In a country where GDP is growing at a steady 6%, FDI is growing and external debt is falling, Bulgaria's rapidly increasing current account deficit appears to be a black spot on the government's otherwise impressive mid-year economic results. Analysts are divided as to the severity of the situation and to understand the true nature of the deficit it is necessary to look beyond the bottom line.
Government figures released September 12 show the Bulgarian current account deficit reached almost $4.2bn in the first seven months of this year, 11.4% of the country's projected GDP for the whole of 2007. By the end of the year the International Monetary Fund (IMF) and EU predict a current count deficit of 16.6% of GDP while the industry experts anticipate a figure close to 20%. Last year Bulgaria's growing current deficit caught the attention of economic think tanks and analysts when the figure jumped to 15.8% of GDP from 12% in 2005.
The immediate cause of this increasing deficit is the continuing growth of the trade gap. While exports during the first seven months of 2007 increased by 8.6% on the previous year to reach $10.3bn, imports grew at almost double the rate at 18.8%, with total imports hitting $15.8bn. With an increase in domestic consumption and government plans to cut income tax and raise spending on social welfare, the trend is likely to continue.
A current account deficit of 20% of GDP would be one of the highest in the region. By comparison, according to the European Bank for Reconstruction and Development, the countries of Central and Eastern Europe are likely to see an average current account deficit of 7.6% while the 13 members of the Eurozone posted a current account deficit of 0.1% of GDP in the first quarter of this year. How significant a problem such a high deficit entails is a subject of much contention.
In Bulgaria's case government spending is well in check with Prime Minister Sergei Stanishev joking last month that Minister of Finance Plamen Oresharski kept the almost $1.4bn budget surplus under his bed at home. The country is also attracting record levels of FDI, which covered 87.7% of the deficit last year. In 2006 the country received $5.7bn in foreign capital and that figure is expected to be comfortably beaten this year, with FDI for the first seven months of 2007 up 14.2% on the same period last year.
Dimitir Chobanov, senior economist at the Sofia-based Institute for Market economics told OBG that such high investment was indicative of the strong confidence foreigners have in the Bulgarian economy. "In fact, rising foreign investment and financial account balance lead to higher current account deficit," he said. "The inflows from FDI and work remittances are the main source of higher demand for foreign goods and services leading to a growth in import and current account deficit. As long as there are such inflows there will be such deficit. The link between these variables is strong and direct. The most important fact is not the rising trade deficit itself but the way it is interpreted by the analysts."
One such analyst is Krassimir Tahchiev, head of research at Sofia-based First Financial Brokerage House. He told OBG the government's tight fiscal policy and substantial reserves would allow the economy to absorb any external shocks. He said the government has sufficient reserves to cover six months of imports - a cushion large enough that the country would be able to withstand short-term external shocks.
He also noted that the nature of the goods being imported was beneficial to the economy, with only 17% of imports coming in the form of consumer goods while 27% were in investment goods which could boost exports in the long term.
On the other hand, Tahchiev said little of the FDI coming into Bulgaria is aimed at boosting exports. He told OBG, "Much of FDI is investment in real estate (36.4%) and construction (12.8%) and another 31% in services such as financial intermediation, trade or repair."
An even bigger threat, he said, was the possibility of Bulgaria losing its attractiveness as an investment location as a result of passive government policy and lack of reforms.
Other analysts agree the deficit could become an even more serious issue should FDI dry up. Juan Jose Fernandez-Ansola, senior resident representative of the IMF in Bulgaria, told OBG, "The Bulgarian current account deficit is a continuing concern. More significant than the figure itself is the fact that the deficit is growing. At the moment a significant amount is covered by FDI but the uncovered part is widening. This deficit is being met not by government borrowing but by bank and corporate borrowing. The recent tightening of global credit is what makes this situation so difficult."
It is this reliance on bank loans that could spell trouble for Bulgaria. Credit ratings agencies have recently taken note of the potential dangers posed to countries with high current account deficits in the wake of the recent credit crunch sparked by defaults on sub-prime mortgage payments in the US. A report by Standard & Poor's places Latvia, which has a current account deficit of 30%, Iceland and Bulgaria at the top of the list of countries most vulnerable to a continued tightening of credit. The report cites "receding global liquidity and rising risk aversion among investors," as a reason these countries are considered at higher risk. In early September, the ratings agency Moody's scaled back its investment ratings for Latvia and Estonia.
As does Estonia, Bulgaria operates a currency board that makes the account deficit so risky. Since 1997 the Bulgarian lev has been pegged first to the Deutsche mark and more recently at a rate of 1.96 to the euro. The Bulgarian Central Bank (BCB) is prohibited from loaning to the government and money in circulation must not exceed the value of the BCB's foreign reserves. While the board has stabilised the currency, it also denies the government the opportunity to set fiscal policy to meet domestic considerations. Earlier this month, speculation surrounding the impact of the current account deficit and credit crunch led the BCB to restate that it would not consider de-pegging the lev. "The effect," said Fernandez-Ansola, "is to place a premium on good policy to reduce this vulnerability."
One option open to the government is to reduce lending growth without affecting investor confidence and causing a 'hard landing'. In an attempt to scale back bank lending the BCB recently increased the mandatory reserve requirement from 8% to 12% of deposits. While this may force banks to increase interest rates, many in the banking industry do not believe it will make a major dent in the domestic demand for loans. "In the long term, the only meaningful measures are reforms that improve economy's competitiveness," said Tahchiev.