The Road Ahead

Economic News

22 Jul 2010
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The draft 2007 budget appears to have confirmed Bulgaria’s strong but steady economic growth and mapped out significant spending increases, many of which are linked to EU projects.

Plans to cut corporate tax to Europe’s lowest rate have also been implemented, with the support of Bulgaria’s business community. This has met with opposition from Bulgaria’s macroeconomic mentor, the International Monetary Fund (IMF), which warns that fiscal relaxation will deny the government much-needed funds and risks increasing Bulgaria’s large external current account deficit.

The draft budget for 2007 approved at the end of last month should give the country “a European start”, according to Prime Minister Sergei Stanishev. The draft plans spending of $13.2bn, an increase of $1.24bn on last year, and equal to 40.9% of GDP. Bulgaria will also contribute $416m to the EU budget next year. There is also a proposition to put $703m towards improving the country’s capacity to absorb EU funds, an area in which Bulgaria has faced stern criticism in recent months. This will be split between co-financed projects and projects for which the EU will reimburse the government after their completion.

Also agreed was a 10% corporate tax – equal to the lowest in Europe – reduced from 15%. Less successful were attempts by coalition partners to cut the social security burden and give small companies tax rebates for reinvestment.

The minimum wage has risen to Lv180 ($118) a month, and pensions have also been increased, after negotiations with unions and between the three coalition partners. In some sectors of the economy, 10% wage increases are slated.

Finance Minister Plamen Oresharski reported that the government was aiming for a 0.8% budget surplus. Due to Bulgaria’s currency board, which ties the lev to the euro, and due to economic growth, recent years have seen budget surpluses significantly larger than the target. Some estimates predict a surplus of as much as 3.3%.

Oresharski said that the budget faced more serious challenges than in previous years. He pointed out that Bulgaria would lose around $335m from its budget in duties and value added tax (VAT) due to EU accession.

Year-on-year inflation stood at 5.7% in October. It is expected that inflation will be lower by year-end, with the IMF predicting 4.8% (though other analysts say as much as 6%). It is worth noting that the biggest driver of inflation has been food products, after flooding and seasonal demand patterns. Food prices, heavily weighted in the inflation “goods basket” increased 3.2% last month, compared to 0.2% for non-food products.

The cut in corporate taxes has been attracting a lot of attention both within the country and outside it. Petar Dimitrov, chair of parliament’s committee on budget and finance told local press that the 10% corporate tax rate – equalled in the EU only by Cyprus – would turn the country into “a leader in Europe” and a “magnet for investors”. Dimitrov praised the government’s good economic results and for making the cut possible. He said that the new rate would help bring the black and grey economy into the light.

The budget announcements coincided with the visit of a mission from the IMF. It reported that “economic performance in 2006 has been strong” and that real GDP growth is expected to increase to 6%. The mission’s report praised the government for maintaining “an appropriately tight fiscal policy stance”, but warned about the growing external current account deficit.

The deficit is due to strong domestic demand, and the currency board prevents the government from using monetary policy to combat it. The mission warned that a relaxation of fiscal policy or resurgent growth in bank credit could exacerbate the problem, and called for a minimum budget surplus of 2% to balance it. The report warned “we see substantial risks from a sizeable and untimely pro-cyclical fiscal impulse in 2007” and criticised “slippage” in the implementation of structural reforms.

Robert Hagemann, head of the IMF mission to Bulgaria, made it clear throughout his visit that the organisation disagrees with the government’s decision to cut corporate tax, calling the decrease “groundless”, the local press reported. Hageman feels that with increased spending demands after EU accession, and with the need for a budget surplus, the cut comes at the wrong time for the country. Hagemann’s stance has almost universally drawn heavy criticism from Bulgarian politicians and business leaders. Minister for Economy and Energy Rumen Ovcharov said, “I think this philosophy is wrong because it doesn’t envisage any growth of Bulgaria’s economy and any foreign investments in order to avoid a rise in the current account deficit”, while Bozhidar Danev, the chair of the Bulgarian Industrial Association, said that the IMF underestimated the benefits of low taxation in reducing black market activity in the economy.

Stanishev has reassured business leaders that controlled public spending, with moderate wage increases and no budget deficits, will ensure stable prices over the next year. He said that there were no grounds for fears that a glut of EU funds would lead to inflation.

Stanishev announced that the country had received foreign investments worth 700m euros ($895m) in the first seven months of this year. He also announced a wide-ranging review of license regimes to ease the regulatory burden on entrepreneurs.

Stanishev made it clear that his priority was stability, and avoiding the public discontent that swept Hungary this autumn after the prime minister admitted lying to the electorate about the extent of the economic reform needed.

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