• Growth is robust in a favourable EU climate, combining high demand and strong EU transfers
  • Fiscal and external balances are in surplus, albeit slowly decreasing
  • The persistent demographic crisis and poverty are two weaknesses that are constraining future growth
  • Bulgaria will soon apply for the ERM II exchange rate system, but euro accession is still a long way off
  • External debt, once a dominant risk, has been sharply curtailed and is forecast to fall further
  • Political instability and enduring corruption are putting the brakes on reform and effective policy-making

Among the fastest-growing economies in the EU

Bulgaria is enjoying its best economic cycle since the period prior to the 2009 recession. In 2015-2017, GDP growth accelerated to reach an average of 3.7%, i.e. one of the fastest rates within the EU. It is expected to stay around that level this year before receding towards 2.8% by 2020.

The supportive external environment and more robust consumption on the back of improved confidence largely explain this favourable trend. Also, since it joined the EU in 2007, the Bulgarian economy has been able to rely on an extra boost from the EU Structural Funds. Their high absorption rate (95% in 2016) has rapidly increased over the past years and is now comparable to that of peer countries. However, as a consequence of Brexit, the next 2020 EU budget could be revised downwards and thus translate into lower EU transfers to the biggest beneficiary countries such as Bulgaria.

A twin surplus showing solid fundamentals

The country presents strong macroeconomic fundamentals with a twin surplus. Since 2016 and after 20 years in deficit, the current-account balance has turned positive largely thanks to stronger exports to the EU market (dominated by manufactured goods, followed by food products) and increased tourism revenues (10% of total exports). The surplus, which amounted last year to 4.5% of GDP, is forecast to go down gradually towards balance by 2023. EU funds and rising FDI attracted by still relatively low labour costs will keep the balance of payments positive in the long run. The fiscal balance is also in surplus at 0.9% of GDP in 2017. Fiscal consolidation has enabled public finances to improve since 2015 and is forecast to keep the budget around balance as from 2020. Public finances are healthy and Bulgaria is one of the EU Member States with the lowest general government debt – 23.9% of GDP – with the slow downward MLT trend projected to continue. Starting from a solid base, the outlook could become more challenging if a number of potential or likely costs are included, such as contingent liabilities from SOEs (8.5% of GDP), planned sharp wage increases in several areas of the public sector and higher spending to address the large infrastructure gap. Looking ahead, the ageing of the population combined with the significant emigration of young, skilled people will reduce the active population and raise pension and health costs. Hence, further bold social reforms will be required to ensure long-term fiscal sustainability.

A longstanding demographic drain and slow poverty reduction

As witnessed in other former Communist countries in Eastern Europe, it will take years for Sofia to tackle structural weaknesses. The demographic crisis, resulting from a constant exodus to higher-income EU countries and a low fertility rate, is the most acute structural risk. With a 30% loss of its population over the past 30 years, Bulgaria understandably has to cope with labour shortages. Coupled with high corporate debt (84% of GDP in 2016), they could constrain future domestic investments, which are projected to remain around their current level, just below 20% of GDP, which is a moderate level compared with the 25% rate considered adequate for a catching-up economy.

Poverty is another issue for Bulgaria, which remains the poorest EU Member State, as GDP per capita has grown only slowly in the first decade of EU membership, especially after the 2008/09 crisis. The government recognises the need for more inclusive growth and is making it one of its priorities. However, weak progress in structural reforms could cause those hindrances to growth potential to persist.

Joining the euro zone still a distant prospect

On the positive side, Bulgaria intends to adopt the euro and will take the opportunity of its EU Presidency to move forward with its application for the ERM II (Exchange Rate Mechanism), the precursor system to the euro, by mid-2018. Although Bulgaria could be the next member of the euro area, as it meets all the Maastricht criteria, the timeline is very uncertain. It could last several years to say the least as it lacks support among euro member states, notably due to persisting high corruption. Meanwhile, belonging to the ERM II should further stabilise the lev, which has been pegged to the euro since 1999. In addition, the banking sector has quickly recovered since 2014, when the 4th largest bank, KTB, went bankrupt. Although two banks still need recapitalisation, the banking system as a whole is now rather sound with good capitalisation and liquidity levels and recovering credit supply. The non-performing loans ratio is still high but is continuing to decrease (from 16.7% in 2014 to 11.4% in September 2017).

Enhanced external debt sustainability

The dominating financial risk has decreased significantly in the last few years. The downward trend in external debt has been accelerating since 2013 as a combined result of increasingly robust economic activity and private-sector deleveraging – 82% of total external debt is private, including intracompany loans for over 20% of GDP – and limited new public borrowing (none is planned until at least 2020). External debt has thus become more sustainable, slightly above 70% of GDP, and is forecast to fall slowly to less than 60% in the coming years. Bulgaria’s liquidity has also much improved. The manageable debt service is projected below 15% of export revenues as from this year in line with falling external debt. Short-term debt, which peaked at a huge 70% of export revenues in 2009, has sharply decreased since 2012 to around 25% of export earnings at the end of 2017. It is covered by robust foreign-exchange reserves at 250%, which keep fluctuating over 7 months of imports.

Political instability affecting policy-making

Bulgaria is prone to recurrent government instability, which affects policy continuity. Governments rarely complete their term and this might again be the case for Borisov’s 3rd mandate since 2009. His leading centre-right GERB party won snap elections in March 2017 and has been in power thanks to a fragile coalition with small nationalist parties with diverging positions on a number of government policies. Moreover, protests from civil society and strong opposition by the pro-Russian Socialist Party frequently put pressure on the incumbent government, which in a way also highlights Bulgaria’s living democracy. Although the government might struggle to survive until the 2021 polls, political stability is likely over the one-year outlook, certainly until mid-2018, when Bulgaria’s first EU Presidency ends.

The domestic security risk is low but could rise with the migrant crisis if the Turkish-Bulgarian border becomes an increasingly used corridor for refugees. In any case, until now, Sofia’s stance towards migrants has been comparatively among the most open in the ex-Communist bloc – despite reports of repressive treatment. This could be explained pragmatically by the fact that Bulgaria is a major beneficiary of EU funds and faces a severe demographic deficit.

Corruption, an overwhelming legacy

Bulgaria’s prominent systemic ill is corruption, a stubborn legacy from the Communist era, giving it the unenviable position of the most corrupt EU country (according to Transparency International).

Therefore, since the country joined the EU in 2007, the European Commission has maintained tighter surveillance of the Bulgarian judicial system in reining in endemic corruption, acknowledging that the fight against corruption is where Bulgaria has lagged the most in the past ten years. EU pressure is supported by an active civil society, which regularly protests against government laxity in tackling corruption (scandals) in the public administration and reforming the judiciary, which lacks independence and transparency. The recent presidential veto on an EU anti-corruption law aimed at increasing the efficiency of the judicial system in addressing corruption might stall the process. More generally, progress is slow when it comes to implementing reforms. During his term, the Borisov government wants to give priority to raising the weak income level and developing infrastructure.

Analyst: Raphaël Cecchi – r.cecchi@credendo.com