Those who welcomed in the New Year by singing the EU anthem and watching the accompanying fireworks display in Sofia’s central square did not need to wrap up as warm as they might have expected as the country experienced one of its mildest winters in recent years. The lack of snow on the country’s slopes played havoc with the ski season, although this picked up later in the year with heavy snowfall in November.
The mild winter and a series of later floods and fires led to a poor harvest and pushed food prices up throughout the course of the year. When combined with the global rise in fuel prices, the resulting high inflation of over 11% year-on-year resulted in serious doubts as to whether the country would be able to fulfil the Maastricht Criteria on inflation levels in order to convert to the euro currency in 2010.
The government’s attempts to curb inflation were hindered by the currency board, which pegs the lev to the euro and denies the government many monetary controls such as setting the interest rate. This was highlighted by the Bulgarian National Bank’s (BNB) attempts to rein in spiralling credit lending in the banking sector. Unable to raise central interest rates due to the currency board the BNB increased minimum reserve requirements from 8% to 12%. However, in a country where 95% of the banks are foreign owned and can source funds from their headquarters, most chose to absorb the additional costs to remain attractive in an increasingly competitive sector.
The currency board was, however, instrumental in enabling the finance ministry to maintain a tight fiscal policy in 2007. It was aided by a simplified tax system, central to which was the new flat rate corporate tax of 10% – the lowest in Europe – introduced on January 1.
The success of the flat tax, which saw state revenues increase by 23% while collection costs fell, has galvanised the government to introduce a personal income tax of 10% in 2008 and allowed the treasury to notch up a record budget surplus of 3.05bn levs ($2.3bn) in the first nine months of the year.
The government was not the only one to feel its pockets filling up. Boosted by EU membership and the new flat tax, 2007 was a strong year for private enterprise. GDP grew at over 6% and the country attracted 5bn euros (almost $7.4bn) in foreign direct investment.
Up to half of this was targeted at the real estate sector where the construction and development of residential, office and retail space continued apace. Fears of a slowdown in British and Irish second homebuyers were tempered by the increasing interest of Romanians, Russians and Northern Europeans.
The large inflow of foreign capital into the real estate sector, combined with a rising trade deficit as Bulgarian companies purchased investment goods from abroad, led to a yawning current account deficit in 2007, that is expected to be about 20% of GDP. This was criticised by the International Monetary Fund but many government and independent analysts have downplayed its significance, saying it is a natural response to the country’s continuing attraction of FDI. The current account deficit is also financed by FDI.
Perhaps a more significant challenge to the country’s long-term sustainable development was highlighted by reports from the World Bank and the Belgium-based Lisbon Council for Economic Competitiveness and Social renewal, a think tank. Human resources remain at a premium in Bulgaria with employers finding it increasingly difficult to attract sufficient numbers of qualified candidates. As a result wages in some professions such as engineering and internet technology programming have risen exponentially in the last three years, albeit from a low base.
With private sector salaries rising rapidly, it was perhaps inevitable that public sector workers looked to gain from the country’s strong economic growth. In October central Sofia was regularly brought to a standstill as the nation’s teachers went on strike, demanding the government surplus be used to raise their salaries 100%. After six weeks of strikes, a settlement was reached, giving teachers a cumulative 45% pay rise.
In the aftermath of the strikes, the Citizens for Bulgaria’s European Development (GERB) party, which strongly supported the teachers’ strike, fared very well in the country’s municipal elections, with the party’s de facto leader, the popular former policeman Boyko Borissov, retaining his role as mayor of Sofia.
The ruling Bulgarian Socialist Party will have reason for concern given the growth of the GERB as the 2009 parliamentary elections approach. However, if it continues to maintain the tight fiscal policy that has reaped rewards in recent years, introduce effective reforms to the nation’s education system and use EU funds wisely to improve the country’s key infrastructure, the potential for future economic growth remains good.
