The Bulgaria 2012 Review: Finance
Bulgarian EU Commissioner Kristalina Georigieva, Finance Minister Simeon Djankov and Economy Minister Delyan Dobrev (L-R). Photo by BGNES
Following are the key developments in Bulgaria's finance sector in 2012
Bulgaria Boasts Healthy Finances, but Still Not on Way to Recovery
Weak domestic demand and a pickup in exports kept Bulgaria's current account in surplus during the years right before the "big recession" erupted. The current account balance changed in 2009 and the term "surplus" is now a thing of the past. The deficit for just three years – from 2009 to 2011 – towered to BGN 5 B and judging by the government's forecasts the country's external balance will show a shortfall for seven years in a row.
Bulgaria's state budget accrued a budget deficit of BGN 128 M in the first eleven months of 2012. Even though it is below 3% of gross domestic product (between 1-2% or over BGN 1 B), experts have warned the country may be facing a vicious cycle. They point out that a number of European governments have been forced to revise their expectations after promising reducing the deficit.
Meanwhile credit rating agencies heaped praise on the government's strong track record of fiscal prudence; low and declining deficit and debt stock, despite subdued economic growth; and the country's strong medium-term growth prospects, particularly if they are backed by increased private investment; and improving absorption of EU funds.
They pointed out however that these strengths are partially offset by Bulgaria's relatively low GDP per capita, which is estimated at USD 6,900 in 2012; its high, albeit declining, external financing needs; and limited monetary flexibility owing to the country's currency board arrangement.
Standard & Poor's Ratings Services said in the middle of December it expects real GDP growth of about 1.7% in 2013 and an average of 2.0% from 2013-2015, supported by a recovery in both domestic and external demand. The agency expects the current account deficit to remain close to balance in 2012, before slipping back into a deficit as domestic demand gradually recovers and the trade deficit widens over the next three years.
The government has continued to consolidate its finances following budgetary deterioration in 2009, despite the low growth in the past two years, and has complied with the requirements of the recently adopted national fiscal pact, according to the agency.
It expects the general government deficit to reach 1.3% in 2012 and stay broadly the same in 2013, though there is a risk of fiscal slippage with parliamentary elections scheduled for mid-2013. However, there is a potential for higher-than-budgeted privatization revenues that could be used to restore the fiscal buffer or provide cofinancing projects. The general government debt is low at an estimated 17% of GDP in 2012 and net general government debt is estimated at 10% of GDP. The fiscal reserve covers at least one year of amortization and interest payments. General government interest expenditure is also low at slightly less than 2% of general government revenues in 2012 and is expected to broadly remain at this level over 2013-2015.
Financial developments in Bulgaria however will depend to a large extent on the developments outside the country and prospects may not be that promising.
Bulgaria is among the Central and Eastern European countries that are most vulnerable to the ongoing debt crisis, according to a report of international consultancy PricewaterhouseCoopers, issued at the end of September.
The report ranked Bulgaria as the fifth most vulnerable to the debt crisis from among the other CEE states, after Latvia, Slovenia, Belarus, and Hungary.
Serbia and Ukraine were also deemed highly vulnerable to the effects of the European debt crisis, according to PwC.
The Czech Republic was the only CEE state that is said to be fairly immune to the debt crisis shocks.
PwC said that while recessions and financial instability are mostly prevalent in Western Europe, Central and Eastern Europe is faced with two major threats – global financial panic and the fate of the euro whose future remains uncertain among the fiscal difficulties in Greece, Ireland, Portugal, Italy, and Spain.
Bulgaria's Economic Recovery to Accelerate in 2013 - Report
Bulgaria's economy should begin showing more signs of recovery in 2013, according to UniCredit Bulbank's Quarterly Macroeconomic Update on Central and Eastern Europe, issued at the end of September.
Analysts of the bank suggest that Bulgaria should be able to win back foreign investors' confidence as financial market tensions are not expected to escalate much further.
According to the report, these factors, combined with a very solid absorption of EU funds, should be enough to push gross fixed capital formation (GFCF) up by around 5% in 2013, adding roughly 1.1 pp to the GDP.
Though to a smaller scale, final consumption expenditures are also expected to improve.
The planned increase in the minimum wage and in pension rates after they had been kept frozen for the past three years should alone boost average households' income by a nominal 3%, while weaker food prices pressure should boost purchasing power, according to the report f UniCredit.
"Against the background of all these factors, we decided to keep our GDP growth forecast unchanged at 0.5% in 2012 and 1.5% in 2013," says Kristofor Pavlov, Chief Economist for Bulgaria at UniCredit Bulbank, as cited by the bank's press office.
In Q2, 2012, GDP growth remained lackluster at 0.3% quarter on quarter, equivalent to 0.5% year on year for a second quarter in a row.
The growth was due to stronger individual consumption and exports.
Exports rose by 3.4% quarter on quarter and by 3.9% year on year, while private consumption went up by 2.4% quarter on quarter, according to the quarterly report.
In July 2012, the consumer price index (CPI) posted its strongest month on month increase (1.5%) in 4 years amid food and energy price spikes.
Meanwhile, core inflation, which excludes volatile energy and food components, rose a meager 0.1% month on month and 0.2% year on year, reflecting the significant slack in the economy which continues to operate below capacity, Unicredit Bulbank reports.
According to Kristofor Pavlov, higher inflation helps to alleviate the borrower's woes as it reduces the real value of debt.
The UniCredit Bulbank Chief Economist for Bulgaria explains that the higher inflation rate creates more incentives for consumption and could therefore be a component of the medicine needed to end cash hoarding, which is one of the factors that hold back domestic recovery.
Bulgarian MPs Pass 2013 Budget amidst Scandals
Bulgaria's Parliament adopted at the beginning of December the country's 2013 State Budget Act at second reading after a debate marred by scandals.
According to the provisions of the budget, Bulgaria's GDP is expected to grow by 1.9% in 2013, reaching BGN 81.486 B.
The exports of the Bulgarian economy are projected to grow by 8.1% year-on-year, while the employment level is expected to stablize at the 2012 figure – 12.4% unemployment. Imports are expected to increase by 10.5% year-on-year.
As a result, Bulgaria's current account balance will reach a deficit of 2.8% of GDP and will keep growing in the medium run.
Planned revenues in the 2013 budget are BGN 18.4 B – of them, BGN 16.6 B from taxes, and the expenditures are BGN 19.2 B – of them the funds owed to the EU amount to BGN 908 M, transfers – to BGN 10 B, and other expenditures – BGN 8.1, thus the budget gap in 2013 will be BGN 802.6 M.
The second-reading debates for the 2013 State Budget Act continued for more than 13 hours, amidst chants for the resignation of Finance Minister Simeon Djankov on part of the opposition, with Djankov in turn describing the opposition MPs as drunks and apologizing after that.
The turmoil during the debates forced Parliamentary Chair Tsetska Tsacheva to declare a break, which is when Djankov's apology came in.
While the MPs where debating the budget for 2013, outraged Bulgarian mothers rallied outside the Parliament building with their babies dressed in clothes saying, "There is no budget for me!" protesting the ruling party GERB's decision not to increase the monthly maternity allowances from their present level at BGN 240.
In spite of their attempts to enter the Parliament with their babies, the mothers were not received by GERB MPs.
In the first day of the budget vote, after heated debates, the MPs passed the budget of the National Health Fund (NZOK), of the State Public Coverage, and the budget frame, and started working on the State budget.
Under the 2013 NZOK budget, health insurance contribution was kept at 8%. The NZOK debate caused the most clashes between MPs from the ruling Citizens for European Development of Bulgaria party, GERB and those from the opposition. The latter proposed to introduce a lower fee for retired people for a general practitioner exam, but it was rejected.
The opposition, left-wing Bulgarian Socialist Party, BSP, presented an alternative budget plan, asking to increase the forecasted revenue from tax collection, particularly from excise duties.
The MPs also passed the subsidies for the State-owned Bulgarian National Television, BNT (BGN 70 M), Bulgarian National Radio, BNR (BGN 42 M) and the BTA news agency (BGN 4 M).
Bulgaria Cooler on Euro, Support for Currency Board Strong
Bulgaria's enthusiasm for the euro cooled down considerably on 2012 as the government and the citizens started to turn against the single currency.
Bulgaria, which like the Baltic states has pegged its currency to the euro for a decade and is one of only three EU countries that currently meet the Maastricht entry criteria in full, made it clear it has no short-term plans to move towards membership over the turmoil in the eurozone.
Though the government has stated that it is postponing plans to join the European Exchange Rate Mechanism (ERM II), the precursor to entry into the European Economic and Monetary Union (eurozone), this is not expected to lead to a change in its commitment to prudent fiscal policy.
The government's firmer than ever stance against the country's eurozone aspirations was shared by a whopping majority of Bulgarians and Steve Hanke, the architect of Bulgaria's currency board regime.
"It would be a complete disaster if you did not have the currency board, " Hanke said in an interview for bTV private channel during his visit to Sofia in December.
"Bulgaria has a system, which is working perfectly right now. Why do you want to fix something that's not broken? I don't think you should be in the euro zone, period," the Johns Hopkins economist, who designed the currency board in Bulgaria and in several other east European countries in the 1990s, said.
"Bulgaria's monetary arrangement is much better than Europe's monetary arrangement. You have monetary sovereignty; you have control over your money. What if the euro blows off? Bulgaria can just switch to the US dollar!"
According to Hanke adoption of the euro would trigger "a real mess" in Bulgaria.
He firmly denied allegations that the rigidity of the currency board system prevents economic development and ruled out the need for Bulgaria to phase out its currency board
"Of course you are poor, but you were poor to begin with. But the trajectory is relatively good. During the crisis the Currency Board has been the key to hold the economy stable," Hanke said.
Bulgaria's currency board has forced its government to control spending, as the central bank is not free to print money to support government borrowing.
"The stable Bulgarian lev and the Currency Board is an institution that puts hard budget constraints. This means that the Bulgarian National Bank can not use the printing press to finance everyone. With this big constraint and that bigger system behind the finance ministry, the finance minister can control the budget," Hanke pointed out.
He praised Bulgaria's Finance Minister Simeon Djankov for "doing a very good job of controlling the budget, especially in the crisis".
Bulgaria today would not only meet the Maastricht Treaty's criteria for joining the euro zone - it would be one of its star members, a point that Hanke stressed upon.
"If you look at the European Union countries, Bulgaria's debt and deficit are very good, may be one of the best. That's another reason why the rating, reputation and bonds sale are good, there are prerequisites for growth."
The renowned economist vehemently rejected suggestions that devaluation of the lev will serve as incentive to the local economy and boost exports.
"This is absolute stupidity! If devaluation was such a wonderful thing, South America would be the richest continent in the world, because there they are continually devaluating."
"If Bulgaria starts to devaluate, there will be a lot of instability in the economy and the economic growth will be much slower."
"Why there has been a big boom in Turkey? The Turkish lira has been stable and strong since 2001. Stability might not be everything, but everything is nothing without stability."
Hanke, who served as an adviser to President Petar Stoyanov from 1997-2001, recommended shrinking further the state, saying this is the only way to fight corruption.
He also urged people not to forget that before Bulgaria installed its currency board system, there was hyperinflation, which had peaked with a monthly inflation rate of 242% in February 1997.
Public support for Bulgaria's eurozone membership has been seriously dented over the last year and a half following the troubling developments in the monetary union.
While at the end of 2010 the Bulgarian society was cut in two over calls for immediate introduction of the European single currency, recent surveys have found out that those who oppose euro adoption now are a huge majority.
A survey by bTV private television shows that a total of 77% of the respondents want the country to continue operating in the Currency Board regime.
According to analysts the Currency Board regime enjoys great public support in Bulgaria and is one of the few and most trusted institutions.
The people prefer to use the lev instead of switching to the euro, even though the local currency is pegged to the euro since Europe is falling short of providing Bulgarians with confidence that it can handle the crisis stemming from unsupportable debt loads in countries like Greece.
Indicatively the highest levels of support for adopting the single currency were seen as far back as in 2008-2009.
International speculators have targeted Bulgaria's currency board at the beginning of the ruling party term in 2009, the finance minister has revealed for the first time.
"The topic was kept secret in a bid to avoid panic that speculators may force Bulgaria into devaluation, just as it happened in Hungary, for instance," Minister Simeon Djankov said in an interview for Sega daily.
"If we had not made it clear back then that we are ready to take difficult decisions, the same fate would have befallen us too," he commented, taking up a question about the government's tight fiscal policy.
Speculators used for their attack the so-called credit default swap (CDS) with spreads widening to 700bp at the beginning of 2009.
In February the same year the currencies of Poland, Ukraine and Hungary dipped by more than 30%.
"From the end of 2008 till May 2010 international speculators flocked to buy foreign exchange, wanting to make the peg unviable and coerce authorities into eventually breaking the peg between the lev and euro.
"These things are always discussed after they are over to make speculators understand you are strong enough," the minister added.
Bulgaria currently operates in a currency board regime and the lev is pegged to the euro.
The country installed its currency board system (CBS) on the first of July fifteen years ago, ending its hyperinflation, which had peaked with a monthly inflation rate of 242%, in February 1997.
This mechanism ensures that all the local currency in circulation is covered by foreign exchange reserves in the coffers of the Central bank. All, government, and Central Bank alike - cannot print money and must operate within the straitjacket.
The Currency Board regime has proved to be one of the most trusted institutions, according to surveys.
Bulgarians prefer to use the lev instead of switching to the euro, even though the local currency is pegged to the euro, analysts say.
Bulgaria Wraps Up Preparations for Bourse Sale
Bulgaria's sale agency picked at the beginning of December Czech company Patria Corporate Finance to act as consultant as the country is looking for an investor for its only stock exchange.
The company, which is part of the Belgian group KBC, was preferred to Deloitte Bulgaria and Bulbrokers Consulting.
For sale is the government's stakes of just above 50% in the Bulgarian bourse and in the Central Depository, which clears and settles trades and also acts as a register of securities.
Within a month, the selected company prepared marketing, legal and financial analysis of both companies, evaluated them and wrote information memoranda.
Bulgaria hopes to find an investor for its only stock exchange during the first quarter of 2013 after failing to do so by the end of this year as initially planned.
According to BSE Chief Executive Ivan Takev the bourse is worth about EUR 10 M, which means a sale of the stake would be worth around EUR 5 M.
However, the depository is not a listed firm, so its valuation and sale price would have to be calculated by the consultants in charge of selling the assets.
At the end of last year insiders told local media that the government's hopes to sell the majority stake in the bourse by the end of 2011 went sour over lack of bidders.
Shortly after the Bulgarian Stock Exchange launched the sale of its shares in January 2011, Finance Minister Simeon Djankov announced that there is a "huge" interest among investors.
CEE Stock Exchange Group however was the only one to openly declare its interest, but no detailed talks have been held so far.
Bulgaria's only stock exchange became a public company in the middle of December 2010 after the Financial Supervision Commission approved its prospectus and the bourse was listed on its own platform. The capital of the bourse is a total of BGN 6 582 860 at BGN 1 apiece.
Bulgaria's Finance Ministry raised at the beginning of October that year its share to 50% plus one share from 44% in the country's stock exchange. The government bought 715,000 shares at BN 1 apiece. The bourse will sell the remaining 50% held by private investors including brokerages and banks.
The shareholders said the move aims to ease the future privatisation of the exchange and the search for a strategic investor.
Since 2008, the stock exchange has traded on the Deutsche Boerse's Xetra platform under a contract that expired in 2012. Bulgaria has discussed ways to sell its bourse stake over the past decade with Sweden's OMX AG and exchanges in Austria, Greece and Poland to boost interest in local stocks and make trading more transparent.
Bulgaria's Bank System – Under Pressure, but Well-Capitalized
The bank system remained well-capitalized, with a capital adequacy ratio of 16.7% and core Tier I ratio of 15.2% at end-June 2012.
With an increase in the domestic savings rate matched by robust growth in domestic deposits over the past three years, banks have paid down their external debt, largely owed to parent banks, by USD 4.7 B between 2008 and 2011.
Bulgarian lenders however suffered a 47% reduction in parent funding during the first half of 2012, the largest drop among banks in Central and Eastern Europe, according to Fitch Ratings.
Funding withdrawals, although slowing, remained significant in the first half of the year, suggesting that "changes in risk appetite, a weaker medium-term economic outlook and limited attractive lending opportunities were the main drivers," the survey said.
The survey covered 43 foreign-owned banks in seven countries in central and eastern Europe.
Group funding at eastern European banks decreased by 20% to EUR 62 B between the end of 2008 and July 2012 , representing a "moderate" 4% of total liabilities, the survey said.
The drop in funding has been largely replaced with domestic deposits, it said.
Bulgaria is followed by Hungary, whose banks saw a 38% reduction in parent funding.
The other countries surveyed are Croatia, Romania, Poland, the Czech Republic and Slovakia.
"In Fitch's opinion, outflows from Hungary also reflected weak prospects for the local economy as well as unorthodox policies implemented by the Hungarian government in respect of the banking system," the survey said.
The Bulgarian banking system is concentrated, with most of the assets owned by large financial institutions from the eurozone.
Greek banks hold nearly a 30% of the Bulgarian banking market, a 20% share of the bank loans and one-third of all deposits.
Some of the biggest lenders in Bulgaria are managed by Italy's UniCredit, Greece's National Bank of Greece, Hungary's OTP and Austria's Raiffeisen.
Other Greek banks present in Bulgaria include EFG Eurobank, Piraeus, Emporiki and Alpha Bank.
Experts have warned that Bulgaria, the European Union member boasting one of the bloc's smallest budget deficit, risks seeing its banks sucked under by the fiscal sins of neighboring Greece.
Bulgaria's central bank and finance minister however have repeatedly tried to assuage fears over funds outflow from Greek bank subsidiaries in the country to headquarters in Greece, saying this is part of the free movement of capital.
Swiss Loosen Bank Secrecy for Bulgarian Citizens Too
Bulgaria's authorities will have access to Swiss banking data and will hopefully be able to bring to justice tax evaders, who hold money in Swiss banks.
This is envisaged by the Double Taxation Avoidance Agreement, which Bulgaria and Switzerland signed on September 19.
The document provides for the parties to exchange banking and tax information every three months, and also to prepare an annual report.
Faced with mounting international criticism of its banking practices, Switzerland meanwhile reached deals easing bank secrecy with a number of EU members states, including Germany, Austria and Britain.
Two years ago Bulgaria's tax authorities found it difficult to bring to justice those tax evaders, who were revealed to hold about EUR 200 M in Swiss banks after a stolen disk of Swiss banking data was bought by Germany.
The problem was that a big part of the deposits of Bulgarian citizens in Swiss banks have been registered as bank accounts of foreigners.
Legal experts have commented that the amount of money held by Bulgarian tax evaders in banks in Liechtenstein and Switzerland is huge is comparison with those 1500 Germans, who were reveled to be hiding taxes for about EUR 100 M in Switzerland.
Taxes in Bulgaria – Something Old, Something New
Bulgaria's parliament approved in the middle of November the final texts of the amendments to the Value Added Tax Act, including the government's controversial proposal to levy a 10% tax on interest earned from bank deposits.
The new 10% levy on people's income on their bank deposits came into force at the beginning of 2013.
Bulgarians will be obliged to include the income on bank deposits in their tax declarations a year later – in 2014 – after the taxation process is streamlined.
The so-called termless deposits, saving accounts, child savings and current accounts will not be taxed.
The banks will be responsible for declaring the tax while only those who file written declarations with the National Revenue Agency, NRA, will be mandated to file declarations on tax from deposits. Taxation on interest earned from deposits will be done at the time it is paid, even if the account was opened in 2013.
The tax was proposed by Finance Minister, Simeon Djankov and came under fierce criticism by the opposition, who said it will affect mainly people with small savings and the retirees.
Local economists and the central bank also voiced firm opposition to the government's decision to introduce a 10% tax on bank deposit income, saying this would dent people's savings and shake the bank system foundations due to capital outflow.
The government said the new tax aims to raise BGN 120 M and force richer people to pay taxes on the income they earn from bank deposits.
Banks in Bulgaria continued to record steady growth in savings, a trend which has been gaining momentum throughout the year, official data shows.
Meanwhile, Bulgaria's finance minister stepped back on plans for scrapping the 10% flat tax, saying it has to stay at least for the next ten-fifteen years.
"Bulgaria needs the low flat tax for another ten or fifteen years in order to catch up with other member states," Simeon Djankov said in an interview for the German newspaper Die Zeit at the end of November.
He stressed once again that the country is ready to stand up for its competitive advantages in the EU and remain firm in its opposition against common EU tax rates.
As of 1 January 2008, Bulgaria introduced a 10% flat tax applicable for all income levels, i.e., there is no non-taxable income threshold. It replaced the previous system, which combined several different tax rates - between 20 and 24%, depending on income.
The Socialist Party, now in opposition, has recently called for the return of a progressive income tax so that the upper-income households as well as the rich are taxed much more than the poor.
Bulgaria's 10% flat rate makes it the country with the lowest personal tax rate among European Union member states. Bulgaria also has the lowest social security rates, which coupled with a 10% flat rate, makes it very attractive for physical entities, employers and potential investors.
Over the last decade and a half, a number of countries introduced flat-rate taxation and Bulgaria jumped on the bandwagon in 2008.
The policy has a number of attractive features - equality, lower tax burden, the general trend to raise budget revenue as more companies leave the "shadow economy", just to name a few.
What made the debate in Bulgaria different is the fact that the proponents of the measure were the Socialists as it is usually the center-right parties that are aggressively pushing tax reforms.
Part of the reason why the flat tax has been an efficient tool in diminishing the "grey economy" in other countries is the willingness of governments to couple it with draconic measures to crack down on tax evasion.
Bulgaria, on the other hand, has notoriously been sluggish with its fight against corruption and organized crime.
Finance Minister Simeon Djankov decided to turn a blind eye to official data, which shows Bulgaria is the EU's poorest country in terms of GDP per capita and people's salaries - among the lowest across the bloc.
Bulgarians' wallets are in better shape than the people of neighboring Romania and soon even the Greeks will envy them, the finance minister declared in November in an eyebrow-raising statement.
"Bulgaria has already overtaken Romania as far as incomes per capita are concerned and is gradually catching up with the other EU countries. Just in a few years we will be on a par with Greece," Simeon Djankov said.
The minister apparently decided to turn a blind eye to official data, which shows Bulgaria is the EU's poorest country in terms of gross domestic product per capita and people's salaries - among the lowest across the bloc.
"Bulgaria and Poland are the only Eastern European countries, which managed to cope successfully with the crisis. The only reason for Bulgaria to be the poorest in EU is that for over 60 years it was ruled by communists," the minister said.
"We are not the only Bulgarian government, which has made reforms - those before us have made their contribution too," he said.
The finance minister spoke as Bulgaria's parliament approved the first reading of next year's budget, which targets a deficit of 1.3% of economic output and introduces a 10% tax on interest from deposits.
"The budget aims to increase people's incomes next year," Finance Minister Simeon Djankov told the assembly.
"The budget will be implemented with a consistent spending policy and we'll have one of the three lowest in the European Union levels of debt-to-GDP ratio and deficit."
Djankov's words echoed a popular statement Bulgaria's president made in an interview for CNN earlier this year, claiming his country is stable and in better financial shape than neighboring Greece despite high unemployment.
"Young Bulgarians are in a much different, more interesting and positive situation than young Greeks. Young Bulgarians do not have mountains of debt and will be free to decide their own priorities and will be capable of funding them," Rosen Plevneliev said in an interview for CNN in May.
The president conceded that "Bulgaria is not perfect" as unemployment is running high, reaching 11.5%, while the economy is expanding at a rate of 0.51%. Yet he made it clear he firmly believes the country is on the right track.
In his words Bulgaria is not among the countries, which need first to find their feet on solid ground and then seek growth and sustainability.
Bulgaria has so far weathered the global crisis without borrowing foreign aid.
Local analysts have predicted a 1% GDP growth in the country in 2012, echoing the forecast of the International Monetary Fund, which increased its earlier estimate of 0.8%.
Bulgaria's economy expanded by 1.7% in 2011.
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