The Bulgarian government was warned last week by the European Commission that it should tighten its fiscal policy to promote economic stability and offset external imbalances.
In a report on Bulgaria's first "convergence programme" since it joined the EU at the beginning of the year, the Commission praised Bulgaria's "sound budgetary position", but cited concerns about fiscal loosening, efficiency of public spending and the pace of reform. It urged the Bulgarian government to "achieve a higher surplus than currently planned in 2007 and to maintain a comfortable budgetary surplus in coming years so as to foster macroeconomic stability and reduce external imbalances".
Bulgaria reduced its corporate tax rate to 10% on January 1, making it the lowest rate in the EU, equal with Cyprus. European Economic and Monetary Affairs Commissioner Joaquín Almunia said that he was "concerned" about fiscal loosening in Bulgaria as well as Romania and Latvia at times of high economic growth. Almunia said that such policies were "not consistent with the objective of running prudent fiscal policies and ensuring suitable convergence".
He concluded: "Stability-oriented fiscal policies are key for sustainable economic development. Bulgaria is, therefore, encouraged to maintain strong budgetary positions."
The report also called on Bulgaria "to further strengthen the efficiency of public spending, in particular through a reform of the healthcare system". Bulgaria has come under criticism in the past for failure to allocate EU funds effectively, leading to warnings that funds may be withdrawn.
The convergence programme covers the period 2006-2009 and forecasts a general government surplus of 0.8%-1.5% of GDP, although target is 2%. The forecasted 0.8% this year represents a sharp drop from 3.2% in 2006. While Bulgaria has a track record of budget surpluses above predictions and the report states that this could be the case again in 2007, it warns that fiscal policy plans risk being pro-cyclical, adding to external imbalances, hence the "invitation" to the government to achieve a higher surplus than forecasted.
Bulgaria has long maintained budget surpluses in order to service its high current account deficit, which is an area of increasing concern. The deficit hit 16% of GDP in 2006, though the government expects it to fall to 13.6% in 2007. Bulgaria operates a currency board, with the lev pegged to the euro, so monetary policy cannot be used to address the imbalance.
The Commission report came days after the Bulgarian government committed itself to a three-year macroeconomic development programme. The programme aims for economic growth of 6% this year, from 6.7% year-on-year to the third quarter of 2006, and 5.5% in 2005. The programme also pledges to cut inflation to 3% in 2008 from 7.2% at the beginning of this year. It also targets a fall in unemployment to 8.6% in 2007 and 8% in 2009 from a current level of around 9.7%.
The government envisages a steady approach to euro membership, with Finance Minister Plamen Oresharski telling local press that it was "not a priority" until 2010. However, Bulgaria will join the Exchange Rate Mechanism (ERM) later this year.
Analysts agree with the government that Bulgaria will experience strong growth in 2007, driven by domestic demand and the benefits of EU accession. A report by UniCredit Group's Bulgarian unit Bulbank predicted that Bulgaria would see another good year. Kristofor Pavlov, chief economist at Bulbank said that Bulgaria now has the opportunity to develop as a lower-cost exporter to other Union members. Another post-accession boost is the €13bn ($17.1bn) in structural funds that the country will receive from the EU.
The report noted that the country attracted an estimated €3.6bn ($4.7bn) of foreign direct investment (FDI) in 2006, an increase from €2.3bn ($3bn) in the previous year. FDI has been a key factor in servicing Bulgaria's current account deficit.