FT REPORT - BULGARIA 2007

'The country is enjoying another year of strong growth, rising foreign investment and a steady decline in unemployment', says the British Financial Times in its survey material. FT quotes opinion expressed by the Vice President of BIA – Mr. Dikran Tebeyan. The article is part of big annual survey on Bulgaria, placed on 4 pages of the newspaper.

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The country is enjoying another year of strong growth, rising foreign investment and a steady decline in unemployment.

There has been fierce competition among international banks to lend to an emerging middle class seeking mortgages to buy brand-new apartments, and consumer loans to furnish them.

The rush by foreigners to acquire property in Bulgaria, from large tracts of agricultural land to a retirement home in a mountain village, continues unabated.

Transfers from the European Union structural funds are due to start flowing next year, enabling Bulgaria to start on the long process of catching up with richer partners.

But this sunny outlook could soon turn cloudy. The European Bank for Reconstruction and Development warned this month the international credit squeeze would have an impact on eastern Europe, slowing growth as the cost of credit rises.

Erik Berglof, the EBRD's chief economist, said this month that east European economies may face a short-term liquidity crisis, but "the more important effects will come in the longer term as growth will come down from very high levels due to the difficulties and higher risks associated with obtaining credit".

The World Bank said in a report on the east European EU member-states that tightening credit would weaken growth in developed markets, with a knock-on effect for emerging market exports.

The new EU member-states have so far remained "relatively unscathed" by market turbulence, while preparations for future euro membership, along with close monitoring from Brussels, have strengthened their position.

But the report, published last month, adds that the possibility of a deepening financial crisis and of a sustained reduction in external financing would affect countries with a high current account deficit.

Bulgaria is among those seen as vulnerable. Fuelled by rapid credit expansion, the first-half current account deficit reached €2.5bn, equal to 10.6 per cent of gross domestic product. It is projected to end the year at a record 19 per cent of gross domestic product.

Plamen Oresharski, the finance minister, says that before the credit crunch hit, the deficit had not given cause for concern, mainly because a high percentage of imports covered equipment and machinery for fast-growing local companies and foreign investors setting up in Bulgaria.

"It's clear we may face risks if European growth slows, as more than 60 per cent of our trade is with the EU," he says.

Foreign direct investment of around €4bn in the run-up to EU accession fully covered the current account deficit last year. While first-half inflows this year exceeded €2bn, covering 74 per cent of the deficit, it is doubtful whether last year's performance can be repeated, says Dikran Tebeyan, economist at the Bulgarian Industrialists' Association. Yet Bulgaria has an additional cushion of at least €1bn in remittances from migrant workers in western Europe. "This figure could actually be considerably higher as people working abroad bring home large amounts of cash," Mr Tebeyan says.

The central bank intervened this year to slow credit expansion, which had been growing at an annual rate of more than 40 per cent, by raising the mandatory reserve requirement for banks from 8 to 12 per cent. The surge in private sector borrowing has already pushed up Bulgaria's gross external debt to 80 per cent of GDP.

There is comfort for Bulgaria in Mr Berglof's view that the presence of foreign-owned banks will underpin financial stability. The sector is dominated by subsidiaries of banks based elsewhere in the EU that rely on parent groups to provide funds for lending.

After three years of annual growth above 6 per cent of GDP, a cooling-off period could even bring benefits, Mr Oresharski suggests.

"At the moment we have issues with both wage and price inflation, while a damping of demand would have a positive effect on the current account," he says.

The year-on-year inflation rate jumped to 9.3 per cent in August, driven by a recent sharp rise in food prices as a result of drought. The year-end target has been revised upwards to around 8.5 per cent.

Wages in the public sector increased 16 per cent over the past year, while private sector increases are estimated at more than 30 per cent as fastgrowing companies scramble to find skilled workers.

The jobless rate fell this summer to around 6.5 per cent, the lowest since the start of transition. But this figure conceals a worsening shortage of labour in sectors such as construction and services that have been driving growth.

Mr Oresharski says Bulgaria has no choice but to maintain the tight fiscal policies that have resulted in budget surpluses, given that the country's currency board arrangement takes away the option of using monetary policy as a tool.

The surplus this year is set to rise to 2.7 per cent of GDP, boosted by higher tax revenues following the introduction of a 10 per cent corporate rate. Income tax will also fall next year to a flat rate of 10 per cent in a renewed effort to capture more of the grey economy in its net.

Next year's budget is still being prepared but Mr Oresharski says it will assume "another year of sustained growth".

Provided, that is, the new EU member-states can weather further turbulence in global financial markets.