TRANSITION REPORT 2014 Innovation in Transition

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Highlights

  • Although the banking sector was under pressure in mid-2014, macroeconomic stability has been preserved. An important local bank was placed under special supervision, but prompt action by the authorities prevented spillovers to the rest of the banking sector.
  • The crisis in the energy sector has worsened. The public supplier and power generation and distribution companies are facing increasing financial difficulties as a result of electricity price cuts, and investment in the sector has been discouraged by policy reversals. The interim government has set up an energy board in an effort to increase transparency and improve dialogue about the challenges in the energy sector.
  • European Union (EU) funds have been suspended due to concerns about governance. The interim government is struggling to restart EU funding for the Environment and Regional Development Operational Programmes. The suspension of such programmes has caused financial difficulties, especially for municipalities which have initiated contracts on the basis of EU funding being available.

Key priorities for 2015

  • The energy sector crisis needs to be urgently addressed. The recent establishment of an advisory energy board, involving key domestic and international stakeholders, is welcome, but should be accompanied by strengthened regulatory capacity and independence, and a more commercialised approach to energy supply and delivery.
  • Banking sector governance and supervision should be improved. Recent events demonstrated weaknesses in this area that must be addressed in order to preserve and enhance confidence in the system. The central bank announced its intention to join the European Single Supervisory Mechanism, which may require major preparations for admission, but if accepted, would strengthen banking supervision in the country.
  • Further efforts are needed to improve business conditions. The authorities should build on changes made in the past couple of years by further cutting red tape and licensing procedures, and streamlining insolvency procedures. There is also a continued need to reduce the barriers faced by small and medium-sized enterprises.

ALTHOUGH THE BANKING SECTOR WAS UNDER PRESSURE IN MID-2014, MACROECONOMIC STABILITY HAS BEEN PRESERVED

THE CRISIS IN THE ENERGY SECTOR HAS WORSENED

EU FUNDS HAVE BEEN SUSPENDED DUE TO CONCERNS ABOUT GOVERNANCE

2014 sector transition indicators
Corporate Energy Infrastructure FI

Source: EBRD.
Note: FI – Financial institution; ICT – Information and communication technology; Water – Water and wastewater; IAOFS – Insurance and other financial services; PE – Private equity.


Main macroeconomic indicators %

  2010 2011 2012 2013 2014
          proj.
GDP growth 0.4 1.8 0.6 0.9 1.5
Inflation (average) 3.0 3.4 2.4 0.4 -0.5
Government balance/GDP -4.0 -2.0 -0.5 -1.9 -2.7
Current account balance/GDP -1.5 0.1 -0.9 2.1 -0.2
Net FDI/GDP 2.7 3.1 3.3 2.8 2.9
External debt/GDP 102.3 89.3 96.2 95.9 n.a.
Gross reserves/GDP 36.0 32.1 40.0 37.5 n.a.
Credit to private sector/GDP 71.8 69.4 68.9 68.8 n.a.

Macroeconomic performance

The economy remains stable but is still struggling. Following a brief upturn in economic activity in 2011, growth has weakened again as GDP rose by just 0.6 per cent and 0.9 per cent in 2012 and 2013, respectively. Exports to the EU have contributed positively, but domestic consumption had a dampening effect on GDP growth in 2013. In the first half of 2014, growth picked up slightly to 1.4 per cent year-on-year (seasonally adjusted), on the back of an upturn in domestic demand. Tourism revenues may have been affected by poor weather conditions during the summer months. The combination of subdued domestic demand and a series of electricity tariff cuts (by a cumulative 13.6 per cent after the January 2014 price cut) have led to a negative inflation rate, although the average inflation rate in 2013 was marginally positive at 0.4 per cent. Annual inflation has been on a downward trend since October 2012, falling into negative territory (-0.7 per cent year-on-year) in August 2013 and remaining negative ever since.

Macroeconomic stability has been preserved. However, fiscal pressures may arise due to a potential bank bailout and the need to increase infrastructure and social spending (especially in light of recent flooding). Bulgaria’s level of public debt is still the second lowest in the EU (after Estonia) relative to GDP. However, under the 2013 revised budget, which was first passed by parliament in July 2013 and then again in August 2013, the deficit was increased to 2 per cent of GDP, the maximum allowed under the law (the actual outcome was 1.8 per cent of GDP on a cash basis). A deficit of 1.8 per cent was budgeted again in 2014, but low revenue collection, costs associated with the resolution of Corporate Commercial Bank (see below) and spending for emergency measures as a result of the recent floods may push the budget deficit for this year to around or above 3 per cent of GDP.

Weak growth is expected in the short term. A modest pick-up in growth is expected this year, but a number of factors make the economy vulnerable to external shocks, including uncertainties surrounding the crisis in Ukraine. Bulgaria’s medium-term growth potential remains good. GDP per capita (adjusted for purchasing power standards) is estimated by Eurostat to be less than half the EU average, so the scope for convergence is still quite high, provided that structural reforms are pursued.


Major structural reform developments

Bulgaria has made progress under the EU’s Cooperation and Verification Mechanism (CVM), but further steps are needed. The latest report from the European Commission (EC) on Bulgaria’s progress under the CVM, published in January 2014, noted that the country had taken a few steps forward since the previous report, but that overall progress was fragile and insufficient. The EC made a number of recommendations for further action in the areas of judicial reform, and the fight against corruption and organised crime.

Business environment conditions remain problematic in certain areas. According to the latest World Bank Doing Business 2015 report, Bulgaria ranked 38th (out of 189 countries), scoring poorly in getting electricity and dealing with construction permits. In its June 2014 report, the European Commission recommended cutting red tape, promoting e-government and streamlining insolvency procedures.

Restrictions on the purchase of agricultural land by foreigners have been introduced. In April 2014 parliament adopted a number of restrictions on the purchase of agricultural land by foreign entities. A key requirement is that the purchaser, whether foreign or Bulgarian, must have lived in Bulgaria for at least five years prior to the acquisition. In January 2014 the constitutional court annulled a measure introduced in October 2013 that would have extended the moratorium on the purchase of agricultural land in the country by foreigners until 2020.

An energy board has been set up. In August 2014 the Bulgarian interim government created an energy board that will serve as an advisory body to the government. The board will consist of all stakeholders in the sector, including the chairman of the energy regulator, and is expected to invite experts from the European Commission, the World Bank and the EBRD. The overall goal of the board is to discuss imbalances in the energy sector and seek solutions to stabilise the sector. However, it is unclear whether the board has legal authority and moreover, whether the next government (after the October 2014 elections) will maintain the board’s role. Major problems still need to be resolved in the sector, including: weak social safety nets; the under-pricing of energy; high energy intensity; and lack of liquidity (that is, payment arrears) in the system.

Support for renewable energy has diminished further. In December 2013 parliament approved a 20 per cent fee on solar and wind power, however the Constitutional Court declared this fee unlawful in 2014. Parliament also voted to limit the amount of energy that can be purchased at preferential prices, which the producers of green energy estimate will reduce their income by an additional 15 to 20 per cent. These measures are part of a series of regulatory interventions that the authorities have implemented to discourage investments in renewables. Meanwhile, in a report issued in June 2014, the European Commission noted that the absence of electricity and gas exchanges and a lack of transparency in the wholesale market remain key obstacles to improving the functioning of Bulgaria’s energy markets. In addition, the country’s dependence on imports from a limited number of suppliers and the lack of infrastructure pose supply shock risks.

A major bank has been placed under conservatorship. In June 2014 the Bulgarian National Bank (BNB) placed Corporate Commercial Bank – Bulgaria’s fourth largest bank (in asset terms) – under a special supervision regime due to depleted liquidity, which had forced the bank to stop making payments and to suspend banking transactions. Another major local bank, First Investment Bank, also had a temporary run on deposits, but an emergency injection of state aid into the banking sector (with approval from the European Commission) helped to restore confidence. As a result, the authorities have expressed their intention to opt in to the European Single Supervisory Mechanism, as part of their policy response. Acceptance is not automatic and may require major preparations, but if implemented it would effectively hand over much of the country’s banking supervision to the European Central Bank. As of March 2014 the banking system had a high capital adequacy rate of 20.4 per cent, but non-performing loans remain above 16 per cent.

Pension reforms have stalled. In November 2013 parliament passed a bill freezing the retirement age to 60 years and 8 months for women, and to 63 years and 8 months for men. This effectively stopped the pension system reforms adopted in 2012, under which the retirement age was to be raised gradually by four months each year until it reached 63 years for women and 65 years for men. The new policy also eliminates the specified retirement age for military personnel, enabling them to retire after 27 years of service. These moves go against the advice of international institutions such as the European Commission and the World Bank, which had argued for raising the retirement age for men and women to 65 in order to help improve the sustainability of the pension system.