, restrictions lifted in 2000 Base money is matched by foreign reserves Elements of currency board Authorities were unable to prevent financial crisis in 1996-97 and decline in external value of the lev A fixed exchange rate between lev and euro (BGN1.96=EUR1.00) Convertibility of lev A long-term commitment to the system by the authorities Threats to currency board contained for now Disinflation and euro weakness have mitigated real appreciation pressures under currency board system since 1997 However, rising price pressures and weaker US dollar against euro in 200607 have suggest real appreciation could place currency board under strain Currency board Reserves and the monetary base (US$ m) 12000 10000 8000 Intl. reserves M1 6000 4000 2000 0 1996 1998 M1 includes demand accounts 2000 2002 2004 2006 Economic prospects Strong GDP growth Inflation resumes downward momentum Fiscal policy remains tight Monetary policy dedicated to currency board Even if lev appreciation, cost-advantage remains Large current-account deficits Manageable external debt service Strong, though falling, FDI inflows High levels of reserves Continuation of reforms Growth to remain rapid Real GDP growth, % 7 6 5 4 Bulgaria Eastern Europe 3 2 1 0 2002 2003 2004 2005 2006 2007 2008 2009 Disinflation to continue Inflation, average annual % 8 7 6 5 Bulgaria Euro zone 4 3 2 1 0 2002 2003 2004 2005 2006 2007 2008 2009 External weakness to persist Current account balance, % GDP 0 -2 -4 -6 -8 Bulgaria -10 Eastern Europe -12 -14 -16 -18 -20 2002 2003 2004 2005 2006 2007 2008 2009 FDI receipts to start falling Net FDI inflows, US$bn 8000 7000 6000 5000 Hungary Bulgaria 4000 3000 2000 1000 0 2002 2003 2004 2005 2006 2007 2008 2009 FDI receipts to start falling (continued) Net FDI inflows, as % of GDP 16 14 12 10 Bulgaria Hungary 8 6 4 2 0 2002 2003 2004 2005 2006 2007 2008 2009 Economic risks Managing underlying vulnerabilities Continuing structural reform post-EU Maintaining reform momentum after EU accession A very poor demographic outlook External deficit Need to review labour market incentives Growth challenge can +5% pa growth be sustained? CA deficit financing has deteriorated Net FDI inflows, % of Current account balance 300 250 200 150 100 50 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 External deficit Has grown partly as a consequence of FDI inflows Private sector foreign borrowing is more worrying This has been shown to a be key factor in supporting income convergence … but economic vulnerability is higher nonetheless Need to monitor risks allied to foreign borrowing Export performance crucial Although non-trade elements of CA have also deteriorated, hopes for improving external stability rest with a recovery of exports Data certainly no clear price- or wage-based competitiveness concerns But continuing structural reforms needed to ensure state enterprises are restructured Sustainability threat not obvious IMF research suggests that CA imbalance is broadly consistent with Bulgaria’s stage of economic development Price competitiveness Gross monthly wages, US$ Predicted Actual Act/pr Predicted Actual Act/pr Czech 685 701 1.02 Bulgaria 268 190 0.71 Hungary 725 719 0.99 Romania 242 253 1.04 Poland 619 627 1.01 Albania 206 236 1.14 Slovakia 661 491 0.74 B&H 372 475 1.28 Slovenia 1,398 1,478 1.06 Croatia 666 922 1.49 Estonia 636 573 0.90 Macedonia 345 421 1.22 Latvia 450 390 0.87 Serbia 257 350 1.36 Lithuania 570 472 0.83 “Equilibrium wages” estimated or predicted on the basis of a relationship between wages and productivity (output per employed, at PPP) and several other variables, across 70 economies. EU membership and growth Positive Reinforces political stability, reduces risks Impact on trade/FDI; removal of residual trade barriers Institutional development aided, albeit over long time frame Encourages macro policy discipline EU funding for infrastructure development Negatives Membership removes reform anchor Much of acquis inappropriate for less developed Harmonisation pitfalls - EU social and environment regulation - Pressure for tax harmonisation Stability or growth bias EU membership and growth • • • • EU entry offers a possibility, not a guarantee of stimulating per-capita GDP convergence Key assumptions: trade integration; macro stability and price competitiveness; further deregulation; slow institutional improvement Modest pace of convergence. On baseline forecast, by 2025 Bulgaria reaches about 40% of EU-15 average income per head, from less than 30% at present Despite post-accession benchmarking, risk that Bulgaria’s commitment to EU-related reform weakens in line with greater political disunity A declining and ageing population Population by age group, thousands and dependency ratio 8000 90 80 70 60 50 40 30 20 10 0 7000 6000 5000 4000 3000 2000 1000 0 2004 2025 2050 65+ (Left axis) 15-64 (Left axis) 0-14 (Left axis) Ratio (Right axis) Adverse demographics • • • • • • Bulgaria’s population has been declining for more than a decade It is projected to decline by another 24% by 2035 and the working-age population by 31% Policies needed to encourage higher labour market participation Incentives need to be reviewed to ensure that participation in the labour force is more effectively encouraged The IMF has called for a “release of excess staff from the public sector”, which it believes would lead to higher labour supply to the private sector Poor demographics shared by most CEE states, a produce of net migration and negative natural population increase Assessment of currency board risks External deficit Public finances Perhaps most worrying aspect of recent economic developments rivate sector component has been rising rapidly, while public sector component has been coming down because of the government's aggressive prepayments. Private sector credit growth a concern Debt structure Very restrictive (budget balance in surplus since 2004, primary balance in surplus since 1994). Fiscal overperformance has been used to build up a huge fiscal reserve, and has used this to make early repayments of public sector external debt. Private sector debt accumulation Much of the external deficit is consistent with Bulgaria’s stage of economic catch-up Non-debt creating finance (FDI) has helped to finance current account deficit, but financing is expect to deteriorate 75% of Bulgaria's external debt in euros. No large market of BGN-denominated instruments to serve as a channel for forcing currency adjustment. Portfolio inflows (hot money flows) are relatively minor. Banking sector Overwhelmingly under foreign control and improving in terms of profitability and stability. Summary of challenges Nature of challenge Growth Keep well-balanced Inflation Emerging energy dependence could increase inflation Fiscal policy Maintain tight fiscal policy Monetary policy Preserve currency board despite large external deficit, manage credit growth and banking sector risk External sector Manage and reduce vulnerability FDI Competitiveness Business environment Ensure opportunities for greenfield investment when privatisation program comes to an end Address problem of falling working-age population, invest in R&D to decrease reliance on labour-cost advantages Need to further improve institutions and regulations