Mind the Gap

Economic News

22 Jul 2010
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Bulgaria's economy received two harsh but not completely unexpected blows Monday after the Central Bank released figures on the country's current account deficit and its foreign investment levels for 2005.



The figures indicated that the country's 2005 current account deficit grew to a new high of 3.16bn euros, while the trade deficit climbed by 50% to 4.08bn euros.



"The rise in imports was fuelled firstly by the higher global prices of oil and secondly by the higher imports of investment goods," the head of the balance of payments and foreign debt department at the Bulgarian Central Bank, Emil Dimitrov, told SeeNews.



"Imports of investment goods rose by more than 30%, which is good as they are used for new production facilities," he added.



The gap increased by 92% from 2004 and now represents a discouraging 14.9% of Bulgaria's GDP.



Historically, one method to offset account and trade gaps has been through strong foreign investment, an area in which Bulgaria recorded record highs in 2004.



Unfortunately, the dramatic escalation of the current account and trade deficits was accompanied by a plunge in foreign direct investment (FDI) in Bulgaria. In 2005, FDI investments in the country totalled 1.88bn euros, down 18% from 2004's high-water mark of 2.28bn.



In 2004, FDI amounted to 138% of the current account deficit, but the decline in 2005 leaves only 59% of the gap covered by FDI.



The biggest contributor to the decline of investments was the lack of privatisation deals in 2005, which accounted for 936.1m euros in FDI the previous year.



The country is expected to attract around 2.3bn euros in FDI in 2006, which is roughly the same amount of investment as last year.



According to the National Statistics Institute in Sofia, 2005 imports increased over the previous year by a robust 26.3% to a total of 14.4bn euros. This outpaced Bulgarian exports, which were up a by a still respectable 18.4% over 2004 to a total of 9.3bn euros in 2005.



The IMF, which plays a strong advisory role in Bulgarian policy, has repeatedly expressed concerns over the effect on economic stability and attractiveness to foreign investors of continuously increasing deficits. To counter this problem, the government has agreed to an IMF recommendation to include a 3% budget surplus in its 2006 budget as a safeguard against rising imports. In 2004, the country finished the year with a surplus of 2.33% of GDP, exceeding the IMF's recommendation of 2.26%.



Bulgaria has set a current account deficit target at 12% of GDP for this year. To reach this goal, experts agree that the government will need to depend on strong revenues and a strict fiscal policy that could possibly nix some hoped-for tax cuts in the coming year.



"With appropriate policies and the reversal of temporary factors that impacted the external position in 2005, we expect some improvement in the external current account deficit in 2006 to below 13% of GDP," the IMF said in a statement following its mission to Bulgaria that ended on January 25.



Complying with the recommendations has put the current government in the awkward position of trying to alleviate IMF concerns while at the same time living up to campaign promises of tax reductions.



Many members of the ruling three-party coalition had promised a reduction of the VAT tax from 20% to 18%. But it now appears that the government will be unable to make good on its promise, as a new VAT bill made public on February 2 outlines a plan to maintain the current taxation rate in the light of the widening current account deficit and surplus requirements.



Georgi Kadiev, a deputy to Minister of Finance Plamen Oresharski, indicated that the VAT tax rate could even be raised another two percentage points should the deficit continue to grow.



Alternatively, if the government succeeds in its efforts to reign in the gap to under the 12% target, the fiscal surplus requirements could be lowered.



Other IMF post-mission recommendations intended to address the deficit include measures to slow lending growth, which is seen as a key factor fuelling the current account gap.



Meanwhile, although rising deficit figures could potentially scare off prospective investors, there is no clear consensus among experts as to the effects the widening gap will have on the economy.



"Alarming deficit figures could dissuade potential investors and send those already doing business here packing," Georgi Ganev from the Centre for Liberal Strategies, a local think tank, told the press recently. "However, the current set of data is unlikely to have such an effect on investors and creditors because Bulgaria's deficits are due primarily to the import of investment and energy goods which are used in industrial manufacture and export-oriented production."



Georgi Angelov, a senior economist for the Institute for Market Economics, also told OBG recently that carrying a trade deficit does not necessarily represent a serious threat to the health of the economy.



Angelov went on to cite the example of Estonia's economy, which has grown by an average of more than 7% over the past five years despite a trade deficit that is equal to 15%-20% of its GDP.

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