By Nick Skrekas

The Wall Street Journal

The Bulgarian economy looks to be stabilizing after weathering the recent financial crisis better than most of its neighbors. The country is on a bumpy road to adopting the euro currency and is expected to become an important energy hub as its political system matures.

The economy contracted 3.6% on an annual basis in the first quarter of 2010 from 5.9% in the previous quarter. However, the government hopes for 1% economic growth this year as recovering exports bolster the expansion. This would be a more rapid recovery than seen in the rest of the European Union.

It is evident around Sofia, the capital, as modern steel and glass structures sprout like mushrooms between the ugly concrete Soviet-era blocks. Classical old buildings are being restored rapidly to their former glory and most are being rented by businesses.

However, the EU finance ministers have decided to set Bulgaria under the excessive deficit procedure, a program to reduce its budget deficit below the 3% threshold of gross domestic product required by the Stability and Growth Pact.

The center-right government dropped its plans for applying for Exchange Rate Mechanism II, the waiting room to the euro zone, after raising the alarm that the 2009 budget gap was 3.7% of GDP because of a number of unreported deals rather than the 1.9% expected due to unaccounted procurement deals.

Previous double-digit inflation and a growing current account deficit have also prevented Bulgaria from joining the ERM II since the nation joined the European Union in 2007. But Bulgaria is one of the few countries expected to slash budget deficits, to 2.7% in 2011, without having to resort to wage and pension cuts; nor is it raising taxes. The Finance Ministry, for 2011-2013, forecasts a budget deficit below 3% while the 2011 budget is underpinned by expectations of 3% growth and a deficit of 2.7% of GDP.

Bulgarian consumer price inflation eased to 1.4% in June on an annual basis from 1.9% a month earlier, so the country doesn't face the risk of stagflation.

Also, the government says that at the end of this year the unemployment rate will be below the 11.4% forecast.

In addition, the skill base of Bulgarian labor has risen dramatically now that workers have access to higher-quality international education. "I study business management in England and will be doing an internship soon at a U.S. company but my goal is to come back to Sofia and contribute to developing the economy here," said 20-year-old student Antoniy Todorov.

Bulgaria recorded its first surplus in dealings with the EU, so it is receiving more cash than contributing to joint budget of the Union. This indicates that absorption of EU funds is improving and the country hopes to improve infrastructure and living standards with EU funds.

There is a rising middle class of young professionals with European aspirations for living standards who are not afraid to spend on luxury goods, quality imported cars and modern real estate.

"My wife and I are making a good living; we recently bought a house close to the sea and plan on having a second child. We don't want to live like our parents did behind the Iron Curtain and we like traveling a lot," said Marian Petkov, a 37-year-old engineer.

But problems still exist for the working poor and pensioners, whose living standards are still squeezed because prosperity has not trickled down to everyone. However, things are better than in previous decades.

Bulgaria experienced a severe financial crisis in 1996. Several banks collapsed, there was hyper-inflation and economic output shrank. In conjunction with the International Monetary Fund, a currency board was implemented to stabilize the economy. It has served Bulgaria well because it has limited political discretion over economic policy and it has amassed ample fiscal reserves to back the fixed exchange rate of 1.95 lev to one euro.

While some of its neighbors are completely dependent on EU and IMF loans, such as Greece with its large bailout, Bulgaria has declined to take a loan from the IMF.

"The country does not need to take a loan for now. We have assessed the options for this year and for next year and we have decided that for now a loan is unnecessary," Finance Minister Simeon Djankov said recently.

However, the country is struggling with organized crime, corruption and excessive bureaucracy, which are still challenges for the one-year-old center-right GERB government under Prime Minister Boyko Borisov.

Meanwhile, as the Bulgarian political system matures, the country is becoming an important international energy hub. "Both the South Stream and the Nabucco gas pipelines have their place in Bulgaria. They don't clash, and the cabinet supports both," Prime Minister Borisov said.

The Nabucco pipeline is intended to link the Eastern border of Turkey to Baumgarten in Austria, bypassing Russia as it transports natural gas between the Caspian region and Europe. The South Stream project is a joint venture between Russia and Bulgaria.

But matters are not as smooth regarding the Burgas-Alexandroupolis oil pipeline due to the limited financial benefits of about US million a year and the potential environmental costs. Greece Prime Minister George Papandreou is planning a diplomatic visit to Sofia to restart the stalled oil pipeline project, in which his country is a partner with Bulgaria and Russia.

While Bulgaria appears less in a rush to join the much troubled euro zone, voters have made clear they will not allow a return of any kind to a centrally planned Communist economy.

Fiscal discipline has been reinforced by Bulgaria's membership in the EU, and the IMF currency board regime served its purpose to inject confidence in the economy. Despite the skepticism over Russian energy projects given past domination by the former Soviet Union, Bulgaria's place as an energy crossroad between east and west is self-evident.

"No one can turn the clock back because the free market has unleashed energy, innovation and growing prosperity. Even if the political system is still in a state of flux, voters will not accept interference from foreign powers through Trojan horse energy projects because we embrace membership of the EU and NATO," said 70-year-old newspaper publisher Ivan Zahariev.