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Country Report Bulgaria

Country Report

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Bulgaria’s economic and political situation remains tense, as yet another government stepped down, the local financial system was shaken by organised bank runs, and bilateral relations with Russia soured markedly due to the halt of construction of the South Stream pipeline.

Strengths (+) and weaknesses (-)

(+)      Track record of fiscal prudence

Modest public surpluses/deficits recorded in the past two decades have resulted in a low level of public debt, which allows the authorities to adopt an expansionary fiscal stance when needed.

(-)       Persistent corruption and cronyism

Persistent corruption and cronyism hurt the business environment. Moreover, there is widespread discontent with governance issues and the close ties between politicians and business oligarchs.

(-)       Continuous political instability

The Bulgarian political elite’s commitment to the common good is perceived to be weak, which tends to affect policy acceptance by the public. Government stability has been very weak  in recent years amid recurrent mass protests.

(-)       Ageing population

Until 2050, the share of the working population in the total population is expected to decline from 67% to 50%, while the share of those aged 65 and older will increase from 19% to 33%. These structural shifts will hurt potential growth and increase the burden on the public budget.   

Key developments

1. Weak economic growth resumes, but outlook remains bleak amid various challenges

Following very low growth of 0.9% in 2013, Bulgaria’s economic recovery, which set in the second half of last year, continued in the first two quarters of this year. However, reflecting the country’s difficult domestic political situation and rising tensions between the EU and Russia economic growth remained relatively weak at 1.2% and 1.6% yoy in Q1 and Q2, respectively. For the year as a whole, growth is projected to come in at about 1.5%. Recovering private investments and private consumption benefitting from recent employment gains and deflation have been the main growth drivers so far this year. Meanwhile exports suffered from markedly lower demand from Russia and Ukraine, even as exports to EU markets have strengthened recently. Notwithstanding Bulgaria’s recent economic improvement, considerable challenges threaten to undermine the country’s fragile economic recovery. On the domestic front, continuing political uncertainty in the aftermath of the October 2nd snap elections may weigh on consumer confidence, while the still unresolved rescue operation of Corporate Commercial Bank (CCB) (see below) involving ongoing deposit freezes (USD 4bn) could negatively affect private consumption and investments. The deteriorating financial position of various state-owned enterprises, some of which hold large deposits at CCB, as well as the recent halt of construction on the South Stream pipeline constitute further risks to domestic demand. Exports are unlikely to provide much relief amid slowing economic growth in the euro area, Russia and Ukraine and the imposition of reciprocal trade bans between Russia and the EU.

Figure 1: Growth performance
Figure 1: Growth performanceSource: EIU
Figure 2: Current account
Figure 2: Current accountSource: EIU

2. Organised bank runs temporarily put stability of the banking system to the test

In June, Corporate Commercial Bank (CCB) and First Investment Bank (FIB), Bulgaria’s fourth and third largest lenders, were subject to partially organised bank runs amid a conflict between CCB owner Tzvetan Vassilev and politician-businessman Delyan Peevski. Fearing a system-wide bank run, Bulgaria’s central bank took over CCB and the European Commission approved a USD 2.4bn government credit line to local banks, which restored depositors’ confidence. Foreign-owned banks, which account for about 70% of system-wide assets, were not affected and even saw their deposit base increase during the bank runs, underlining the overall stability of the sector given a capital adequacy ratio of 20% and high liquidity ratios. While a melt-down of Bulgaria’s financial system, which might have put the peg of the Bulgarian lev to the euro at risk, could be avoided, the incident revealed serious shortcomings in banking sector supervision, as well as the country’s exposure to its politically well-connected oligarchs. In order to address the former, Bulgaria will become the first non-euro area member to be subject to the ECB’s Single Supervisory Mechanism (SSM) and the European Banking Authority (EBA) was asked to audit the operations of the Bulgarian banking supervisor. While it still takes some time before these measures will result in meaningful improvement, in the short-term the central bank will have to decide on whether to let CCB fail, as its owners – Mr. Vassilev, Russian bank VTB and Oman’s sovereign wealth fund – cannot or do not want to recapitalise the bank.

3. Snap elections do not provide incoming government with stable majority

After just over a year in office, Bulgaria’s Socialist-led government resigned in July and handed over power to a caretaker government that governed the country until early elections were held on October 2nd 2014. Apparently, the government’s resignation followed the Socialist Party’s poor performance at the European elections amid continuous public disapproval with its earlier attempt to appoint oligarch Delyan Peevski as head of a beefed-up secret service. The snap poll was won by former prime minister Boyko Borissov’s centre-right pro-Western GERB-party, who formed a minority coalition government with the newly founded Reformist Bloc of former EU Commissioner Meglena Kouneva. In order to ensure sufficient parliamentary support for its policies, the new cabinet relies on support from two smaller parties, but given considerable ideological differences, risks of recurrent government instability remain high.

4. Bilateral relations with Russia worsen as EU demands South Stream stop

Bulgaria’s once cordial relations with Russia have deteriorated markedly in recent months, following the implementation of EU sanctions and the halt of construction works on the Russian-sponsored South Stream gas pipeline amid EU complaints about the dodging of competition rules. While Bulgaria’s Socialist-led government had tried to uphold its pro-Russian stance amid rising international criticism, the recent caretaker government has been a staunch supporter of the country’s EU and NATO membership. It even warned against various Russian efforts to destabilize Bulgaria. Going forward, bilateral relations with Russia will remain tense, as the current administration remains committed to the caretaker government’s pro-Western foreign policy. This may weigh on Bulgaria’s economic outlook, as Bulgaria has attracted large numbers of Russian tourists and (real estate) investors in recent years.

Factsheet of Bulgaria
Factsheet of BulgariaSource: EIU, CIA World Factbook, UN, World Economic Forum, Transparency International, Reporters Without Borders, World Bank.

Background information

Bulgaria joined the European Union in 2007 and is its poorest member, with a GDP per capita just below half the EU average. Moreover, in 2011, 49% the population was at risk of poverty or social exclusion, according to data from Eurostat. EU accession gave Bulgaria access to European funds for development. Yet, due to government capacity constraints the absorption rate of these funds is one of the lowest in the EU, though improvement has been booked in the past years. The Bulgarian population has fallen markedly in the past two decades, decreasing by 22% to 7.2m over 1990-2013, on the back of a low fertility rate, a stagnant life expectancy and one of the highest emigration rates in the world. The Bulgarian economy is fairly open. Bulgaria is a net exporter of services on the back of its tourism and transportation sectors. The banking sector is dominated by subsidiaries of EU companies, which account for about 70% of system-wide assets. The sector is well capitalised and liquid, but provisions related to a large share of non- performing loans - a legacy of the pre-2008/2009 credit boom - hurt margins.

Following a period of more than 40 years in which Bulgaria was a satellite of the Soviet Union, Bulgaria’s communist regime collapsed in 1989. The country became a parliamentary republic in 1991. The government holds executive power, while the directly elected president fulfils a non-executive function.  Particularly in recent years, government stability has been weak, as Bulgaria’s economy struggled to recover from its deep recession in 2009. A weak rule of law, persistent corruption and organised crime are major issues that have impeded approval for the aspired membership to the Schengen area. In 1997, Bulgaria introduced a currency board and pegged the lev to the euro. The Bulgarian government has stated that ERM II membership will be postponed until after the eurozone crisis has stabilised. 

Economic indicators of Bulgaria
Economic indicators of BulgariaSource: EIU
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Author(s)
Fabian Briegel
RaboResearch Global Economics & Markets Rabobank KEO
+31 30 21 64053

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