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Bulgaria - Economic Situation July 2004 Edi Segura, Oleg Ustenko Summary Since the beginning of the year, the Bulgarian economy has continued to expand at a healthy rate. In the first quarter of 2004 (Q1), gross domestic product grew by 5.3% year-over-year (yoy), supported by a sharp rebound in industry and services. During the first five months of 2004, the government maintained prudent fiscal policies. The general budget showed a surplus of 1.9% of the projected GDP, which compares favorably with a targeted full-year deficit of 0.7%. The upsurge of world oil prices triggered an acceleration of consumer price inflation, which reached 7.3% yoy in June. On the back of rapid imports growth, the merchandise trade deficit continued to deteriorate, widening by 42.9% yoy to 4% of projected full-year GDP in JanuaryApril. Over the period, the current account deficit, however, narrowed by 3% yoy to EUR 734 million due to growing inflows from tourism and current transfers. Though the current account deficit is relatively high, it is more than offset by foreign direct and other investment inflows. On July 8, 2004 Bulgaria came to an agreement with the IMF on a precautionary stand-by arrangement to provide support for the country until it joins the European Union in 2007. In mid-June Bulgarian government completed the negotiations with the EU that confirmed the year 2007 as the date for Bulgaria’s accession to EU. Economic Growth In first quarter of 2004 (Q1), economic growth in Bulgaria reached a high level of 5.3% yoy. The acceleration of economic growth was caused by a rebound in Bulgarian industrial and service sector. Real GDP and Real Growth by S ectors, % yoy 8 6 4 Value added growth in industry reached 2 6.4% yoy in Q1, which compares very 0 favorably with 5.7% yoy over the same Q1Q2Q3Q4Q1-2 period last year. Industrial sales 2003 2003 2003 2003 2004 expanded by 21.1% yoy in April, a Agriculture Industry growth rate which is 2 percentage points Services GDP higher than the one recorded a month ago. At the product level, food Source: Bulgarian National Statistical Institute processing, wood and furniture production demonstrated the highest rates of growth during the month. Sales in the food processing industry increased by 12.1% yoy, primarily due to a substantial increase in food prices (7.0% yoy) and particularly in alcohol drinks and tobacco (28.1%). In April, strong increase in the domestic production of wood (68.0% yoy) and furniture (36.5% yoy) leaded to 1.6% yoy decrease in prices for these products on the domestic market and increase in the value of these products’ export. In Q1 Bulgarian service sector grew at 6.2% yoy level. Agriculture showed the lowest level of growth among other sectors (1.2% yoy). The slow rate of growth in this sector negatively affected the cumulative rate of growth of the whole economy. Based on Bulgaria’s economic performance in the first quarter of 2004, the government revised its GDP growth forecast from 5.3 to 5% for this year. The medium- term macroeconomic projection continues to rely on growth rate somewhat above 5% in 2005 and 2006. Fiscal Policy Supported by robust economic growth fiscal performance has been successful. In January-May, the general fiscal budget posted a surplus of Lev 710 million (EUR 363 million). The figure accounts for some 1.9% of the projected GDP while the government is targeting a full-year deficit of 0.7%. Over the period, consolidated budget revenues reached Lev 6.38 billion (EUR 3.24 billion), while expenditures amounted to Lev 5.67 billion (EUR 2.88 billion). Good performance of the economy in the first five months of the year supported a 3% yoy growth of budget revenues. Budget expenditures also increased but the rate of their growth was lower than revenues (2.5% yoy). The large fiscal surplus in April and May had a symmetric upward impact on the stock of the fiscal reserve, which rose from EUR 1.15 billion at the end of April to EUR 2.37 billion at the end of May. This increase will have a downward impact on the money supply and would tame the inflation rate. In the middle of May the Ministry of Finance presented the draft of the 2005-year’s budget. It includes a 5% wage hike in the public sector and 4.5% pension hike. The draft fiscal parameters look consistent with the broad objectives for reduced fiscal intermediation and planned tax cuts. The wage and pension hikes are relatively tight given the projected inflation rates and the rate of economic growth. During January-April 2004, the amount of public debt (internal and external) increased by 4.02% from EUR 8.51 billion at the end of 2003 to EUR 8.86 billion at the end of April 2004. The monthly rate of growth in April was 1.03%. The total stock of the public internal and external debt of the end of April can be translated into 48% of the forecasted GDP in 2004. Public Debt Dynamics in 2002-2004 eop, billion EUR Internal Debt 12 10 External Debt (public and private) Governme nt External debt 8 6 4 2 0 2002 Q1- Q2- Q3- Q4- Q1- Apr03 03 03 03 04 04 Source: Bulgarian National Bank The increase is mainly attributed to increase in interest rate for some part of previously issued debt instruments and the currency value in which they were denominated. Rapidly growing liabilities in the private sector have pushed up the gross external debt by 6.1% yoy to EUR 11.4 billion as of end April. The private debt accounted for 35% of the gross external debt of Bulgaria. As of end April, the external debt accounted for 59% of the forecasted full-year GDP. This increase in private borrowing is due to improved access of the private sector to external financing. Monetary Sector Starting December 2003, inflationary pressures in the consumer market began to fade away. During June 2004, the consumer price index (CPI) fell 1.8% on a month-over-month basis, after it was close to zero in May. However, on an annual basis the consumer prices growth accelerated to 7.3% yoy in June compare to 6.8% yoy in May. Higher oil prices seen in the group of non-food products and a new rebound in the service prices contributes for the accelerated inflation rate. On the other hand, the annual index in the group of food prices slowed to 7% yoy in May relative to 7.8% yoy in April. Despite the overall Source: Bulgarian National Statistical Institute, price rebound in June, it should be Bulgarian National Bank expected that CPI inflation may ease down in the second half of the year due to the high base from the fall of last year and signs of positive supply shocks in the agricultural and food sectors. The year-average inflation however is likely to stay around 5-6% that would exceed the figures used in the budget projections for this year and would generate higher than projected fiscal revenues. Change in official foreign reserves, EUR mn 400 300 200 100 -200 -300 -400 Source: Bulgarian National Bank Apr'04 Jan'04 Sep'03 May'03 Jan'03 -100 Sep'02 0 May'02 At the same time, producers’ inflation continued to accelerate. The producers’ price index (PPI) in the industry increased significantly in April to 6.3% yoy from 1.4% yoy a month before. It should be expected the PPI will rebound, as the industry is more sensitive to external oil price shocks. Monetary aggregates growth slightly decelerated in May as money supply (M3) growth fell to 1.23% mom from 2.28% mom in April. Money supply growth slowdown was attributed to some deceleration of credit growth. The growth of credit to non-government sector slowed down to 50.8% yoy in April from 52.3% yoy. . With the aim to reduce credit growth, the monetary authorities transferred government deposits in commercial banks to the central bank, thus reducing banks liquidity. Also, starting July 1, 2004 the minimum reserve requirement of 4% was imposed on financial instruments with medium and long-term maturities. Significant upsurge of commercial bank credit, especially of consumer lending, triggered an increase of import demand thus implying further widening of external gap. In an attempt to stimulate economic growth, the Bulgarian National Bank (BNB) put down its base interest rate to 2.44% in May per annum from 3.83% month before. In July, the Bulgarian official foreign reserves increased 30% yoy to EUR 6.2 billion supported by robust inflow of foreign direct and portfolio invetsment in the first half of 2004. However, the BNB’s end-year target for gross reserves equals to EUR 5.7 billion because of expected interest payments on external obligations and relatively large current account deficit. International Trade and Capital 25.0% Exports of goods and services 20.0% 15.0% 10.0% Imports of goods and services 5.0% 04 03 Q 120 03 Q 320 02 Q 120 02 0.0% Q 320 The annualized CA gap has slid from 9.1% of GDP in the 12 months ending on March 31 to 8.2% in the 12 months ending on April 30. The whole improvement is recorded in one month, as the CA deficit has dropped by 40.2% to EUR 217.8mn in April. The foreign trade deficit continued to deteriorate, widening by 42.9% yoy in Jan-Apr and 6.2% in April. Change in export-import qoq, % Q 120 In January-April 2004 the Bulgarian current account (CA) deficit was EUR 735.8 million, which is 2.6% lower than at the same period in 2003. The deficit accounts for 3.8% of the projected fullyear GDP relative to 4.3% a year ago. Source: Bulgarian National Bank On the other hand, growing inflows from tourism and current transfers, as well as lower income transfers to non-residents, have contributed to the overall narrowing of the CA deficit. Larger tourism inflows and lower energy imports in the summer months would bring favorable seasonal effects in the following months until the end of September. This would most likely translate into a CA surplus in Q3. However, the annualized figures may not sustain the positive shift in April, as the oil price effects would have significant upward impacts on the merchandise imports in May and June. In January-April, the balance of the merchandise foreign trade netted a deficit of EUR 776.6 million. The gap widened by 43% yoy in euro terms and accounted for 4% of the projected full-year GDP. The export growth rate improved from 6% yoy in March to 10.8% yoy in April. Over the period of January-April, import grew faster than export (13.9% yoy). The import statistics show a slight deceleration in the growth rate in April against March but the 3-month moving average is indicating rapid expansion rates for both import and exports that are likely to keep the foreign trade gap at a record high-level this year. The trade balance would start to improve seasonally on a monthly base in the summer months but the annual indices will continue to pose concerns on the external balance. The geographical breakdown of the foreign trade shows that the exports to EU 15 grew by 10.6% yoy in January-April or nearly two times faster than the overall rate. The export performance regarding the countries in Central and East Europe was even more impressive marking a rise by 23.9% yoy for the same period. Despite the deficit in the CA, the overall balance of payments netted a surplus of EUR 33.8 million in January-April against a deficit of EUR 2.9 million for the same period last year. In January-April, the net inflows of FDI rose by 2.2% yoy to EUR 401.9 million and the final payments for the privatization of the telecom company BTC will boost further the foreign investment statistics by more than EUR 200million in June. Net FDI flows, million EUR 450 400 350 300 250 200 150 100 50 0 -50 Q1- Q2- Q3- Q4- Q1- Q2- Q3- Q4- Q102 02 02 02 03 03 03 03 04 The state investment agency has Source: Bulgarian National Bank upgraded the forecast for FDI inflows this year from $1.6 billion to $2 billion (some 7.5% of the projected GDP). The structure of the expected investments comprises: $565 million from privatization inflows, $415mn from investment expansion, and $1.02 billion from green-field projects. Bulgaria is about to be included in a global investment index for 42 countries that would also support the inflows of FDI. International Programs On July 8, 2004 the IMF and Bulgaria came to an agreement on a stand-by arrangement to provide support for the country until it joins the European Union in 2007. Bulgaria wishes the agreement to be only a precautionary stand-by arrangement under which the IMF would provide credit to Sofia only if the country was in desperate need. Under the provisions of the agreement, Bulgaria could draw on $130-140 million (EUR 106-114 million) in IMF funds. In exchange, Bulgaria would have to push ahead with IMF-imposed austerity measures. A two-year stand-by arrangement for $300 million agreed upon in 2002 expired in February. On June 10, 2004 a loan from the World Bank to Bulgaria in the amount USD150 million was approved. This loan intends to sustain reforms across diverse sectors of Bulgaria’s economy while supporting the execution of the government’s reform agenda. This program’s main objectives are: to achieve average annual growth rates of 4.5-5.0% during 2002-05; to reduce the poverty rate by half by 2005 compared to 2001; and to reduce the unemployment rate from 18.1% in 2001 to 12-14% in 2005, while making substantial progress towards EU accession. The EBRD remains one of the most active international financial institutions in Bulgaria. It has established a private sector financing program in Bulgaria. The Bank's activities and portfolio have increased considerably over the last 24 months, as a result of the positive improvements in the country. The Bank is a foremost catalyst for investment in Bulgaria (collective business volume of EUR 784.2 million as part of total funds mobilized of EUR 3.2 billion) and is positioned to play a fundamental role in guiding the country through the challenges ahead. The purpose is to wholly and proactively support Bulgaria by further encouraging the expansion of the private sector and increasing activities in infrastructure. Other Developments Bulgaria has consistently continued the implementation of the Europe Agreement which set the terms of accession to EU in 2007. No major issues that could jeopardize this target date are currently envisaged. Consequently, the European Union leaders recently confirmed the year 2007 as the date for Bulgaria’s accession to EU. The leaders of EU 25 member states voiced content with the completion of Bulgaria's entry talks. Bulgaria’s political situation has remained stable over the past year. The protocol for Bulgaria’s accession to NATO was signed in March of 2003 and the country was officially recognized as a NATO ally on April 2, 2004. Bulgaria actively continues to fulfil the statutes of the Copenhagen Political Criteria. Standard & Poor's Ratings Services assigned an investment grade to Bulgaria, the tenth sovereign currently rated by the agency that has made the transition from speculative grade to the investment grade. The agency raised its foreign currency sovereign credit ratings on Bulgaria to BBB-. The long-term local currency credit rating is raised by one notch to BBB while the short-term ratings for both local and foreign currency are placed at A-3. The outlook on all ratings is stable.