With Foreign Direct Investment (FDI) down in the first half of the year, a large portion of European funding on hold and sovereign ratings outlook on negative, concerns are growing that Bulgaria's economy faces tougher times ahead. While there are indeed serious challenges, fundamentals remain solid.
FDI in Bulgaria totalled 2.078bn euros ($3.066bn) in the six months of this year, down 18% from 2.537bn euros ($3.74bn) in the same period of 2007, according to data published in August by the Bulgarian National Bank (BNB). This represented a fall from 8.8% of Gross Domestic Product (GDP) to 6.3% in the first half of 2007.
FDI has been one of the major drivers of the Bulgarian economy over the past decade, helping it rebound from the economic crisis of 1996-1997, when 19 banks closed and street protests erupted. The country has drawn in 25bn euros ($37bn) of FDI since 1996, when it attracted only $200m.
A wave of privatisations, a surging real estate market and liberalisation of the banking sector have all contributed to drawing in foreign investment in recent years. As well as reinvigorating the economy, FDI inflows have brought about upgrades in skills and technology in various sectors, including real estate, steel milling, power generation and IT. They also help to finance Bulgaria's widening current account deficit, estimated at 22% of GDP. However, foreign investors' imports of raw materials and capital goods are themselves primary drivers of the deficit in the first place.
Economy and Energy Minister Petar Dimitrov confirmed that FDI had fallen about 500m euros in the first six months of the year. His previous forecast of 7bn euros ($10.33bn) by the end of the year may now be out of reach.
Dimitrov said that investors may have been put off by negative publicity surrounding the European Commission's (EC) three progress reports on Bulgaria issued since the country's EU accession. Each report highlighted problems in tackling corruption and organised crime, and in efficiently allocating EU funding.
If this is the case, the worst may still be to come. On July 23, after the publication of its final report, the EC indefinitely suspended some $750m of funding to Bulgaria, with the right to freeze an even bigger share of the $11bn it is due until 2013, should progress not be made. The action is targeted at specific areas, including road building, which is largely contracted out to foreign companies.
The authorities fear that the consequences could be considerably broader, impacting overall business confidence.
"A flight of foreign investors from Bulgaria would be the worst adverse effect of the EC report," Dimitrov was reported as saying in the local press.
However, the EC's criticism is not the only factor putting a break on FDI inflows.
With very few big-ticket privatisations left (ailing tobacco firm Bulgartabac is being sold off factory by factory), large lump sums of FDI are in shorter supply. The contraction of the UK's housing sector looks likely to have curtailed Britons' investment in Bulgarian real estate. And with the credit crunch biting, lending conditions are tightening, making project finance more restricted.
Given these factors, FDI inflows of $3bn in the first half arguably represent a respectably strong performance, and certainly does not seem to justify the doom and gloom being spread in some corners of the media.
Bulgaria's high current account deficit and large external imbalances are, however, a cause for concern, and the forecast for Bulgaria's burgeoning but unbalanced economy has become a little cloudier in recent months. On August 15 Fitch decided to give the country's debt instruments and long-term local currency debt a negative outlook, representing concerns that a "hard landing" may be in the offing, the organisation said.
"The negative outlooks signal Fitch's concern that Bulgaria's booming economy, now running a current account deficit of around 22% of GDP, is on an unsustainable path," analyst Andrew Colquhoun, director in Fitch's Sovereigns Group, said in a statement.
"The composition of Bulgaria's growth looks increasingly frothy, with construction, real estate, and financial services contributing 3.4 percentage points of the 6.3% growth in the economy's gross value-added in 2007," Fitch warned. With all three sectors taking a hit in Europe over the past six months, Bulgaria will face leaner circumstances than had been expected.
Nonetheless, Fitch firmly reiterated the country's strengths, namely its "rigorously disciplined macroeconomic policies", which have also made the country more attractive to investors in recent years. The government is expected to deliver another fiscal surplus this year, making the country a net general government creditor. Furthermore, Fitch forecasts that such a surplus would cushion the country against the impact of a potential EU funding freeze.
Given the fact that the reformist socialist-led government of Sergei Stanishev has been increasingly buffeted by dissatisfaction among certain interest groups (including teachers and steel workers) and a resurgent but fragmented opposition, it is remarkable that political risk is not considered a major factor in the economic outlook. This reflects the broad consensus in the mainstream parties that Bulgaria's free-market, business-friendly policies should be continued. Ratings agencies and investors remain confident that this consensus will not break down.
However, it is important to note that since Bulgaria's accession to the EU, this consensus is being tested by parties such as Boyko Borissov, who is challenging the current coalition by appealing to populist sentiment.
The BNB's latest estimates put first half growth at 6.2%, an impressive figure, given the slowdown in Bulgaria's European trading and investment partners. But Bulgaria may not be as invulnerable to a downturn as it appears - it may just take a little longer for the symptoms to show.
With both tighter international conditions and challenges of its own, Bulgaria cannot count on high growth and strong FDI flows continuing indefinitely. But with its strong macroeconomic basis -- such as low public debt, stable exchange rate and relatively strong economic growth -- the country is in a good position to continue with the reforms that have helped it fare well with investors over the past few years.