Sticking to Fixed Exchange

Economic News

22 Jul 2010
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Bulgaria is expected to experience leaner economic times over the coming year, but reports of an impending crisis appear to be somewhat unfounded.

On November 3, the European Commission (EC) issued a warning that Bulgaria is set to face slowing growth, consumption and investment over the coming year, while the current account deficit and inflation will remain high.

The commission expects Gross Domestic Product (GDP) growth to be trimmed from 6.5% this year to 4.5% next, as a slowing European economy acts as a drag on Bulgaria. Meanwhile, it forecasts inflation of 12.4% by year end, the second highest in the EU, while the current account deficit is expected to hit 23.9% of GDP - the bloc's largest.

Europe has been hit by a serious economic slowdown, exacerbated by the global credit crunch. The wide EU economy is expected to grow at only 1.2% this year, according to the EC, while the international press has reported that the eurozone (which does not include Bulgaria) will grow at a meagre 0.1%. As European countries - particularly in the eurozone - are Bulgaria's key trading and investment partners, it seems inevitable that the Balkan country's burgeoning growth will be curtailed.

The EC expects inflation to fall over the coming years, to 7.9% in 2009 and 6.8% the following year, easing one of the key pressures on the economy, though not as much as policy makers would like.

The EC also predicts that the current account deficit will remain stubbornly above 20% of GDP in 2009 and 2010. This might seem surprising, given that a slowdown in growth would seem likely to scale back imported consumption, and that lower levels of investment should lead to lower imports of capital goods. On the other hand, Bulgaria's export markets are in trouble, and the prices of the products it sells overseas, such as steel and agricultural produce, are falling. International bodies such as the International Monetary Fund (IMF) have long warned that the external imbalance is unsustainable, and serious concerns are now spreading. The deficit has been financed by inflows of capital from abroad - inflows that seem likely to fall considerably due to the credit crunch and lower growth in the eurozone and Bulgaria.

Bulgaria has limited scope to tackle the current account and inflation issues through monetary policy, as it is in a currency board arrangement that fixes its exchange rate against the euro. This obliges the Bulgarian central bank to track the European Central Bank's (ECB) interest rate movements, and rules out devaluation of the Bulgarian lev to cheapen the country's exports. At present, the ECB is loosening monetary policy at a time when higher interest rates in Bulgaria could help lower consumer demand, and therefore inflation and import levels.

The government and central bank have reapeatedly ruled out the possibility of abandoning the currency board, which has helped underpin Bulgaria's economic stability for the past decade. Indeed, adjusting the fixed regime at a time when currencies are fluctuating wildly could prove to be a disastrous move.

Furthermore, with growth expected to fall, and inflationary pressures easing, it may be that the ECB's rate cuts will help buoy the Bulgarian economy. There is an increasing perception that a sharp drop in growth is rapidly overtaking inflation as the country's primary economic concern. Some reports in the international press have cited the possibility of growth levels falling to well below the EC's forecasts - 3% or even lower.

Indeed, on October 28, Kristalina Georgieva, vice president and director of strategy and operations at the World Bank, urged the Bulgarian authorities to prepare an emergency stimulus package to be activated if the economic shocks turn out to be greater than expected.

"For instance, what are we going to do to stimulate domestic demand if unemployment increases?," she asked a conference in Sofia.

Three days later, the IMF and the Bulgarian government scotched reports that they were in the midst of negotiations for a Fund bail out scheme. Such "rescue packages" have already been extended to Hungary and Ukraine, and fears are growing that more countries in Eastern Europe may follow them.

As the government has pointed out, however, Bulgaria is in a relatively strong position in that it has a large fiscal surplus. Thanks to an IMF-designed plan aimed at securing stability and reassuring investors, the country has been running a remarkably tight budgetary policy for several years. Fiscal reserves are expected to reach $8.3bn by the end of the year, theoretically providing ample scope for government stimulus measures. Hungary, on the other hand, has been scrambling to tackle a widening budget deficit.

As Georgieva has warned, any fiscal boost would have to be well designed, particularly given continuing worries about corruption and misallocation of official funds. And the government would be wise to ensure that new spending rounds do not exacerbate external imbalances or the long-term budgetary position. Furthermore, a reinvigorated drive for structural reform to tackle the economic weaknesses exposed by the current situation should prove beneficial in bolstering stability and future growth.

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