Despite measures restricting banking liquidity introduced earlier this year, the latest data released by the Bulgarian National Bank (BNB) this week suggests that we have not yet seen the end to the country's credit boom. As a result, the most widespread expectation is that new measures will soon be implemented to drain excess banking liquidity - yet the measures being suggested are not without their critics.
The BNB is thought to be considering increasing banks' minimum obligatory reserves and issuing additional treasury bonds. Yet some financial analysts point out that these measures, recommended by the IMF, are largely ineffective. This is thanks to the availability of external credit lines and the ability of most local banks to obtain cheap credits through their foreign parent companies. Moreover, local banks argue that the rate of credit expansion is sustainable with the quality of credit portfolios conforming to high standards and the share of non-performing loans (NPLs) at very low levels.
In its latest report, the IMF does accept that "despite the rapid growth of bank credit, prudential indicators suggest that the banking system remains healthy". Yet it also maintains that the credit boom helps fuel excessive domestic demand, which in turn is sustaining import growth -- and thus having a negative impact on Bulgaria's external trade balance. Most economists agree that the current account deficit, which has reached 8% of GDP this year, is the single biggest macroeconomic concern for Bulgaria.
According to the IMF, containing excess demand in the short term will require a tight fiscal policy and the draining of excess banking liquidity. Under the latest IMF precautionary stand-by agreement, the Bulgarian government has to target a deceleration of credit growth to 33% by the end of the year - an ambitious goal, should the present lending trend continue.
Meanwhile, banking analysts argue this macroeconomic link between credit expansion and the current account deficit is overstated and that there are other more important factors affecting Bulgaria's worsening external balance.
Tim Ash, emerging market economist at Bear Stearns bank in London, told the OBG this week that "actual credit is small relative to the size of the economy. It is therefore not that easy to explain away all or even the majority of the current account deficit as the result of credit expansion."
According to the latest statistics produced by the central bank this week, the total credit volume to non-financial institutions and banking clients has now reached Lv11.8bn ($7.2bn), which is around 30% of projected GDP in 2004.
Petya Tsekova, chief economist at the United Bulgarian Bank (UBB), agrees this ratio is below other countries in transition and is sustainable. "The main factor that influences the current account is the competitiveness of our economy", Tsekova said, adding, "The government needs to do much more to support the Small and Medium-sized Enterprise sector."
The banking sector statistics seem to further support the view that the weight of lending to consumers, which is directly responsible for growing domestic demand for imported goods, is actually relatively low. As much as 77% of all credits are extended to the corporate sector, not consumers.
At the same time, although consumer loans are expanding at a much faster rate, they are starting from a very low base. As Tsekova pointed out, "The banks have only recently turned their attention to consumer and retail banking. Following the banking crisis in 1996, all attention was on improving credit portfolios, which consisted entirely of corporate clients."
Even though the attention has shifted towards attracting individual customers, the average size of consumer loans remains very small, with most of them below Lv5000 ($3000). Tsekova admitted, however, that such loans are primarily used to purchase imported household goods and electronics, which make a limited contribution to the widening trade deficit.
Ash argues that this has been seen in many other emerging economies and there is no need to be overly concerned. According to him, "Bulgarians are fresh to the household credit world, and are eager to boost their living standards by getting their hands on some of those goods which they have been deprived of for so long. But as long as the economy continues to grow robustly, and attracts Foreign Direct Investment, this should not be an enormous problem."
Yet, local analysts do not think that the IMF and the central bank will turn a blind eye to exploding consumer finance. The government is also afraid that not responding at all may send the wrong message to foreign investors and credit agencies. Bulgaria's tight fiscal policies have so far secured three credit upgrades this year. Ironically, this has made obtaining additional liquidity on the foreign markets even cheaper, thus making previous measures constraining banking liquidity much less effective.
While there is a general political consensus in Bulgaria to stick to the tight fiscal and monetary policies proposed by the IMF, Krassimir Tahchiev, senior analyst at First Financial Brokerage House (FFBH) argues that "tightening credit policy any further would do more harm than good". A large proportion of credits are used to upgrade the equipment. As the trade deficit account shows, a significant part of the trade deficit was caused by imported capital goods, which should help to improve Bulgaria's economic competitiveness. According to Tahchiev, however, "The government tends to talk tough on credit, yet tends to pursue a relatively unchanged policy towards credit expansion."
On the other hand, Ash thinks that in reality the IMF is not that concerned. He told the OBG this week that "[The Fund] remembers the large current account deficit run in the Baltic States in the 1990s, which also had currency boards. The policy response is quite natural: keep fiscal policy tight and try and encourage more prudence from the commercial banking sector."
Meanwhile, bankers who claim they have already implemented adequate measures, think that credit will decelerate naturally as the banking system matures and the market for eligible consumers saturates. The natural pace, however, may prove to be too slow to satisfy financial regulators, especially if the current account deficit worsens. It is therefore more than likely that in order to meet its 33% deceleration targets, the government will try to suck out some excess liquidity from the domestic market later on this year, without -- analysts hope -- slowing down the rate of growth in much needed investment in the real sector.